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You can spot the Tesla short-sellers by the egg all over their faces. But how can a loss-making, low-volume automotive player have the second largest market capitalisation (at over $100 billion) of any in the world? Is this a bubble? Victor Hill is asking.
Wild trading?
Elon Musk must occasionally allow himself to feel slightly smug (though only after four-twenty in the afternoon) these days. Tesla’s share price (NASDAQ:TSL) has been on an upward-trending rollercoaster ride this year, hitting $968.99 on 03 February – up from just under $500 on 08 January, or a gain of over 80 percent. Since then the price has eased but is still around $800 as I write. Whichever way you look at it, it is as if one of SpaceX’s Falcon V rockets has been attached to the company’s stock market performance – and this was one of the most popular shorts within the hedge fund universe just one year ago.
What is going on? There are both short-term factors in play here as well as long-term ones. Tesla is a concept stock – that means that people who believe in Mr Musk’s vision of an all-electric automotive future tend to like the stock, regardless of the short-term financials. (Tesla has had massively negative cash flow.) But then Apple (NASDAQ:AAPL) is a concept stock for a similar reason – buying the stock involves buying into the vision of seamless communications by cool people. (Albeit that Apple is sitting on a cash pile the value of which is more than the annual GDP of New Zealand.)
But what started out as a brave vision now looks eminently realisable. Cars are going to be all-electric, whether we like it or not, sooner than many people thought. In the first week of February Mr Johnson announced that the UK would ban the sale of internal combustion engine (ICE) powered vehicles in 2035 – five years earlier than previously planned. Now that ban might be accelerated further to 2032. The ban will include the sale of hybrids – something the mainstream automotive industry, hit by all kinds of adversity, did not like at all.
Moreover, the news-flow has been encouraging. Tesla’s financials are improving and production capacity is expanding. The company had a rocky start to 2019, burning through $1.1 billion of cash in the first half of last year as it struggled with the production and delivery of its more affordable Model 3 (which retails for around £38,000 in the UK).
Yet the firm turned a corner in the second half of 2019. In Q3 2019 Tesla booked a profit of $143 million. In Q4 it generated $1 billion in cash after capital expenditure with revenues of $7.38 billion and it posted its second consecutive quarterly profit, this time of $105 million. In January Tesla announced that it would deliver more than half a million cars in 2020 – up from 367,500 in 2019.
Even though Tesla posted an annual loss for 2019, as it has every year before, its finances are looking more robust. Operating costs were down about 7 percent last year, partly as a result of the company’s decision to close down its network of showrooms in most countries and to sell direct. Automotive sales were up 13 percent and deliveries rose by 50 percent. Its new Shanghai Gigafactory has been operational since last October making the Model 3, this being the first wholly foreign-owned car plant in China. With another factory under construction in Germany, Tesla is poised for global expansion. Deliveries of the new Model Y SUV are due to begin this spring, ahead of schedule. And next year Tesla will launch its futuristic Cybertruck which, supposedly, will command higher margins.
But the company’s sky-high valuation is about more than improved efficiency and new factories. Many analysts think that Tesla is likely to emerge as the clear market leader in the small electric battery car market. That implies that the established automotive giants such as Volkswagen (ETR:VW) which are fast developing a range of electric models will struggle to keep up. (I’ll be talking about that in the March edition of the MI magazine.)
ARK, a New York-based investment management firm, has produced a valuation model which expects Tesla’s share price to soar to $7,000 in five years as a result of increasing sales, rising margins, decreasing costs and its project to build a fully autonomous taxi network. (The concept is that Tesla owners will allow their cars to become part of a self-driving taxi fleet when not in use – and the profits generated thereby will be split between the owners and Tesla). ARK’s Bear case estimate is $1,500 and its Bull case projection is $15,000[i].
But the Tesla bears are still sceptical. They argue that Tesla will be challenged to reduce unit production costs without sufficient economies of scale. They doubt that Tesla will be able to ramp up capacity significantly in the short-term to satisfy demand for an admittedly attractive product. They point to evidence of safety issues. And of course they question the company’s corporate governance, despite Mr Musk having stepped down as chairman of the corporation for at least three years in September 2018. Apparently, there are still hedge funds taking out short positions.
High beta
The medium-term outlook for Tesla’s share price must be evaluated in the context of overall market performance. Tesla’s is a classic high-beta stock: when the market rises, all things being equal, Tesla’s shares rise by more than the market. Conversely, when the market falls many of Tesla’s investors will start selling and the stock is likely – again, apart from exogenous factors – to fall by more than the market. Tesla’s recent record highs were achieved, let it be noted, as the NASDAQ was nosing into record territory. On Tuesday (11 February) the NASDAQ closed at an astonishing 9,639.
It follows that if there is a general market sell-off then Tesla’s share price would tumble. Most economists think that the chance of a global recession in 2020 is relatively low and most equity analysts think that the outlook for corporate earnings in the US is excellent. However, the coronavirus is beginning to cast a shadow. If there is a global pandemic then the world economy – and thus the markets – will take a hit. But then, if that happens, our share portfolios will be the least of our worries.
Incidentally, the Shanghai municipal government said last Friday (07 February) that it would help companies dealing with factories which have closed because of the virus, such as Tesla, to “resume production as soon as possible”. It’s not clear as I write (Thursday) if the Tesla plant has been permitted to re-open.
What seems to have happened in the last two weeks or so is that the short-sellers have started buying. If a stock continues to rise significantly then short-sellers start buying the shares to hedge themselves against further losses on their short positions. If enough investors do this, it pushes the stock price up even further, forcing even more buying by short-sellers. This effect, known as a short squeeze, is unlikely to be repeated as more and more short positions are unwound.
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According to Forbes, Tesla’s stock price hike on Monday was partially attributable to a Forbes analyst’s report which speculated that Tesla could be an attractive acquisition target for Alphabet/Google (NASDAQ:GOOG). In that note, the teenage scribblers hypothesised that a deal with Google could see Tesla’s value rise to $1.5 trillion. As far as I can tell this was pure speculation, not analysis.
Tesla the brand
Almost everybody who knows what an electric car is knows that a Tesla motor car is a beautifully engineered, high-end specification, elegantly designed vehicle that emits zero CO2. A sleek and silent machine that turns heads and accelerates like a wild cat, its passengers enjoying comfort – and, inevitably, status. (Surely only intelligent and successful people drive Teslas? No?) And not only status but the feel-good factor derived from saving the planet…
But, as we all learn in those business school marketing modules, the brand is much more than the features and benefits of the underlying product. Brands are about the feelings of trust and loyalty that a particular corporate logo and presence engenders. And in this respect, Tesla suffers from the stewardship of its brilliant, visionary but somewhat whacky founder and CEO. Let me give you just one recent example.
The US automotive website Jalopnik reports that Tesla allegedly removed the autopilot features from a customer’s used Tesla vehicle without warning. Jalopnik refers to the customer as “Alec” and claims that the customer purchased a 2017 Tesla Model S on 20 December last year from dealer who had purchased the vehicle directly from Tesla at auction.
Social media reveals that a lot of people out there – including present and former Tesla owners – like the product yet find the brand dodgy. The best way for Tesla to counter that would be to bring in a safe pair of hands to ramp up corporate governance issues – preferably at CEO level. Mark Zuckerberg faced a similar challenge at Facebook – and then hired Cheryl Sandberg as COO in 2008, arguably with great success.
The electric future
Four-twenty is supposedly the hour at which, in trailer parks across America, ageing hippies light their first spliffs of the day. Or so the urban myth has it. $420 was also the share price at which Mr Musk was going to take the company private in September 2018 when he was getting friendly with the Saudi Arabian sovereign wealth fund. That tweet got him into a whole lot of trouble.
Since then Tesla has emerged as something much more than Mr Musk’s brainchild – though it will always be that. It is a unique brand which just cannot satisfy demand. If you think the dream stacks up: BUY – preferably on the downturn. But keep your safety belt tightly clasped. This won’t be a mature, stable, dividend-paying stock for another decade. But it could make you a whole load of money.
***
This is not the place to rehearse the standard model of climate change which is ultimately driving the transition of the automotive industry – i.e. why anthropogenic carbon emissions from burning fossil fuels create a greenhouse effect which in turn causes global warming…
But there are still a few quasi-scientists people who talk about a climate change hoax. More interestingly, there are those scientists who take a more nuanced view of the standard model. For example, Dr Patrick Moore doesn’t doubt that human beings have boosted the level of CO2 in the atmosphere substantially since 1800; however, he questions whether there is a direct correlation between levels of CO2 and global temperatures. He – along with others – thinks that global warming is largely due to solar activity, about which we can do nothing. (I am not qualified to determine if that is nonsense or the opposite.)
These discussions, however, don’t really matter for investors, in my view. That is because the political class overwhelmingly in the West – with the possible exception (almost certainly temporarily) of the current US administration – has entirely embraced the standard model of climate change. They had to, on pain of being shamed.
Therefore, whether you are a true believer in the standard model or a sceptic, the fact is that the focus of public policy for at least the next half century will be on reducing carbon emissions. Anyone who opposes that policy will be labelled a dinosaur (or much worse).
There are already elements within the climate change movement – Extinction Rebellion for one – which have characteristics which sociologists would describe as cultic. But when a marginal cult becomes the state religion – just as in 4th century Rome which embraced Christianity, having persecuted it viciously in previous centuries – it pays to be on the right side of orthodoxy.
The Emperor Julian (who reigned as Sole Augustus 361-363), known by Catholics as Julian the Apostate, tried to reinstate the pantheon of Roman Gods, rejected by his half-brother, Constantine. (A religion now called paganism, as it was last surrendered by pagani – simple county folk.) In order to gain the support of the Eastern Army, which was still largely pagan, he unnecessarily invaded Sassanid Persia (aka Iran)…And he came a cropper…
Julian was succeeded by the upstart Jovian – who restored Christianity. Whatever the historical parallels readers might infer (Mr Trump as a modern Julian?) there is one thing to take away. Whenever a new religion arises, huge geopolitical instability is unleashed. I hope to explore that theme in more detail this year.