Tesla $93B Valuation: Does A Great Product Equate To A Great Stock?

Tesla's valuation has reached $93 billion this week. Does it really have such a strong competitive advantage to merit such a valuation premium?

The question Tesla Motors Inc TSLA analysts and investors often ask nonbelievers who question their investment decision is: have you driven a Tesla? The implication is simple: Tesla has built a superior vehicle, and therefore the company deserves a superior valuation. Jim Cramer called the stock a buy because his wife has driven one and absolutely fell in love with it.

Such logic assumes that a company that introduces a great product will have decades of stock appreciation. History proves otherwise. For every Apple Inc AAPL there are many GoPro's GPRO and Fibits, both of which saw their stock prices fall 90% because they simply have not been able to dominate their market like Apples does.

Tesla investors see the company using a similar playbook as Apple: deliver hardware leadership (iPhone, iPad, Mac, Apple Watch, etc.) and dominate with the software ecosystem (App store, OS upgrades, streaming services, Apple Pay, etc.). In other words, Tesla delivers on car electrification with cost and performance and will dominate with an eco-system of Robo Taxi’s, paid software features, etc.

Car electrification is the path forward simply because it offers many advantages: quiet ride, exceptional handling due to the low center of gravity, low maintenance due to simplicity of the electrical motor and exceptional performance due to the instant power delivered from the batteries. Traditional oil gas stations are now even installing superchargers to adapt to market evolution. Most analysts agree electrical car will gain share for the next two decades.

From a valuation perspective, Tesla has effectively caught up to Volkswagen, which is the second-largest auto manufacturer in the world with a $100 billion market cap. Yet the difference in vehicles sold per year shows such a stark difference (figure 1). I bring up VW because it's currently Tesla's biggest competitor. They have, or will have, electric cars in three segments: the Porsche Taycan to complete with the Model S, the Audi E-tron to compete with the Model X and the Volkswagen ID.3 to compete the Model 3 on the low end. VW.

Figure 1: Approximate number of vehicles sold in 2019.

 Let’s first study at the basic assumptions that Tesla will operate an Apple-like business model with both hardware and software leadership.

The Hardware Leadership (The Car):

One key claim to justify Tesla's valuation is its multi-year lead on battery technology. Based on the many objective performance reviews of the Taycan Turbo S, this is becoming a highly questionable claim. The Taycan seems to outperform the Model S P100D in all categories (acceleration, handling and racing capabilities). Based on the performance on the Nuremburg circuit, Porsche has solved a key weakness of battery technology, which is the cooling after each discharge (performance degradation during repeated accelerations). Other key attributes such like charging time and range seem to be comparable or better for a similar size battery.

Historically, all of Tesla batteries have been sourced from Panasonic, which may have given Tesla a lead over the competition, but Panasonic has since made their batteries available to anyone and Tesla themselves announced they will source from other suppliers for the China Model 3 (LG Chem), implying batteries themselves are becoming commodities with minimal differentiation. The battery cells themselves present about 50% of the yield cost of the entire electic power plant. The control electronics, power management systems and battery pack assembly are an integral part of the overall cost and performance toolkit for each auto manufacturer. Tesla has also historically taken more risk on pushing its battery technology in order to get more range; this has likely resulted in many fires to which Tesla has recently sent range reducing Over-the-Air (OTA) updates to address this potential risk.

How about product cost? A common criticism of the Taycan is its price, which is significantly higher than the Tesla S, under the assumption Porsche is at a significant cost disadvantage due to its battery technology. This is difficult to assess as Porsche customers want exclusivity, status, and prestige. Porsche has never made a mass vehicle, nor does it intend to in order to maintain its brand image, therefore Porsche commands significant price premiums on its vehicles independent of cost.

LG Chem has announced plans to build a battery factory in Poland, twice the size as Tesla’s Gigafactory 1 that will allow the company to supply batteries for up to 1 million electric vehicles per year. With Ford pricing it’s Mach-E and VW pricing the ID3 at similar price points as the Model 3 for similar battery sizes, there is a large probability that the cost advantage gap Tesla is enjoying will disappear completely in 2020 as these manufacturers reach volume. If these assumptions are correct; Tesla’s hardware (Car) business should be valued similarly to traditional car manufacturers or ~8x EV to EBITDA.

The Software Leadership or Full Self Driving (FSD) Capabilities:

This is probably the most controversial subject as Elon Musk said there will be 1 million Tesla Robo Taxis in operation in 2020; and if true could potentially justify the $93B valuation. Tesla is also not allowing leased vehicles to be purchased by the owners after the lease period ends as they will be rolled back into the Robo Taxi fleet.

This is likely quite a controversial subject as it is very difficult to assess the exact maturity of the FSD. Many news headlines and online reviews rave about Tesla self-driving capabilities despite this being a large contrast to the recently released Software Revision with the Smart Summon features, which allows a car to drive by itself in a parking lot back to its owner. As demonstrated in many Youtube videos, there is much improvement still required; cars often miss stop signs, drive in the wrong direction of traffic and have very erratic movement. Even if Tesla was able to make miracle progress on the technology, it will take years for regulators to fully approve such technology on the road.

Furthermore, based on independent research, Tesla is way behind the competition in autonomous driving as shown in the chart below (figure 2). Many Tesla investors confuse lane assist with self-driving capabilities; in fact, Audi e-tron also has the same auto-pilot capabilities as Tesla (actually Audi is at level 3 autonomy vs Tesla at level 2).

Audi does not want to deal with the lawsuits Tesla has on its plate, so Audi has announced they will not offer that feature in the U.S. until regulations are clear. This is probably one of the reasons Tesla’s third legal counsel has quit over the past year.

Figure 2: Autonomy Leaderboard (source: Navigant Research).

Every auto manufacturer now offers auto-pilot on their high-end vehicles (BMW, GM, etc.), they just don’t call it full auto-pilot to avoid confusion. Also, many of the reviewers don’t bring their pillows for a nap while filming themselves on the autobahn; so, these videos don’t tend to go viral and don’t often make the headlines. GM monitors drivers with cameras and will shut down the driving system if they don’t watch the road. Tesla is nowhere close to these standards.

Here is a link to the review of the self-driving capabilities of the Audi e-tron (available in Europe).

MobileEye, a unit of Intel, has presented some extremely impressive demos at CES; showing an unedited drive through the dense and busy streets of Jerusalem. This type of capability is clearly ahead of what Tesla has demonstrated to date.

Tesla has announced that FSD will be available by the end of 2019 and confirmed on the October investor conference call that Tesla may grant certain customers early access to a “feature complete” version of the company’s “full self-driving” (FSD) capabilities by the end of 2019. Musk said that this wasn’t “for sure”, but that he thinks Tesla is on track for the release. Tesla has been charging $7,000 per car for the future FSD software, which was supposed to be available by the end of 2019. The estimated attach rate has been estimated to be about 30%; so roughly 1 in 3 customers have paid FSD. It is very unclear how this situation will play out.

As for the balance of software features: OTA (over the air) updates are now available from every manufacturer BMW. It will be interesting if Tesla can start charging for new features (they recently floated a new performance upgrade for $2,000, but historically have given features for free). That could be welcomed income dearly needed by Tesla.

In terms of valuation, Tesla is simply in last place in terms of autonomous driving capabilities. And with the potential liability claims from FSD (multiple active NHTSA investigations into deaths caused by auto-pilot), it is likely that Tesla does not have a leadership position. 

Total Valuation:

Historically, the car industry has been one of most challenging industries due to competition, sensitivity to downturns, and capital requirements. For these reasons, valuation multiples on car companies have been very low relative to other market segments.

Ignoring the $10 billion of debt Tesla has and acknowledging VW has caught up to Tesla in technology and capabilities, both cars should command similar valuations. Simply looking at revenue, which is flattening for Tesla around $24 billion per year (revenue in mature markets like the US and Norway are down year-over-year) and comparing to VW at $240 billion, Tesla's share price could fall 90% from here. At best, Tesla is worth $10-$20 billion, assuming some growth in the next few years with the Model Y and China growth.

Elon Musk has perhaps engineered the greatest stock bubble in history, with millions of believers behind him. In my opinion, Tesla investors seem to be buying into the vision of Tesla’s CEO, not using rational estimates to make their investment decisions.