Vilas Capital on Tesla Inc TSLA short below
Before we delve into our investment thesis on Tesla, Inc., a little background may be helpful. We are value investors. You know, the backward looking, head in the sand, numbers focused relics that have no business discussing the future. We simply “don’t get it (the vision)”. We miss every Google, Apple, Cisco Systems, etc. It is a wonder we have any clients.
My personal background is that I have a degree in Mechanical Engineering, Tau Beta Pi, from the UW – Madison, an MBA in Finance and Economics, quaint and old fashioned as those are, from the University of Chicago, and a CFA. I have been in the investment business since 1993, running both equity and fixed income strategies. The two mutual funds I managed grew from $5 million and $13 million, respectively, in 1993 to multi-billion dollar funds each due to performance that attracted significant attention. I started a mortgage insurance company in 2009 that is now public (NMI Holdings, Inc), formed an investment partnership called The Vilas Fund, LP in 2010, and started a mortgage banking company in 2012 that is profitable and growing nicely. I understand and enjoy business, especially growing them. More on my background at the end, if interested. Enough about me.
Tesla Inc TSLABy Maurizio Pesce from Milan, Italia (Tesla Factory, Fremont (CA, USA)) [CC BY 2.0], via Wikimedia Commons
Tesla, Inc. is an over-hyped, lousy company, from a financial perspective, that is destined to go bankrupt. There, I said it. Bring on the critics. Contrary to the likely barbs and pitchforks we will receive, I do wish that global warming was not occurring and that the polar bears and penguins could live undisturbed in their former environments.
Tesla is a new(er) entrant into the automobile, solar and battery storage businesses. Since Tesla’s current revenue is roughly 99% automobile related and, due to the Model 3 introduction and projected sales, this ratio will likely remain similar for quite some time. Thus, Tesla is an auto manufacturer, plain and simple. Panasonic supplies Tesla (and any other company willing to submit a purchase order) with batteries. Other companies provide Tesla with electric motors, tires, wheels, etc. Thus, with a few extraneous business lines, Tesla designs and assembles cars. For comparison, Honda makes jet airplanes, ATV’s and boat motors. Still, Honda is considered an auto company as the majority of its revenue is derived in that business. Until Tesla’s battery storage business and solar equipment business become majority contributors, it will remain viewed as an auto company.
Unfortunately for Tesla, none of those businesses are currently profitable, nor do we see any possibility of them becoming materially profitable over any visible time horizon. Tesla has had a ton going for it: extremely cheap equity and debt capital, government loans, huge government subsidies (federal and state), a manufacturing plant that was purchased for nearly nothing (NUMMI, $42 million in relation to a multi-billion dollar replacement cost), a marketing oriented CEO who has an eye for beautiful cars (with the possible exception of the Model X), and a great idea to put a really big battery in a high end electric car so that it can go over 200 miles before needing to be recharged. However, with all of these positives, the company has not made an annual profit despite catching the auto giants asleep at the wheel. Now, to help raise capital, they have shown large demand for electric cars (373,000 Model 3 reservations at last disclosure) and, therefore, have placed a large bullseye on their back. The executives inside of the top 10 auto manufacturers now all need an electric car strategy. Surely, their Boards of Directors are demanding it. What was once a market niche that Tesla could dominate will become far more competitive with time. There is, and can be, no doubt or argument about this.
Due to their desire to be vertically integrated, Tesla has stated that it, and Panasonic, who owns and controls the battery IP, must construct a large factory to manufacture enough batteries to supply their cars. In fact, Elon Musk said that this factory would roughly double the amount of production of lithium ion batteries worldwide and that for each 500,000 cars manufactured, another battery factory must be built. Now, due to my quaint economics training, I was under the impression that when the demand for a product or commodity rises, the price of those items in demand must rise to incentivize more production. If it requires the tripling of lithium ion battery production to simply make 1 million electric cars per year, out of a ~90 million worldwide car market, will that not affect the price of the raw materials that go into battery production? And since raw materials make up roughly 85% of a batteries cost of goods sold (per Bob Lutz in an interview on CNBC), would that not overwhelm the potential economies of scale of building a really big battery plant? When the US mandated Ethanol and used roughly 30% of corn production to make it, the price of corn rose roughly three or four fold for a significant period of time. We are talking about increasing the production of lithium ion batteries by 200% to get to 1 million cars per year (roughly 1% worldwide market share). Will this not cause the cost of those batteries to rise, not fall as the market is expecting? Will this battery cost inflation not hurt the economics for electric vehicles? Of course it will.
Valuation and Returns
The stock market is assuming that Tesla will become a very large manufacturer of cars, battery backup systems, and solar equipment. Further, the market seems to be thinking that Tesla, to quote Will Ferrell from the “trust tree” scene of the movie Old School, will come up with “something really cool that I don’t even know about”. They better.
Tesla has a significantly larger enterprise value today than Ford Motor Company. I will use Ford as it is the only domestic auto company to avoid bankruptcy and is, therefore, selling at a premium to the rest of the industry. Tesla has roughly 176 million shares outstanding, up from the 163 million they report, as GAAP requires that all options are assumed to not be exercised when the company is losing money. If it earned a profit, Tesla would show 176 million shares fully diluted. Tesla has nearly $7 billion in debt post the recent convertible bond issue. Thus, at $302 per share, Tesla has an enterprise value of roughly $60 billion. Ford has 3.9 billion shares outstanding with roughly $15 billion in excess cash, held for a rainy day. Thus, at its current price of $11.34, Ford has an enterprise value of roughly $29.2 billion. Simplistically, enterprise value is the amount of money it would take to buy a company and leave it with no net debt or cash on its balance sheet. On an enterprise value to revenue basis, Ford is selling at a ratio of roughly 0.2 given the revenue