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Last May – when You’re here (NASDAQ: TSLA) the shares were trading at around $ 150 on a split-adjusted basis – CEO Elon Musk said on Twitter that Tesla’s share price was likely too high.
Tesla share price is too high IMO
– Elon Musk (@elonmusk) May 1, 2020
As Tesla stock continued to rise for the remainder of 2020 and maintained its massive gains, Musk began to change his mind. By the time Tesla held its fourth-quarter earnings call last week, the stock had more than quintupled from what Musk considered “too high” less than a year ago. Nonetheless, Tesla’s CEO explained why the imminent arrival of autonomous driving technology would justify the company’s high rating.
There’s only one problem: Musk’s entire argument rests on an error. We will take a look.
Mathematics of Elon Musk
Tesla’s auto revenue last year hit a record $ 27.2 billion, and the company achieved GAAP operating income of $ 2 billion. Tesla expects to grow significantly from this base. It plans to increase its vehicle deliveries by around 50% per year on average in the short term, as it increases its battery and assembly capacity, localizes production and introduces new models.
Nonetheless, based on Tesla’s closing price on Wednesday of $ 864.16 and its diluted stock count of 1.124 billion shares, the company had a fully diluted market cap of nearly $ 1 trillion. Even if Tesla were able to increase their profits tenfold, that wouldn’t justify the company’s recent valuation without aggressive expectations of continued growth.
During Tesla’s recent earnings call, Musk felt that the stock remains reasonably priced considering the profit potential of Tesla’s full autonomous driving capabilities.
… [I]f Tesla’s ships, say, hypothetically, vehicles worth $ 50 billion or $ 60 billion, and these vehicles become fully autonomous and can be used … as robotaxis, utility goes from an average from 12 hours per week to potentially an average of 60 hours per week. … [L]and let’s just assume the car becomes twice as useful … that would double the company’s revenue, which is almost entirely gross profit. … [I]It would be like … having $ 50 billion in extra profit basically because it’s all software.
In short, Musk argues that the FSD capability will make every car Tesla builds considerably more valuable because it can be used more than a personal vehicle. Musk believes Tesla will capture that extra value as near pure profit, resulting in a massive profit inflection that would allow the company to make tens of billions of dollars a year in just a few years – with plenty of room to keep growing.
Image source: Tesla.
It’s a giant mistake
Alas, this “plan” is built on a mistake. First, while typical car owners may only spend 12 hours a week in their vehicles, actual taxis are used much more often. In New York, for example, some taxis are used for double shifts and can run 100 hours a week (or even longer). These vehicles are not more 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 rideshare market will reach $ 260 billion this year. This represents a huge opportunity, but reaching $ 50 billion or more in revenue will not be easy. It will take time for the robotaxis to disrupt the traditional ridesharing and taxi markets. And even when they do, Tesla will face stiff competition as there are plenty of other companies hoping to roll out robotaxi services as well.
Robotaxi services can generate higher margins than car manufacturers in the long run. However, Musk’s implicit assumption that Tesla could double its revenues with minimal incremental costs – thereby earning pre-tax margins of 50% or more – is clearly wrong. If Tesla set its robotaxi prices high enough to earn such high margins, competitors would undercut it and steal its market share. This competitive dynamic will severely limit the opportunity for further profit from using Teslas as a robotaxis.
Look at the core business for Tesla’s value
Many Tesla Bulls expect the company to become the world’s largest automaker within 10 to 15 years, delivering 10 million or more cars per year. If Tesla can achieve this while hitting double-digit auto operating margins and developing lucrative side businesses in solar, batteries, and robotaxis, Tesla stock could certainly reach its valuation over time.
However, investors should not rely on robotaxis as a magic bullet that will make Tesla massively profitable overnight. Tesla may develop a nice robotaxi business in parallel, but the growth of the core auto business will determine whether Tesla’s stock continues to skyrocket or falls back to earth in the coming decade.
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