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John Engle
John Engle
Articles (175) 

Tesla Has No Moat: Elon Musk Doesn’t Care But Shareholders Should

There is trouble brewing for the cash-burning carmaker

In a pair of recent research notes, we discussed a strange feud brewing between Elon Musk, the billionaire tech futurist and CEO of Tesla (NASDAQ:TSLA), and Warren Buffett (Trades, Portfolio), the renowned value investor and CEO of Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B). In our first piece, we discussed Musk’s attack on the idea of strategic “moat,” a concept popularized by Buffett in which he looks for companies with structural advantages that protect their earnings power and that can be built upon to further the profit-making potential of those firms. Examples of moats include low-cost production and established brand equity.

Musk does not like moats. When asked about the idea recently, Musk called them “lame” and “quaint.” Instead, Musk argued, innovation is the only true feature of a company’s long-term survival prospects: The company with the swiftest pace of innovation will win in the end. In our second piece, which addressed the later developments in the feud including a rather bizarre Twitter tirade from Musk, we observed that innovative cultures and systems represent strategic moats in their own right.

Thus, for all his bluster, Musk failed utterly to undermine the idea of strategic moats. Instead, he has revealed his own lack of understanding of the concept. That should give Tesla investors pause.

Tesla shareholders should worry about something else: When it comes down to it, Tesla has no moat. And that is going to mean big trouble for the upstart automaker.

Innovation is a moat … that Tesla does not have

The number of players in the electronic vehicle space is rapidly increasing, with Tesla finding invigorated competition that includes industry giants such as General Motors (NYSE:GM), Ford (NYSE:F), Jaguar and BMW. These companies are entering the market with the aim of going head-to-head with Tesla, and that should have Musk worried.

A Tesla bull might argue that the company does not need a moat because, as Musk said during the latest earnings call, the only true advantage is pace of innovation. Yet on that score Tesla looks to be in serious trouble. In terms of cutting-edge tech like self-driving vehicles, competitors such as Alphabet (NASDAQ:GOOG) and its partner Waymo, as well as GM, have stormed far ahead of Tesla by virtually all accounts. And with Tesla losing top talent to competitors at a staggering pace, including a top Autopilot executive jumping ship for Waymo last week, it is increasingly apparent that Tesla is becoming an innovation laggard.

Likewise, Tesla has recently decided to cut its capital expenditure outlook in an effort to save its rapidly depleting financial resources. Yet that means, by Musk’s explicit admission, that the next generation Tesla vehicle, the Model Y, will not see production for years.

Even as Tesla cuts its capital investment forecast and sees production stall, a multi-billion-dollar deluge of investment by well-heeled competitors threatens to erode whatever limited advantages the upstart might have had in battery technology, autonomous driving, charging infrastructure, and next-gen vehicle design.

Therein lies one of Musk’s major blunders, and a fault of many Tesla bulls: While Musk’s company may be in poll position in terms of market reach and public perception, it lacks anything like the resources of the legacy automakers that are committed to eating the Tesla’s lunch. It will lose the game of innovation because it cannot afford to compete.

Thumbing his nose at the banks

Strangely, Musk has apparently decided that he does not want to tap capital markets to access the financial resources that are absolutely critical to expand production and build facilities that can build such promised future offerings as the new Roadster, Model Y and Tesla Semi.

On the first quarter 2018 earnings call earlier in May, Musk stated in unequivocal terms that he had no intention of raising further dilutive funding. Yet the company has a net working capital deficit of $2.3 billion and is expected to run another record loss in the second quarter.

Analysts are already questioning whether Tesla can keep the lights on without a capital raise, let alone fund the sort of expansion necessary to keep the Tesla growth story alive and the company’s tech on a par with the better-financed legacy automakers. No doubt the exigencies of financial reality will eventually win out over Musk’s hand-waving insistence that nothing needs to be done.

Hazards ahead

Innovation is expensive, and Tesla’s hunger for cash has been insatiable. Funding more research and capital development will require billions of dollars more than Tesla has. Yet Tesla has no clear path to profitability, despite Musk’s various tweet claims to the contrary. As competition heats up, Tesla will find its position swiftly eroded.

Tesla never really had a strategic moat, just a first-mover advantage. Now that other companies with radically more financial muscle, manpower and access to R&D facilities, Tesla’s fundamental deficits will show ever clearer.

Even if everything were to go perfectly for Tesla, with production ramps, new products coming out of new factories, and the legacy automakers continuing to lag, it would still not justify the company’s inflated market capitalization. Tesla is currently valued on a par with Ford, which produces radically more cars – and generates billions of dollars in profits every year doing it. Tesla’s market capitalization of roughly $50 billion implies a stratospheric growth trajectory and higher margins than it is ever likely to deliver.

Verdict

Even in a best-case scenario, Tesla is grossly overpriced. And the best-case scenario is vanishingly likely to materialize. This is one stock no one should have in their portfolio.

Disclosure: I/We are short TSLA via long-dated Put Options.

About the author:

John Engle
John Engle is President of Almington Capital - Merchant Bankers. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin and an MBA from the University of Oxford.

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