A recent Business Insider article addresses the elephant in the room at Tesla (TSLA, Financial): its overblown share price. This is a subject we have touched on in recent research notes, in which we discussed the fact that, at a market capitalization of $55 billion, Tesla already has a decade of monumental growth priced into its stock – and no meaningful acknowledgement of the numerous ways in which things could go wrong, or at least not quite as right as CEO Elon Musk promises they will.
The Business Insider piece discusses a “what if?” scenario in which Musk recognized and acknowledged the economics of the electric vehicle market, rather than rejecting facts in favor of his personal vision, and opted to target the luxury sector rather than trying to expand into the mass-market.
In this research note, we take a look at Business Insider’s counterfactual scenario, and address why Tesla has already passed the point of no return.
Business Insider asks: “What if?”
The article asks a series of questions about how Musk could have led Tesla in a different strategic direction that would not have resulted in the cash-burning, highly leveraged “production hell” of the Model 3 mass-market sedan’s production ramp:
What if Tesla had presented the Model 3 as an entry-level luxury car and priced it accordingly, admitting that the market for cheap EVs is currently tiny and instead looking to acquire buyers who wanted a smaller, cheaper version of the Model S, a Tesla version of the BMW 3-Series to BMW's larger 5- and 7-Series?
What if Tesla had accepted that in 2018, 150,000 as a production target could have been easily achieved? Tesla could have aimed to build just 50,000 Model 3s, about 1,000 per week, pricing them between $50,000-$80,000 leaving the mass market to the more manufacturing-skilled Nissans and Chevys of the world.
What if Tesla had concluded that a share price well above $300 per share was a fluke, and that it should have been running itself like a company at maybe $150, with significant cash demands in an industry notorious for being a money furnace? After all, it's worth noting that Musk, who owns 20% of Tesla, could remain a billionaire on paper even if the automaker were worth far less than it is now.
What if Tesla had downplayed the Model 3 in 2017 and 2018, reminding itself that both the Model S sedan and Model X SUV had suffered difficult births, with assorted delays and predictable early build glitches?
What if Tesla found itself in a position where its core business — the Model S and Model X — was running at a steady clip of 100,000 in yearly deliveries? What if Tesla decided to manage that business adroitly for a year or two, before taking a blind leap into the Model 3?
The road not taken
The Business Insider piece is quite unequivocal in its criticism of Musk and his strategy. It concludes that, had Tesla stuck with the potentially very profitable – albeit far smaller and less ambitious – luxury EV market, then it would probably be doing very well for itself:
Tesla would be doing OK, Musk would still be a superstar and quite rich, and the planet would still be spinning on its axis. Heck, if Tesla's stock price weren't surging in the way that some investors want it to, the company might even think about paying a dividend.
For what it is worth, we would be inclined to agree with the conclusion that, had Tesla pursued a narrower strategy, it would still carry a high share price and multi-billion-dollar market cap. Perhaps it could even claim a valuation on par with Ferrari’s (NYSE:RACE) $25 billion; the European sportscar maker commands a much higher sale price, but Tesla’s higher volume would probably be enough to even things out.
While such a situation might ultimately benefit the company, and ensure its survival, it would crush the positions of many true-believing longs. Shareholders have been scorched during reorganizations many times at many companies; Tesla could survive. The problem is that Musk might not.
No going back
The particular idiosyncratic problem facing Tesla is that its largest shareholder, Musk, has used his Tesla shares as collateral for loans to fund other projects, as well as fund his conspicuous consumption habits. Indeed, the company’s CEO has personal debt worth at least $624 million – and probably substantially more. While a normal CEO might be able to take the hit to his personal fortune from his company’s market cap correcting downward, Musk’s high personal leverage could prove dangerous.
If Tesla’s share price fell to reflect a market cap closer to $25 billion, it could result in a potential margin call. That would be bad news for Musk and means he will never accept such a correction.
Thus Tesla is caught between a rock and a hard place. While it could become a viable and profitable business in the luxury sector, its CEO’s financial condition requires that it not give up the mass-market dream.
Musk continues to fight to make reality conform with his dreams. But he and Tesla’s shareholders seem bound for a rude awakening.
Disclosure: I/We are short TSLA via long-dated put options.
