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Tuesday, November 24, 2020

Tesla Investing: Bean Counters vs Visionaries

"Bean Counter vs Visionarie" commissioned image by @lastly_the_squirrel_thing

Since its IPO, Tesla has been a controversial stock. It has attracted bulls and bears. It has been one of the most-watched names out there and Tesla has become the most valuable auto company in the world by market cap. This is despite the fact that Toyota sells about 25 times more cars annually than Tesla. This dichotomy has been a defining feature of the stock and perhaps the company in general. Evaluating the company as an investment, there are two primary camps: the bean counters and the visionaries.

The bean counters look at the balance sheet. They see that (prior to Q3 2019) Tesla lost money in nearly every quarter. They see Tesla's volumes are minuscule compared to other automakers. They see that the company has had to raise capital year after year to fund operations. 

The visionaries see that Tesla has a world-changing vision that could lead to significant growth and profit. They see that Tesla has products that their customers love. They see that Tesla is on the forefront of several trends that will change the way we get from A to B.

I'm not going to pretend to be unbiased here. I'm a longtime Tesla customer and even longer TSLA shareholder. I've appeared on a podcast discussing (arguing) Tesla's quarterly results with (against) 'Montana Skeptic'. 

Why Auto Analysts Got It Wrong 

When many brokerages initiated coverage of Tesla, they looked at the product (likely a Model S at that time) saw 4 wheels and assigned an automotive analyst. As rational as that sounds, Tesla is not a car company, sure they make cars, but they are a technology company and cars are one of their technology delivery 'vehicles' (more on this in the next section). 

Tesla is a "Story Stock." This means that you are not going to find the value of the company by looking at the financial results from past quarters. Instead, it means that the company has big ambitions and the value of the company rests in their ability to deliver (or not) on that vision. This is a radically different method of evaluating a company than looking at fundamentals, comps, price to book, dividend yield, or discounted cash flow and it requires a radically different skillset. 

Tesla Is Not A Car Company 

I assert that Tesla is not a car company. Yes, they make cars, but that is a result of their larger mission, not the ends in itself. So, if Tesla is not a car company, what are they? They are a technology company, they are an end-to-end renewable energy company, they are an engineering company that is not afraid to tackle hard problems. 

To varying degrees, Tesla consists of:
  • A battery pack manufacturing company - Powerwalls, Powerpacks, Megapacks, car battery packs... Tesla purchased ATW Automation in 2020. The company made battery modules and packs for the auto industry.
  • A battery pack management provider - All of the above battery packs need control systems for charging and discharging, heating and cooling
  • A battery cell manufacturing company - Tesla purchased Hibar Systems in 2019 for their battery cell automation solutions. Tesla's current "pilot line" for new cell types qualifies as one of the top 10 cell plants in the world for kWh output. Tesla partners with Panasonic, CATL, LG, and others, but they also have their own cell production efforts. 
  • A battery research and design company - Tesla purchased Maxwell Technologies for their dry electrode innovations in 2019. The battery cell is a fundamental building block for many of Tesla's products. Advancements here leads to better products, more revenue, less capex, and more margin.
  • A manufacturing automation design company - Tesla purchased automation expert Grohmann Engineering in 2016, Compass Automation in 2017, and Perbix, a maker of highly automated manufacturing equipment, in 2017. They don't want to just make things the same way Toyota, GM, and the others do it. They want to rethink manufacturing. This means they cannot just buy the stamps and presses that are available. They have to invent the machines to make their products.
  • An AI hardware company - Tesla developed its own AI inference engine to comprehend the world around the car from the streams of data coming from the cameras and sensors. 
  • An AI software company - Tesla hired Andrej Karpathy away from OpenAI in 2017 and purchased DeepScale Inc. in 2019. DeepScale was known for their innovative energy-efficient deep neural network AI computer vision system.
  • An energy arbitrage company - Tesla's AutoBidder software allows Tesla to buy and sell energy based on grid supply and demand. This is currently used for their industrial-sized battery systems, but someday we might see residential Powerwall ganged together to form a virtual power plant that can earn credits for their owners. 
  • A solar retailer and installer - Tesla purchased SolarCity in 2016
  • A solar cell reacher company - SolarCity bought Silevo Inc. in 2014. 
  • An insurance company
  • A vehicle recharging company that sells home charging equipment
  • A vehicle "refueling" company that deploys and operates a network of fast-charging stations and destination charging
  • A guerrilla marketing company - whether it is launching a car into space, selling short-shorts, smashing windows, or selling Tesla Tequilla, Musk and co. know how to generate buzz in our modern social-media-driven news cycle
  • A glass developer - Tesla has develops specialized glass for their vehicles and solar roof products. As I write this they have a job opening on their website for a Glass Studio Specialist to "work closely with design team on the manufacturing of prototype glass and product development associated with advanced glass compositions and inner layers."
  • A worldwide car "dealership and Service Network" - Unlike most auto manufacturers, Tesla does not have a network of independent dealerships to sell and support their vehicles. This means that Tesla has to provide this service themselves in every region where the vehicles are sold. 
Viewing a company superficially only by its most visible products is a recipe for an incomplete analysis. This type of thinking would have led you to only see Apple as only a computer company, Amazon as only an online bookstore, Google as only a search engine... And today, if you are viewing Tesla as only an automaker, you are missing the majority of the value of the company.

Tesla The Outlier


Tesla stands in stark contrast to traditional car companies. Tesla vertically integrates. They make their own seats, infotainment system, navigation software... sure they still have hundreds of suppliers, but they are component suppliers for Tesla's solutions. Whereas legacy automakers have expertise in drivetrains and manufacturing, and little else. Any hard problems encountered by most automakers are farmed out to their suppliers. The automaker may get the result they are looking for, but they do not develop the in-house skills to further optimize for the next release nor to tackle similar problems that will occur in the future. And whatever solution that supplier designed immediately becomes available to every other competitor that also contracts with that supplier.

The auto industry is in a period of disruption. This means that past results are no longer a valid predictor of future results. The companies that are willing to sacrifice short term gains, to establish a long term portfolio of compelling products will be the long term winner. However, when management is 'graded' only on their short term quarterly results, you are not going to get a viable long term plan.

Moving The Goalposts

Critics have consistently moved the goalposts with regards to Tesla. They said there was _no_ market for EVs. However, when the Roadsters sold, they dismissed this and said there is only a niche market for rich treehuggers; this is the only market and Tesla will remain a bespoke automaker at best. Then Model S came out. It won award after award. It was a reimagining of what a car could be. It will never sell, the touchscreen is too big and people like knobs and buttons, they said. Tesla does not have the supplier agreements to produce more than a hundred per year, they said. Tesla ramped production to 100,000 per year and brought out Model X. With that achieved, the critics conceded the high-end luxury market but said that Tesla could never deliver a high-volume vehicle. Well, Model 3 ranks as the world's all-time best-selling plug-in electric car, with more than 500,000 delivered and Tesla's cars accounted for 81% of the battery electric vehicles sold in the United States in the first half of 2020.

One of the drums the critics of Tesla bang the loudest is Tesla's acquisition of SolarCity. If you view Tesla as just an automaker, the purchase makes no sense. However, if you look at Tesla as an end-to-end energy provider, it's a great fit. Tesla already has stores in malls and other retail locations to sell their cars. Someone buying an EV is far more likely to be interested in solar than the average car buyer. Once you have solar, you might be interested in a Powerwall to store the energy. And at the industrial scale, Tesla could sell massive solar installations and the Powerpacks or Megapacks to store the energy these solar panels produce. The SolarCity acquisition was an investment. It allowed for better utilization of their retail space, it allowed for cross-shopping and up-sales. It was an investment in Tesla's energy storage business.

Now the critics point out that competition is coming. I have two replies to this. One, the legacy automakers don't have the right skillset or engineering talent to make a competitive product. They have a long history of making gas-powered vehicles, they love the rumble and noise; it's a long and difficult path to change the culture at a large company. The half-hearted efforts that they've made to-date are evidence of this. Two, recall that Tesla is not a car company. When a competitor comes out with a car and a potential buyer asks, "Can you sell me solar panels to charge it? And have my solar and charging data all in one app? Does it have over-the-air updates? Can you sell me insurance? Can you sell me a battery pack to mount in my garage to store solar energy and to use during a winter storm black-out? Can I drive coast-to-coast on a fast-charging network?..." A point product is not the same as a full solution.

As of late October 2020, Tesla short-sellers have lost $27B betting against Tesla this year. Perhaps it is time they stop moving the goalposts and admit that they didn't understand the company.

Tesla's Success Is Self-Evident (now)


As I was writing this, Tesla achieved an incredible milestone, they were inducted into the S&P500. This is a major accomplishment for any company. With this milestone, I assert that Tesla has moved through all three stages of truth:

Stage 1: They were a niche player making Roadsters for rich Hollywood types. They were, at best, ignored and, at worse, ridiculed.

Stage 2: Tesla was the target of a massive Fear, Uncertainty, & Doubt (FUD) campaign. As just one example, the Koch brothers (who are deeply embedded in the fossil fuel industry) financed a multimillion-dollar misinformation offensive against electric vehicles. Tesla was the primary target for much of this FUD. These erroneous messages were often prominently placed in search results and occasionally picked up by media outlets. If you believed things like this, EVs polluted as much, if not more, than gas-powered cars, were nearly certain to burst into flames, and had to have their "toxic" batteries replaced every 3 to 5 years.

Stage 3: Now that the UK, California, and other places have put a date certain moratorium on gas and diesel car sales and Tesla has shown that EVs can be made GAAP profitably, there is a wave of fast-follower EV startups and the legacy carmakers are rushing to bring a number of EVs to market within the decade.

Perhaps we've finally come out on the other side of this. After years of the mainstream media predicting Tesla's demise, now we see articles with titles like, "Why Tesla stock could go to $1,000, according to a Wedbush analyst" on Fortune.

Conclusion 

The 'value' of a company cannot always be found in a spreadsheet.

Tesla has shown that there is a demand for EVs and specifically for their EVs. They've shown that they can sustain GAAP profitably and they are being inducted into the S&P 500. These achievements should allow many of the bean counters to now see the value of Tesla. There is a megatrend toward transportation electrification and Tesla is the leader in the space. Add Tesla's ambitions for energy, semi-trucks, autonomous vehicles, robotaxis, and more and you can see why the stock trades at a premium. 

For me, as an investor, when I purchased a Model X in 2016, it became obvious that Tesla was on the path to success and the pack was nowhere to be seen. This was my 3rd EV and I had been following the industry press closely. Tesla had the lead and no one was even trying to catch them. 

At the start of this article, I said that Tesla is a story stock and the value of the company rests in their ability to deliver (or not) on that vision. Tesla has the swagger to attack the best engineering talent. Talented engineers are key to achieving their goals. Combine that with the history of accomplishing things that no other company has been able to bring to market and the future looks bright for Tesla.

Disclosure: I'm long Tesla
This is not investment advice. Do your own research, consult a professional. 

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