Bulletin
Investor Alert

Outside the Box Archives | Email alerts

Jan. 23, 2021, 10:20 a.m. EST

Why Tesla is not a safe stock for long-term investors 

new
Watchlist Relevance
LEARN MORE

Want to see how this story relates to your watchlist?

Just add items to create a watchlist now:

  • X
    Tesla Inc. (TSLA)
  • X
    General Motors Co. (GM)
  • X
    Toyota Motor Corp. ADR (TM)

or Cancel Already have a watchlist? Log In

By Rob Hansen

Tesla is one of the world’s highest-flying stocks. While optimism about the future of electric vehicles (EVs) is understandable, Tesla’s current valuation reflects aggressive assumptions about its dominance of the electric vehicle market and its array of ancillary businesses. 

On the surface, Tesla /zigman2/quotes/203558040/composite TSLA -0.99% is a structural grower in EVs with potential network effects, significant first-mover advantages and seemingly limitless possibilities in adjacent businesses. These factors have propelled Tesla’s valuation to astounding levels. Aside from selling EVs, Tesla’s other service-oriented and ancillary businesses appear to offer immense potential.

For businesses with these types of nascent ancillary or service-oriented offerings, investors typically pay a small premium for a low probability of big potential in the future. Tesla’s current valuation reflects a high probability that its EV business will remain dominant and still unproven businesses will succeed.

Optimistic expectations

The role of government policy is important to the EV growth story worldwide. Governments have begun to tackle global warming by establishing policies to support zero-emission vehicles, such as EVs. The world’s largest automobile markets (China, the U.S. and Europe) have utilized a combination of subsidies and regulation to help cultivate the EV industry. This has driven volume growth expectations to elevated levels for Tesla.

One does not have to be an EV bear to have concerns about Tesla’s current valuation. Assuming a 22% compound annual growth rate in EV sales volumes over the next 10 years implies that Tesla is trading at more than 60x 2030 EPS. Even for the most bullish investors, this is too high a price for just an automobile business. Therefore, we estimate that just under half of Tesla’s market value is derived from selling EVs and the rest is from ancillary businesses. While Tesla’s shares tend to run ahead of fundamentals, current levels imply that it will dominate EV sales and many of its adjacent businesses are a sure bet. In short, a lot must go right for Tesla’s valuation to be justified. 

The foundation of the Tesla thesis largely rests on its first-mover advantage with battery technology and supply chain mastery. Tesla’s first-mover status has theoretically bred an insurmountable lead in battery IP and supply chain, which should lead to lowest-cost production. Once lowest-cost production is established, Tesla will then reduce consumer prices and undercut rivals right as the S-curve of EV adoption kicks in. Tesla is expected to increase its sales from 500,000 cars per year today to close to 4 million cars by 2030, generating automobile gross margins that are 1% to 4% higher than its peers. For reference, GM /zigman2/quotes/205226835/composite GM +1.44% sold an average of 4 million cars worldwide over the past three years with gross margins of 19%.

There are many uncomfortable assumptions about competition embedded in Tesla’s bull thesis, but given Tesla’s market cap, we think the Tesla story is more complex than just selling EVs like any other original equipment manufacturer (OEM). Otherwise, Tesla would not be trading at such a high valuation. 

More than an automaker?

The foundation of Tesla’s business model is based on the number of EVs Tesla puts on the road. The company’s first-mover advantage builds a driver base, which industry analysts believe will morph into subscribers that can be monetized every month, as Tesla’s subscribers are expected to pay a monthly fee for various additional services. Eventually this will churn out predictable profits with software-like margins that are decided by the number of monthly active users (MAU) multiplied by average price per unit (ARPU). 

What services can Tesla provide? This is where industry analysts’ imaginations have taken hold. Many envision a menu of potential monthly surcharge services that subscribers can choose from to add to their vehicle. Potential services include: an autonomous vehicle package (currently an upfront cost), regular performance upgrades, monthly supercharging fees, monthly maintenance packages and even Tesla Infotainment complete with live streaming and/or Tesla Arcade. 

Tesla also has ancillary businesses that could be monetized and packaged with its vehicles too; there is Tesla Energy, Tesla Insurance and Tesla Mobility. Suddenly Tesla is not just an OEM, but also an OEM plus a Software as a Service (SaaS) business. But wait, the story doesn’t end there. Tesla recently announced significant updates to its battery technology as well as ramping up its own battery manufacturing capacity. The company could become a battery supplier to other OEMs too.

Tesla’s current share price is telling us the cake has been baked and we can eat it too. While parts of this exciting story may play out over the next five- to 15 years, progress is unlikely to be as linear as the market suggests. In fact, there are several key risks that the market may be overlooking:

Rising battery competition

There are three key ingredients necessary for a first-mover advantage to be sustainable: 

1. Time to build a wealth of technical expertise.

2. Accumulation of potential scarce resources such as key suppliers, talented employees, etc.

/zigman2/quotes/203558040/composite
US : U.S.: Nasdaq
$ 675.50
-6.72 -0.99%
Volume: 41.09M
Feb. 26, 2021 4:00p
P/E Ratio
1,075
Dividend Yield
N/A
Market Cap
$654.83 billion
Rev. per Employee
$445,694
loading...
/zigman2/quotes/205226835/composite
US : U.S.: NYSE
$ 51.33
+0.73 +1.44%
Volume: 17.13M
Feb. 26, 2021 4:00p
P/E Ratio
11.88
Dividend Yield
0.00%
Market Cap
$72.91 billion
Rev. per Employee
$790,226
loading...
1 2
This Story has 0 Comments
Be the first to comment
More News In
Industries

Story Conversation

Commenting FAQs »

Partner Center

Link to MarketWatch's Slice.