Last may – when Tesla (NASDAQ: TSLA) the shares were trading for around $ 150 on a split-adjusted basis – CEO Elon Musk opined on Twitter that Tesla’s stock price was probably too high.
Tesla’s stock price is too high for me
– Elon Musk (@elonmusk) May 1, 2020
As Tesla’s shares continued to rise for the remainder of 2020 and sustained its massive gains, Musk began to change his tone. By the time Tesla held its fourth-quarter earnings call last week, the shares had more than quintupled the level that Musk had considered “too high” less than a year ago. However, Tesla’s CEO explained why the imminent arrival of fully autonomous technology would justify the company’s high valuation.
There is only one problem: Musk’s whole argument is based on a fallacy. Let’s take a look.
Elon Musk math
Last year, Tesla’s automotive revenue reached a record high of $ 27.2 billion, and the company achieved a GAAP operating profit of $ 2 billion. Tesla expects to grow dramatically from that base. It projects that it will increase its vehicle deliveries by about 50% per year on average in the short term, as it increases its battery and assembly capacity, locates production and introduces new models.
Still, based on Tesla’s closing price on Wednesday of $ 864.16 and its diluted share count of 1.124 billion shares, the company had a fully diluted market capitalization of nearly $ 1 trillion. Even if Tesla were able to increase its earnings tenfold, that would not justify the company’s recent valuation without aggressive expectations of continued growth.
During Tesla’s recent earnings call, Musk opined that the shares remain reasonably valued if we consider the profit potential of all the autonomous capabilities that Tesla is building.
… [I]f Tesla ships, say, hypothetically, $ 50 billion or $ 60 billion in vehicles, and these vehicles become fully autonomous and can be used … like robotaxis, the utility increases from an average of 12 hours per week for potentially an average of 60 hours per week. … [L]Let’s assume that the car becomes twice as useful … that would be double the company’s revenue again, which is almost the entire gross margin. … [I]it would be like … to have $ 50 billion in incremental profit basically because it’s just software.
In short, Musk argues that the FSD’s ability will make every car Tesla builds dramatically more valuable, because more than one personal vehicle can be used. Musk believes that Tesla will capture that extra value as almost pure profit, generating a massive inflection of earnings that would allow the company to earn tens of billions of dollars annually within a few years – with plenty of room to keep growing.
Image source: Tesla.
It’s a giant fallacy
Unfortunately, this “plan” was built on a fallacy. First, while regular car owners can only spend 12 hours a week in their vehicles, real taxis are used much more frequently. In New York City, for example, some taxis are used for double shifts and can operate 100 hours a week (or even more). These vehicles are no longer valuable just because they will be used more: production costs determine the selling price of the vehicle more than the intended use.
Second, Statista estimates that the global taxi and race car market will reach $ 260 billion this year. This represents a considerable opportunity, but reaching $ 50 billion or more in revenue will not be easy. It will take some time for the axis robots to disrupt traditional travel and taxi sharing markets. And even when they do, Tesla will face a lot of competition, as several other companies are also hoping to launch robot taxi services.
Robotaxi’s services can earn higher margins than auto manufacturers in the long run. However, Musk’s implicit assumption that Tesla could double its revenue at minimal incremental costs – thereby earning pre-tax margins of 50% or more – is clearly false. If Tesla set its robot tax rates high enough to be able to get such high margins, competitors would cut its price and steal its market share. This competitive dynamic will dramatically limit the opportunity for incremental profit from using Teslas as robotaxis.
Look at the core business for Tesla’s value
Many Tesla bulls expect the company to become the largest automaker in the world within 10 or 15 years, delivering 10 million or more cars annually. If Tesla achieves this while achieving double-digit automotive operating margins and building profitable parallel businesses in solar, batteries and robotics, Tesla’s shares can certainly grow in value over time.
However, investors should not count on robotics as a magic bullet that will make Tesla extremely profitable overnight. Tesla may develop a good robot taxi business in parallel, but the growth of the main automotive business will determine whether Tesla’s shares will continue to rise or fall back to earth in the next decade.