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Tesla, overvalued or undervalued?

On June 10th, Tesla’s market cap reached ~$190bn, making it the most highly valued automotive company in the world, ahead of Toyota. At that point, Tesla also become worth more than Ford, GM and Fiat Chrysler put together.

This is eye catching, given that Tesla only sold 367,500 cars in 2019, while Toyota sold more than 10m.

And the valuations of the companies speak their own language. While Toyota was trading at 8.4x last 12 months earnings back in January, Tesla was already at that time trading at 50.2x earnings, suggesting an extremely high confidence in Elon Musk’s ability to grow the company (and its earnings) in the years ahead. This earnings multiple has only gone up with the most recent increase in the share price.

What’s going on (and what is the bull case)?

Why are people so excited? And how does this relate to venture capital? From a venture perspective, it is very interesting because Tesla works across multiple areas of tech innovation, such as AI (autonomous driving) and energy efficiency, including energy storage (battery technology). If we think about a future of ubiquitous autonomous vehicles, and a much bigger reliance on renewable energy, both of these technology areas will be important. So, while there are many reasons why people are excited about Tesla, there seems to be two key ones:

  1. Prospect of market dominance: Tesla currently produces electric cars with the longest range, and in the views of many, quite possibly also the best. If you can keep making the best cars, this could translate into a dominant market position as the world transitions from petrol to electric over the next decade (15 years from now it will be illegal to sell new petrol, diesel or hybrid cars in the UK, so the days of the internal combustion engine as the dominant engine for mainstream transport are literally numbered). So, Tesla might then become the dominant car company – if not by volume then by profit? That would certainly justify a high valuation.
  2. Proprietary Technology: Tesla is delivering lots of technology innovation to create competitive advantages, and this could translate into long-term advantages in battery and autonomous vehicle technology. Both of these areas could give Tesla large sources of revenue and profit outside their own car production. So, there is an argument that betting on Tesla is a bet on more than just their ability to make good electrical vehicles.

It all sounds plausible, but does it stack up?

The bear case

Are there arguments why Tesla might still – ultimately – be priced too highly? Tesla CEO Elon Musk certainly seems to think so. On May 1st Elon tweeted that he thought Tesla was overvalued. At the time, the valuation was around $130bn – much lower than today. So, what’s going on?

Tesla still loses money on every single car they make. Yes – they did manage to eke out a $16m profit for the first quarter of 2020, but of this, a whopping $354m came from regulatory credits. So, what’s that about?

Regulatory credits are basically money paid directly or indirectly from other automakers, who still record too high emissions on the vehicles they produce. Without these credits, Tesla would have been $338m in the red. If you compare that to the 103,000 cars produced in Q1, that’s a loss of almost $3,300 per car!

One could argue that this is the cost of developing a market leading position, but the question is whether Tesla can maintain that lead as other automakers start ramping up electric vehicle production. In years gone by, mainstream automakers haven’t gone all in on electric cars (and if you know that Tesla sells every car for less than it costs to make, you can more or less see why), but the major automakers are making a big push now, with Volkswagen targeting one million EVs produced by 2023. If anything, there is a risk that this is going to push the retail price of EVs down and reduce the amount of regulatory credits Tesla can get from other automakers, making it even harder for them to reach sustainable profitability.

But what about the technology? Leadership in battery technology and manufacturing capacity, and also in autonomous driving? Not all industry observers are certain that Tesla has a sustainable technological lead. On June 22nd, Berstein tech analyst Toni Sacconaghi highlighted in a report that although Tesla currently has an advantage, it is uncertain that they can maintain this gap to competitors, as most of their current lead in vehicle distances comes not from proprietary technology, but from really good EV engineering. It is a safe bet that companies like VW and Toyota will be able to copy a lot of Tesla’s engineering innovation, and likely introduce a few new things of their own.

So, what about leadership in autonomous driving? Tesla certainly get a lot of data from their current fleet of cars. But in Waymo (re: Google) they have a formidable competitor , and as other automakers start fitting their cars with sensors to capture data, Tesla’s lead in data access could also be eroded.

And finally, Elon Musk is starting to see some real headwind over his reasonably generous pay deal. Whether one agrees with it or not, you can’t help but worry that these types of things distract from the still significnant work Tesla has to do to make good on all the expectations baked into the share price.

As we can see, there are weighty arguments on both sides as to whether Tesla is currently overpriced or underpriced. So, should you buy or sell Tesla stock? Whatever your view, remember John Maynard Keynes’ important insight around contrarian investing: “The market can stay irrational longer than you can stay solvent”.

On the other hand, if you are looking for long-term investments as an antidote to the daily volatility of the public markets, there is always investment in early stage, capital light tech companies tackling sizable global markets. That’s what we specialise in at SuperSeed.

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This article is published by SuperSeed Ventures LLP which is authorised and regulated by the Financial Conduct Authority. The article does not constitute substantive research or analysis, and should not be construed as an investment recommendation in relation to Tesla Inc. or any other publicly traded company. Please note, investments in unlisted early stage companies are illiquid and expose investors to a significant risk of losing all money invested. Please always seek independent financial advice before making investment decisions.