•A hedge fund has concocted a complicated Tesla strategy.
•That strategy is symptomatic of investor confusion around Tesla.
•Investors want Tesla to remake the car business — but it already has.
Tesla is a gravity-defying stock. After an epic run over the first quarter of 2017, it reported a predictable titanic loss — and yet shares remain above $300, giving Tesla a market cap larger that Ford and on par with General Motors.
A fundamental analysis of Tesla is sort of terrifying. The company is taking a claimed gross margin in the 20%-30% ballpark and turning it into a cash-incinerating rush to build a car that it intends to sell for $35,000. That’s a margin-obliterating strategy; Tesla’s only hope with the Model 3 is to be able to make back its money on scale.
The scale is ambitious. By 2020, a million vehicles could be rolling off the assembly lines (probably at more than one factory, as Tesla has the capacity at its Fremont, Calif. plant for only around 500,000).
Between then and now, we can enjoy the spectacle of Tesla investors tying themselves in elaborate knots to come up with investment plans.
Take Chamath Palihapitiya, a Silicon Valley hedge-fund manager who appears to be simultaneously very bullish and very confused about Tesla. Like many other tech guys, Palihapitiya probably thinks that Tesla holds the key to a monopolistic future in which its electric vehicles will literally run everything else off the road.
But with EVs making up only about 1% of global sales, there’s still a ways to go before Tesla takes over. The company’s stock is up over 1,000% since its 2010 IPO, but with that massive gain has come routinely gut-churning volatility.
This makes it tricky to figure out when to actually buy Tesla’s stock. If you dove in last year, you’d have booked a lovely gain by now. But if you bought in late in 2015, you would have endured a will-testing swoon.
Chaos yields complexity
Palihapitiya’s solution is to avoid buying Tesla’s actual stock and to instead buy its convertible debt. My colleague Linette Lopez checked out Palihapitiya’s presentation at the Sohn Conference on Monday and relayed his plan: “There is … a way to protect yourself from [Tesla’s] downside while sharing in the upside — the 2022 Tesla convertible bonds. Palihapitiya sees them as a reasonable coupon that pays a reasonable conversion price.”
According to Palihapitiya, with the 2022 bonds you’re “guaranteed not to lose money as long as Tesla’s worth $15 billion …. More importantly, while our downside is protected, if this guy manages to pull it off, we get 95% of the upside.”
That sounds pretty clever, and on its face it is. But consider what Palihapitiya is really saying. He’s telling you to buy into Tesla’s capital structure rather that invest in its actual stock. As an investment strategy, it comes off as skittish. True, if Palihapitiya is right, Tesla’s bonds will convert to equity in the future and if the stock continues to ride high, you share in the gain.
But there’s a non-trivial risk that Tesla goes to zero. And while there’s presumably decent liquidity with Tesla’s bonds, you’re locking yourself into what looks more like a hidden Tesla dividend than the company’s growth. Following this logic, you’re really saying that the only sure thing about Tesla — its volatility — is too much to handle, so you’ve got to come up with a workaround.
I’m not suggesting that Palihapitiya’s recommendation isn’t useful for some investors. But it is symptomatic of how Tesla bulls are overthinking everything about the company. If Tesla is laden with potential, then just buy the stock. Unless there’s a big pullback, Tesla may actually consider splitting before it ever turns a profit!
Tesla has throughout its history presented many buying opportunities. And if history is any guide, there will be another chance to buy in. A few profitless quarters coupled with the flushing out of a lot of short sellers, as well as slow Model 3 deliveries until mid-2018, should knock Tesla back down to $200-a-share or less and create a straightforward chance to buy the next rally.
It’s interesting that Palihapitiya’s comments followed the annual Berkshire Hathaway meeting, where Warren Buffett and Charlie Munger offered their usual wisdom about how to get rich. Berkshire has lost money and made some bad calls, but Buffett’s whole avoid-what-you-can’t-understand investment thesis remains excellent advice.
Tesla at the moment is really quite easy to understand. It has achieved modest success selling expensive all-electric luxury vehicles to a small cadre of customers who are for the most part happy with their cars. Over the next year, it will try to greatly expand its market by selling a less-expensive vehicle to those who can’t handle the steep sticker price of a Model S or Model X.
If Tesla can sell the Model 3 for less than it costs to build, it could show a profit. At which point it will be able to shift from losing money on the more expensive cars and, assuming steady demand, realize the 20%-30% margin.
The problem with the Apple analogy
The problem is that Tesla could conceivably do that right now. In that context, the Model 3 is an incredibly bad idea. As a business proposition, of course, not as a means to achieving Musk’s vision of a fossil-fuels-free future and a rescue of planet Earth.
Palihapitiya’s presentation involved something beyond the Tesla-investment idea that was more alarming, by the way. Like countless others, his fund is trying to link the Tesla story to the Apple story, which is good PR as Apple just hit an $800-billion market cap.
He argued that while the analogy is valid, Tesla hasn’t yet redefined the market. The intellectual error here is grave. In fact, Tesla has created a market that didn’t exist prior to its emergence. Tesla is really the only electric carmaker of any significance in the history of the auto industry. It inhabits a market of one and, depending on how you look at it, already has a monopoly.
General Motors is currently selling just over 1,000 per month of its Bolt EV, a vehicle that arrived last year and has a range comparable to what the Model 3 should deliver. It also has a price tag of $30,000 after tax credits and incentives. Tesla should easily outsell that as soon as the Model 3 is available.
GM isn’t relying on the Bolt to generate the roughly $3 billion the company has been minted in quarterly profits. For that, GM has SUVs and pickups.
So think about it: Tesla has a $50-billion market cap and monopoly control of its market — and yet it has almost never made money. The Model 3 will actually make it harder, not easier, for Tesla to turn a profit. And if Tesla can sell a million cars by 2020, competition will arrive and Tesla will lose its monopoly status.
For what it’s worth, this will make Musk happy — he knows Tesla can’t handle all global EV demand. His vision will be achieved only if other carmakers use their vast capacity to also build EVs.
Only then will Tesla see the benefits of having remade the electric car market. But they will be much more meager benefits by then.
This column does not necessarily reflect the opinion of Business Insider.