Tesla (TSLA, Financial) is perhaps the most viciously tribal stock trading today. Many bulls are vociferously supportive and expectant of massive gains to come. Many bears rub their hands with glee at the prospect of imminent bankruptcy – or at least a humbling share price collapse.
In truth, Tesla faces many harsh realities, including a deteriorating financial position, production problems and mounting competitive threats. But that does not mean Tesla is going to collapse. Anyone who has read our previous analysis of Tesla will know our position falls in the bear camp. But we would also point out that the bear thesis does not rely on Tesla falling apart. In fact, it simply relies on material realities dispelling psychological props supporting an outrageously inflated share price.
The false binary
A fundamental error in reasoning perpetrated and perpetuated by Tesla bulls is that the company represents a binary investment opportunity, i.e. it will either be a massive winner or will collapse utterly. In other words, Tesla bulls will often attack bears by asserting that Tesla has numerous options for funding and growth, and that there is little chance of it filing for bankruptcy or anything so drastic.
Here’s the thing: The bulls are right on that score. Sure, there has been a lot of speculation about the reasons for CEO Elon Musk’s claimed intention to raise no new outside capital. Some suggest it has been shut out of capital markets, either by investment banks going cold on the prospect, or even SEC investigations rendering a large capital raise impossible at this time.
All of that, of course, is just speculation, and we surmise that Tesla can indeed tap capital markets. In fact, it appears it will have to do so very soon, despite Musk’s protestations to the contrary. Certainly the company will need at least a few billion dollars by the start of 2019 to pay sky-high operating expenses, cover interest payments and fund growth projects. If indeed the company intends to grow the rate it claims it will, Goldman Sachs’ projection of $10 billion in external capital needs between now and 2020 looks fairly accurate.
Despite its monumental cash burn and weakening balance sheet, Tesla will very likely be able to fund its operations via capital raises. But that is nothing for bulls to crow about. Given its deteriorating credit rating, large-scale debt issuance is not likely. That leaves a stock offering as the chief option – and a pretty painfully dilutive one at that, especially if the share price continues to fade.
Survival is not the same thing as success
Furthermore, Tesla could survive as an automaker, even a profitable one, but never achieve the growth and margins currently promised by Musk & Co. and believed by the company’s legion of shareholders. Here too, the false binary rears its head. The simple fact is that Tesla is already valued – by market capitalization – virtually on a par with BMW, and is not far off Daimler-Benz. These are companies producing millions of cars and generating billions in annual net profits. Yet Tesla is priced as if it is about to join them at the big kids’ table. In reality, even if the Fremont plant gets up to the promised product rates, Tesla will still be producing a tiny fraction of the cars made by these supposedly comparable automakers. And to get to anywhere near their levels of production will require many years of construction and many billions of dollars in investment. In other words, Tesla’s market cap is already crediting it with growth that will take several years to achieve, even in a best-case scenario.
But Tesla bulls do not see it this way. Assailed by negative analysis, they cling to notion that if Tesla does not die, it will triumph. Obviously, the idea that Tesla will collapse overnight (or even at all) remains far-fetched, so they assume that any success must mean the triumphal story will hold. In reality, there are many shades of gray, and anything other than total victory means Tesla is grossly overvalued.
Verdict
The simple reality is that the current share price already anticipates huge growth and leaves zero room for error. Thus, this is not a matter of the bulls winning with a Tesla triumph or the bears winning with a Tesla bankruptcy. Rather, it is a case of the bulls winning in the unlikely event that Tesla delivers on all its promises and more (something it has failed to do repeatedly over the years) or the bears winning if literally anything else happens.
We are already seeing signs of Tesla walking back its promises of a $35,000 mass-market Model 3. Some bulls have argued that this is a good thing because the “performance” model and other souped-up versions will carry higher sale prices and thus better margins. That is true, but only in a narrow sense. With the mass-market closed off, entirely or in part, the explosive growth narrative falls apart.
Even if Tesla produced hundreds of thousands of cars and got the sort of eye-watering margins enjoyed by the likes of Porsche, it would only justify a market capitalization a fraction of the $50 billion Tesla is currently valued.
Disclosure: I/We are short TSLA via long-dated PUT OPTIONS.
