Friday, September 6, 2013

Tesla: A Follow up

My post on Tesla must have touched some nerves because I got more than my usual share of backlash from Tesla bulls. While some of it was just vitriol, many contained interesting counter arguments to mine. I thought it  would be useful to play devil’s advocate and present the case for being bullish on Tesla. I have to tell you that I was not able to convince myself but I may convince you.

Before I make the case for Tesla bulls, I would like to be clear on two points. First, I have no economic or emotional stake in the outcome of the valuation. I don't have a short position on the stock, and don’t plan to, and I have never owned Tesla and don’t regret missing out on the run-up either. Second, notwithstanding the hyperbole that has prefaced some of the press descriptions of my post, I don’t consider myself a valuation guru, expert or prognosticator.  If you are bullish on Tesla, I don’t view you as a sucker or a dunce and I can think of at least three justifications for your bullishness. 

A. Tesla has viable paths to higher value: In presenting my estimate of value for Tesla, I thought I was fairly explicit that it was “my” valuation and not “the” valuation of Tesla. One reason I posted my spreadsheet and left it open, for you the change, is because I understand that there are and always will be differences of opinion on the future of a company, especially one as explosive as Tesla. As I see it there are three possible paths to a value higher than the current price. 
  1. The disruptor: It is possible that Tesla is one of those rare companies that disrupts an entire business and changes the definition of what comprises success. Just as Amazon upended the retail business and Apple the smart phone business in the last decade, it is possible that Tesla will create a new paradigm for a successful automobile company: a company that generates Ford-like revenues with Porsche-like margins. (My valuation for Tesla, the disruptor)
  2. The power train/battery master: I may have misclassified Tesla as an automobile company and that it’s real innovations are in the power train and battery technology that will make electric cars viable. Ted Lim, one of the commenters on my Tesla post brings a great deal more knowledge than I do to this possibility and he points out the potential for Tesla to become the supplier  to other automakers making electric cars. The potential market for batteries and other original equipment may be smaller than for cars but the margins may be better. (My valuation for Tesla, the OEM company)
  3. The "first mover": If Tesla is more technology than automobile company, there is the possibility that if it can establish itself as the leader in the business, there may be a tipping point, where size feeds itself. In practical terms, you are arguing that if Tesla charging and service stations are more extensive than the competitors, buyers of electric cars will be more likely to buy Teslas, thus making it the "electric car" company. (My valuation for Tesla, the network winner).
While I view these paths as narrow and difficult to sustain, I can see why others have a different point of view. There is one note of caution I would add about profitability. Some of you have pointed out that Tesla already has a 25% profit margin and that my assumption that it will generate a pre-tax margin of 12.5% is therefore way too pessimistic. There are two reasons to not get carried away with the current margin. The first is that margin that Tesla is reporting is a gross profit margin, which is significantly higher than an operating margin or a net margin; there is many a cost between the gross and the net. The second is that having a high gross margin, when you are selling relatively few cars at a high price is easier to do than maintaining that margin as you scale up. 

2. Tesla is a pricing game, not a value proposition: When stocks are up four fold or five fold, as Tesla has over the last year, they attract a different class of investors and what happens to the stock price may be more a reflection of what I call the pricing game, rather than underlying value. In two earlier posts, one after the Facebook IPO and one early this year on Apple, and argued that the pricing game is characterized by two features. The first is the ebb and flow of momentum will cause prices to move with investor mood shifts; remember how quickly the momentum game shifted against Apple in September 2012. The second is the supremacy of “incremental information”, where small pieces of news, that have little effect on long term value, have an outsized effect on price. Thus, the story that Elon Musk (who has been masterful at directing the price game to Tesla’s benefit) will be driving across the country in a Tesla S (to show that the car has the range to do so) will get news coverage and may affect the stock price. While I am a believer in long term investing based on value, I have a great deal of respect for the pricing game and recognize the dangers of getting in the way of momentum, at least in the near term. I also know that there are others who are far better than I at playing this game and don’t begrudge them their profits. Thus, if you have been playing this game with Tesla for the last year, you not only have the profits to show for it but also my respect. 

3. There may be a “strategic” buyer for Tesla: This may be cynical of me, but I think of strategic buyers as buyers who first decide that they absolutely have to buy a company and then come up with a price to make that a reality. Since the decision to buy is made before the price is set, it should come as no surprise that strategic buyers tend to pay too much. In the context of Tesla, it is obvious that every large automobile company wants to be the winner in the "electric car" race and will invest large amounts to succeed. While Toyota, Daimler and Ford may all be trying to do this internally, at the moment, history also tells us that patience is not a strong suit in most corporate boardrooms and that one of these companies will probably feel the urge to move faster and spend more. At a market cap of $20 billion, Tesla may seem to be too large a target but as I noted in a series of posts last year, good sense seems to go out of the window in the acquisition process, and more so with large acquisitions than small ones. If Tesla is acquired, you can rest assured that Mr. Musk will extract a significant premium over the market price, even if that price itself is substantially higher than value, and that the acquiring company (and its bankers) will come up with nice buzzwords (control, synergy) to explain it away. 

I hope this post does not come through as defensive. I stand behind my judgment of value for Tesla in the my last post, but all I would take out of that valuation is that I would not buy Tesla at today’s price. Given my fear of getting whipsawed in the momentum game, I would not sell short either. It was not meant to be investment advice.  I am a firm believer that investors have to take responsibility for their own choices and I will respect yours. Thus, if you are a long-term investor in Tesla, because you believe that there are viable pathways to a value higher than the price, I understand your motives. If you are a trader who is playing the pricing game with the stock, I can tell you that I wish I could play that game as well as you do, but I stink at it. So, I won't even try. In closing, though, if you are a Tesla bull and you feel threatened by a blog post from me, I think you may be a lot less secure in your bullishness than you think. 

69 comments:

Anonymous said...

Can you do a DCF for the hyperloop? Even if you could, it would be GIGO.

Buffett once famously said, that if he was teaching a valuation class, he would ask his students to value an internet company, and if any of them claimed they could, he would give them an F.

Tesla fits into that same class of investments.

At a $20B valuation, Graham's concept of "margin of safety" no longer exists in the stock price.

Aswath Damodaran said...

It is a cop out to claim that you cannot value young, growth companies. You value them with a lot more noise. So what? The market is trying to deal with the same uncertainties and come up with a price, which comes with its own distribution.
I think your odds of finding a bargain are much greater with these companies is greater than your odds with a nice mature company. Of course, your valuation is going to be a lot more precise, but so is the price.

Sam Cornwell said...

Regarding the acquisition of Tesla Motors (which Elon Musk has made clear will not happen at least until mass-market production has begun) would you not consider tech companies like Apple or Google to be more aligned with Tesla's ideology? These companies have huge stockpiles of cash and could justify a $20bn purchase on a company that has taken 10 years to build and is currently making almost every internal combustion engine in the world look bad.

Alternatively $10bn for Tesla Motors is a bargain to an innovative company like Toyota or Honda.

Rohit said...

Professor,
It is funny how many ultra optimistic assumptions are necessary to justify this price. BMW sales with Porsche margins in 10 years, yet only 25% upside from here. Tells the entire story.

Having learnt basics of value investing from your blog and many other kind people on the internet, I can't help but noticing how polar opposite the valuation assumptions here are compared to the assumptions made when we value say MSFT. There you have to assume sustained value destruction, sales slowdown, margin compression and sometimes you can't kill the thing even then.

I came to the same conclusion you did regarding TSLA. The best valuation (I did a more simpler one i admit) I could come up with was around $200 a share and then decided I won't short it because I did't want to stand in front of a train even if I felt it had run out of fuel. Equally greener money to be made elsewhere I suppose at much lesser risk of capital loss.

If I had a gun to my head to short this thing, I would assume Ford projected 2023 Sales and Porsche 2013 margins to come up with a valuation. Add 20% margin of safety to that and that would be the price I would begin shorting at. So probably never !

Anonymous said...

"It is a cop out to claim that you cannot value young, growth companies."

It's not a cop out at all. Ask Rupert Murdoch how his valuation of myspace went (he paid $500M for it). A lot of these young internet companies - pets.com, were "young growth companies"-until they went BANKRUPT.

What you're missing in your valuation is adaptability to CHANGE. You are assuming a predictable ramp of sales and profits in an industry that will probably be the most prone to change, something which makes absolutely no common sense.

"I think your odds of finding a bargain are much greater with these companies is greater than your odds with a nice mature company."

If this is true, as you claim, why is it that the great billionaire investors like Carl Icahn and Warren Buffett love to invest in mature, established companies? Beacuse if you're a real businessman (as opposed o a VC pump and dumper ala facebook), you want a mature business with fat profits and MINIMAL competition. One thing I can GAURANTEE you with Tesla is that there will be anything BUT minimal competition. In your analysis, you didn't even mention BYD and its battery technology, which is almost inexcusable.

In essence you are valuing Tesla in a bubble, as though it's the only company on the planet and one immune from competitve forces. Basically a castles in the air valuation.

Rohit said...

Anonymous (the one who commented after me)-
Dude, try to understand the intention behind professor's post. He was just trying to show the assumptions behind the bullish case. He even admitted that he couldn't convince himself of the assumptions he made!! Don't give him grief now for trying to placate the bulls.

I think you are reading the wrong post. This was not meant for you. The one he made couple of days ago, that's the one for you :)

Anonymous said...

Professor: can you do a valuation of Dex Media (ticker symbol: DXM).

@Rohit: Grow up. You have no right to tell me what to read, what not to read, what to say and what not to say. I bet you have a little brother or something to boss around, get on it.

Aswath Damodaran said...

Rohit,
I think that the previous post won't help either. The point that Anonymous is making is that companies like Tesla can never be valued because there is too much uncertainty in the future and that they are always over valued. I am confused how you come to the second conclusion if you assert the first one.

Thomas Lee said...

No need to be aplogetic in your article as your tone implies. I full agree with all you say. Currently the stock is taking a life of it's own based purely on momentum. Time will tell if TSLA becomes a disrupter/game changer but even if it reaches that pinnacle you will have other auto companies trying to penetrate TSLA's own market that it built such as a BMW, MB, Ford, GM, etc.
Based on a value standpoint best to stay away both long and short.

Rohit said...

Anonymous - sorry dude if my tone was perceived as bossy. My comment was meant as a joke. Lesson learnt!

Professor - Curious to know your thoughts on NRCIA/NRCIB valuation scenario. It is not a business valuation question, but more of a share class valuation question.

Anonymous said...

Mr. Damodaran congratulations not only for your very sound valuation of Tesla, but also for giving it to the public for free.
Also, I would like to congratulate you for sharing your valuation classes and the accompanying material.
It is magical that we can participate in a teaching of such a quality. I feel truly obliged, thank you.

(A Greek Fan)

Anonymous said...

When a stock costs 60%/year to borrow (as Tesla briefly did in May), you know for sure it's not being priced on fundamentals.

Anonymous said...

"Rohit,
I think that the previous post won't help either. The point that Anonymous is making is that companies like Tesla can never be valued because there is too much uncertainty in the future and that they are always over valued. I am confused how you come to the second conclusion if you assert the first one. "

Well if one looks at investing/valuation in the Benjamin Graham sense, Graham preached (and Buffett has many times confirmed) that the central concept of investing is margin of safety. Graham was a street fighter who lived through the great depression and saw the evaporation of earning power in companies once thought to be indestructible. Therefore Graham's risk aversion, diversification, and insistence on bargain purchases.

And as Buffett said, you don't buy dollar bills for 95 cents. You buy dollar bills for 50 cents.

Now a company like Tesla may be worth X, or it may be worth Y. You can do one of two things: (a) claim to know its value; or (b) claim that you can't value it (for the reasons stated in earlier posts). I would add that I would choose (a) or (b) not on the basis quantitave factors like the company's age, rate of revenue growth, etc., but on qualitative factors, such as product line, nature of competititon, and so on, and in each case these quantitative factors are subject (ie to mean Monster beverage has more favorable qualitative characteristics than Tesla-but others wouldn't agree nor would I expect them to).

Either way, if you adhere to Graham's principles, you only pull the trigger when there's a margin of safety. I pick (b) and so there really can't be any margin of safety in Tesla, for me, in its current form. Were Tesla to demonstrate some sort of earning power or asset base that would enable an investment with a margin of safety, the thesis would change. But if, as you claim, you can WITH A HIGH DEGREE OF CERTAINTY value Tesla at $60 odd dollars per share, more power to you. My point was simply that I saw nothing in the valuation to suggest anything closely resembling that degree of certainty (subjectively), let alone a sufficient margin of safety.

But these are subejctive analysis and I apologize in advance if I ruffled any feathers, I merely enjoy having these spirited discussions and have the highest respect for a Professor who doesn't confine himself to an ivory tower as easy as that may be.

tb said...

For those out in the bullish camp, I must ask if you have any idea on how long it takes to ramp up production and all the distribution chain, plus the structure growth to handle all that. Many are classifying what is in fact an industrial company has a tech company. But this company needs factories to actually delivered sales from its R&D/IP. So either someone with the capabilities in place to scale it up rapidly buys them soon, or I can't phantom how they will achieve the production needed to deliver the sales figures implied by even modestly bullish expectations. I for sure haven't seen any statement by EM that would give credibility to those estimates.

anonymous2 said...

How much branding/marketing played a role as to move Tesla at the present stage? Is it the iron-man Musk image thing? Indeed the powertrain is the core technology yet in comparison there are many companies(ARTISAN, wrightspeed(founded by a tesla co-founder), via motors etc.) who offer only powertrain, but they struggle to get funding from VCs or 80% population never heard of nor they made much into the news.

Aswath Damodaran said...

Anonymous,
You seem like a serious value investor. So, let me try to engage you. You offer two choices, claim to know the value and concede that you cannot. I would offer a third choice: I can try to estimate the value, which is exactly what I did at Tesla.
I am surprised that you view my estimate as having a high degree of uncertainty, but the distribution of values that I put up for my estimate towards the end of the last post reveals how much uncertainty I feel about the estimate.
In fact, I like the notion of margin of safety (at least as Seth Klarman describes it) but I use my simulation results to set how big the margin has to be. With a company like Tesla, where the uncertainty about value is high, the margin of safety should be higher. With a company like 3M, where I feel much comfortable making my estimates, I would use a lower margin of safety.

Jason DaCruz said...

@Anonymous -- it is impossible to definitively value any company. Such is the nature of the world we live in, and the source of excitement in finance.

Also -- it's probably worth noting that Carl Icahn's investments in mature companies are a sign of his older age, and massive capital base. You should probably read up on him.

Something similar could be said of Buffett. But please don't forget how hypocritical he has been wrt valuation: Berkshire owns and otherwise has exposure to many derivative products that are subject to similar variability and valuation difficulties.

@Rohit -- I would really love to see how you arrived at the $200 valuation. I think this is a market-can-remain-irrational-longer-than-I-can-afford-to-buy-puts type of scenario.

Rohit said...

@Jason- See my instablog on Seeking Alpha below. I get to 150ish there. Then I did a bit more of stretching and tried to be more optimistic to get at 200.Admittedly it was a much more simpler exercise than what the professor did here.

http://seekingalpha.com/user/1535381/instablog

Anonymous said...

Trying to understand the "margin of safety" concept...why would a diversified investor need a margin of safety? If Tesla is 0.01% of my portfolio, why does it matter whether the outcome is uncertain?

Devan Stormont said...

2. The power train/battery master

I would have agreed with this strategy before they went public; this was largely their publicized strategy until they started filing to go public. While I'm still very much in favor of their engineering and marketing efforts, it seems to me that they abandoned this path to take the chance to be a larger manufacturer when they went public.

kai xiang said...

To anonymous,

if tesla is only 0.01% of your portfolio, why do you bother to long it.

margin of safety is just a value investor's concept of buying things on the cheap, as no one can be sure of his estimation of the intrinsic value of any securities.

Anonymous said...

Elon Musk's cross-country trip is not a manipulation. The guy knows that the next step is to put people, who are worried about buying a car that won't let them drive wherever they want, at ease.
It is very smart (not manipulative) of him to demonstrate that it is possible to take long trips without worry. (Also, he is a genius because this way he can do business and spend quality time with his kids, but that's besides the point.)

Yes, he will get a lot of free advertising, but he is not asking for it. He knows that people, including journalists, are interested and will pick up on it.
If you want to see manipulative CEO's you should look among the big shots who keep lying to us until it is obvious how incompetent they are (BP CEO).

Why don't you just admit that there is academic knowledge and then there is psychology and then there are situations that are exceptions from the rule?

How much do you think Ford's first care has cost? How about the first airplane? First railway?
You don't buy a house and say your first day you lived in it cost you 200,000. Yes, it theoretically did cost you that much, but you are investing in long term.

Aswath Damodaran said...

Did I claim that Musk's cross country trip was manipulation? I just said that, in the larger scheme of things, it does not impact value much. And I am not admiring his capacity to shape the narrative, just as I have admired Bezos doing the same at Amazon.
As for exceptions to the rule, of course. But the question you have to ask yourself is this: if you price a company to be an exception to the rule right from the start, where is your upside?

Richard Vijay said...

Prof Aswath, Its a very interesting article, i have been following both your articles and feedbacks.

Your comparisons and explanation on automotive industry must be appreciated.

Keep writing, we would love to see more numbers, references.



I was wondering what if, if T starts to change its business model and starts supplying its innovative 'battery' and 'power train' to other OEMs, cutting into ref : http://www.ranker.com/list/the-best-auto-engine-brands/werner-brandes )

Few of the automotive non-OEMs are larger and better than OEMs, isn't?



Disclosure: My own views and no way related to any employer or biased any interested parties. Purely its a mark of acknowledgement of ideas or views or discussions, which i found interesting.

Anonymous said...

"I think your odds of finding a bargain are much greater with these companies is greater than your odds with a nice mature company. Of course, your valuation is going to be a lot more precise, but so is the price."

"Also -- it's probably worth noting that Carl Icahn's investments in mature companies are a sign of his older age, and massive capital base. You should probably read up on him."

I find this sentiment that "young growth" (whatever that means) companies are somehow better bargains than other companies odd to say the least.

If you look at Icahn one of his first conquests was a REIT, which he later renamed Bayswater Investment Trust. Among Buffett's first investments were GEICO, another insurance company, and a windmill company named Dempster Mill. The great Cornelius Vanderbilt invested in the NY and Harlem Railroad, hardly the Tesla of its tiem. I guess the other thing this says about these people is that they're able to extract and create immense value from (what was at the time) less than desirable assets. Icahn even did this with TWA, again not a trendsetter in any way. To me, these examples are far more interesting than the Teslas of the world. Keep in mind many of these companies weren't even traded on any markets. Yes this is good stuff, this is what I consider to be the good, interesting finance, the stuff that's the nitty gritty and not in the open and almost invisbible. I wonder if you had asked Cornelius Vanderbilt when he bought the NY & Harlem what he planned to do w/ it, I wonder if even he would've known the answer at the time.

Anonymous said...

Professor, where did you get the data set for all auto companies in the previous blog post?

Thanks,

Anonymous said...

Professor,
I'm the anonymous that made the "Occam's Razor theorem" comment on your last post and appreciate you flipping the perspective on this blog post even if you don't personally agree with it...yet.

One very important yes/no answer question and 3 others not as important:

#1)Have you driven this Model S yourself yet?

2)Did you know it's been given the best rating of any car ever by Consumer Reports and Motor Trend? (As well as other auto publications)

3)did you know it's gotten the highest safety rating of any car ever tested by the NHTSA?

4)Would your opinion on valuation change if next year when Tesla releases the Model X it has the best ratings and safety of any SUV ever built? (Ie. One might assume their Gen III car to be released in 2016-2017 has a good chance to be the best rated and safest mass market car ever too in that case)

Thanks,
EP

Aswath Damodaran said...

Too many Anoynmouses (is that even a word) to know which one I am responding to, but in no particular order, here are my answers:
1. When I say that the likelihood of a bargain is greater with young, growth companies, what I am saying is that pricing mistakes (in both directions) are larger when there is a lot of uncertainty about the future. So, young, growth companies are more likely to make both the most overvalued and the most undervalued lists.
2. The data comes from Capital IQ.
3. I have never driven a Tesla but have heard rave reviews of the car (its styling, safety and other features). Would driving a Tesla change my value for the company? I don't think so because I try to separate what I think about a company & its products from what I think of it as an investment. What will change my valuation is evidence that Tesla is cracking the mass market code and that may very well come with the great reviews.

Jason DaCruz said...

Professor, I think a good portion of the debate above could be resolved by saying: there is a difference between a good company and a good investment.

I've visited the Tesla showroom in Short Hills, have sat passenger in a privately-owned car, and only encountered positive reviews from current owners. Though there are many indications that Tesla is a good company, there are no convincing arguments that would lead me to believe that Tesla can achieve high operating margins in the future, or that it can effectively scale revenue at a lower margin, to justify its current valuation.

neroden@gmail said...

"Buffett once famously said, that if he was teaching a valuation class, he would ask his students to value an internet company, and if any of them claimed they could, he would give them an F."

Buffett can be an idiot sometimes.

Warren Buffett's principle is to only buy companies *he* understands. This makes perfect sense and is a good investing principle.

Except that *I* understand different companies than Mr. Buffett understands.

I would never try to put a value on a risky, incomprehensible company like Coca-Cola -- I don't have any idea why people buy sugar water, or what might cause them to stop doing so, or to start buying it from someone else. I don't *understand* the soda business.

On the other hand, I can value an Internet company quite easily, because I *understand* how money is made on the Internet. (eBay is particular was especially easy to value.)

"Tesla fits into that same class of investments. "

But there is no such class of investments! For every company, there are *some* people who understand it and can value it, and there are *other* people who don't and can't. It's really that simple.

Professor: I like your analysis, and I generally agree with it. However, I have intensively analyzed the electric car industry, Tesla in particular, the renewable energy industry, the fossil fuel industry, the automotive industry, and the transportation sector in general. I understand the technology, I understand the politics, I understand the psychology in the boardrooms, and I think I understand the psychology of the buyers. I've been following the global trends in transportation for decades.

And as a result, I think all three of your scenarios in this post are quite likely. If I assign a 30% probability of success to each of them, I get a 80% probability of success overall.

I also think you've missed a possible scenario. After watching Tesla reservations and looking at the global economic trends, I think the market for luxury electric cars is much larger than most people think it is. And I think Tesla has no competitors in that market for at least 10 years. Which means it's able to charge monopoly prices -- its margins should actually improve even while it increases volume to meet the luxury car demand.

This is sort of a combination of "disruptor" and "first mover", where Tesla doesn't have to succeed fully at either path, but if it succeeds partially at each, it can become *the* "electric luxury car company". With Porsche-like margins but volumes 10 or 20 times larger than Porsche -- for a decade or two anyway.

If Tesla has four viable paths to a $200 share value (your three and this one) *without* cracking the mass market, I think the odds are that it's going to make *one* of those paths, though I don't know which one.

" The great Cornelius Vanderbilt invested in the NY and Harlem Railroad, hardly the Tesla of its tiem. "

Actually, it was, in some sense, the Tesla of its time. I've studied railroad history intensively. There were lots of startup railroads; most went bankrupt. The NY and Harlem was being priced just like those other railroads, but it was uniquely well-positioned....

neroden@gmail said...

" With a company like Tesla, where the uncertainty about value is high, the margin of safety should be higher. With a company like 3M, where I feel much comfortable making my estimates, I would use a lower margin of safety."

See, this is exactly the thing. I think the uncertainty in the value of Tesla is much *lower* than the uncertainty in the value of (for example) Bank of America.

3M is admittedly more stable than Tesla, but 3M is exceptional among American companies.

Some companies with more uncertainty in their value (in my opinion) than Tesla include ExxonMobil (and every other oil company), General Motors (and every other gasoline car company), General Electric (due to its financing arm) and every bank in existence.

Volatility is not the same as uncertainty of value. The great opportunities come with volatile stocks whose value is actually pretty clear to people studying fundamentals. The big losses come from non-volatile stocks whose value is deeply obscure (like Lehman Brothers).

neroden@gmail said...

" Were Tesla to demonstrate some sort of earning power or asset base that would enable an investment with a margin of safety, the thesis would change. "

I think Tesla has done so -- or, more accurately, had done so for the stock price *before* the current runup.

There isn't that much margin of safety left with the current stock price, though there's still some; as this post shows, $200 valuations are easy enough to justify, and that's a matter of buying dollar bills for 80 cents.

More importantly from my POV, I think there is no margin of safety whatsoever on a lot of stocks which are considered "blue chip". Accordingly Tesla is a better deal than most alternatives.

Buying a dollar bill for 80 cents is certainly better than several of the investments Warren Buffett has made recently. Wells Fargo is worth precisely $0 per share, for instance, because their listed net asset value includes illegal and voidable sham mortgages amounting to more than the company's total net asset value.

But people like Buffett blithely, and blindly, "invest" in these worthless companies. I've had to cut my estimates of Berkshire Hathaway value due to his spending shareholders' money on worthless securities issued by a bank which has admitted to continuing systematic fraud. (I actually wrote Mr. Buffett a letter about some of the frauds Wells Fargo has admitted to.)

Anonymous said...

I like your valuation of Tesla, the notion that the company is highly undervalued is nothing new but it usually comes from bears who basically call bulls stupid (no real data or analysis).
However, your analysis was refreshing and made lots of sense. A textbook method of valuation backed by a brilliant guy like yourself. It took guts and I respect that. Which is why I was disappointed to see your follow-up article defending the bulls. Do you always try to please both sides? I mean did you really expect no criticism or angry wall streeters?

Anonymous said...

TSLA is leasing most of the vehicles it sells and is backing the residual value on its own books. And it keeps changing the accounting methodology behind loss reserves behind the lease residual value. This point alone is a sign that TSLA is playing accounting games. Does anyone really know what the value of these vehicles will be worth 2 or 3 years from now? Hell no..not even the experts, there's no historical basis to value these cars.

CH868 said...

"If this is true, as you claim, why is it that the great billionaire investors like Carl Icahn and Warren Buffett love to invest in mature, established companies?"

Both Icahn and Buffett invest in mature and established companies because they have too much cash. Where else can they invest to generate decent ?

Ted Lim said...

Your initial post on Tesla absolutely touched nerves from both Tesla bulls and Tesla Bears. Mainly because the media chooses to spin things the way they want and people get too emotional. Aside from that, Tesla bulls defend this company vehemently—some for monetary reasons and some who truly believe we need companies like Tesla to further the human race and business. It’s going to be another mega post so I’ll apologize in advance.
I’m going to reiterate that the posts are productive and I think your point was valuation doesn’t necessary equal value. Many of the comments I have read so far have been looking at these posts as a “be all end all” and forget that the holy grail of investing is momentum + value. The problem with this is we can’t necessarily price momentum (except with a few data points of 52 week highs—which for Tesla’s case doesn’t make sense due to squeezes, the secondary, etc.). I also agree with your ending statement that if you are swung by one person’s opinion (no matter how influential or highly regarded), the investor hasn’t done their due diligence which makes them a sheep and not a bull.

Profit Focus: I do want to build on a few things on your follow up post though. To the point on profitability, I pointed out the gross margin profit target because I feel that was the true number to peg success on. More importantly, I wanted to use the trend of GM as an indicator. I do acknowledge your point on there being many variables in between gross and net which matter, especially in expansion. Tesla was notorious in 2008 for being in the verge of bankruptcy and the auto industry is filled with failures due to lack of cost management in this area. If anybody has read about DMC, they’d know. Fortunately, I think track record is a good indication and it seems that the management team doesn’t want to be in this position again so they watch their costs very closely and focus on execution (as I stated in my previous comments). Your point is stated in many interviews with the Tesla team and seems to be hammered into its corporate DNA: improving margin while scaling up.

Pricing Game: To your point about the pricing game, news outlets fascinate me. The Elon Musk road trip is definitely not manipulation as some commenter pointed out (not sure why he accused you of this). It’s the media getting bored and our society’s focus on Billionaire’s lifestyles. You touched on a very important point bringing this up. Tesla’s Marketing budget is nonexistent. They’ve been able to sell all these cars without any type of push strategy. Headlines like this are the marketing. It makes people scratch their heads and go: Tesla? This question will direct them to Google then to the store. We’re going to be seeing headlines like this for a while, as there is no need for Tesla to push for more demand through traditional company methods due to supply constraint. Your post was an unintentional marketing tool (think about it).
--Continued

Ted Lim said...


Strategic Buyer: Case in point for this was Microsoft and Nokia this past week. We saw MSFT shares get hit on the acquisition. There absolutely will be a significant premium if Tesla is bought out, but I am doubtful of this happening due to the incumbent automakers’ conflict of interest and hubris. This is one of the main reasons why larger licensing deals haven’t taken place. Too many automakers didn’t see Tesla as a threat and laughed it off (in some cases it continues). There’s too much pride in the auto industry—we saw this very recently with Hyundai—nobody took them seriously, and look where Hyundai is now. What more an electric vehicle company. To another comment about a large Technology company buying Tesla—I see this as a stretch of imagination and if the technology company bought it I’d short it after asking the question: What business are they in? There was a post in the WSJ about why Apple should buy Tesla which I thought was ridiculous. Cars are arguably the second biggest purchase of a normal consumer’s life, it’s not Apple’s business.

The only scenario where I see Tesla being sold is if Musk really sees that the acquirer would really facilitate widespread electric vehicle adoption. Nobody on any leadership board of any automaker has expressed true interest of a petrol-free future. They should, but they won’t—at least not yet.

To end, I think that the message of your last paragraph needs to be taught in more classrooms. Invest in what you know and form your strategies based on that. There’s too much focus on just making money which tempts people to make bad decisions. I look forward to reading future posts—Tesla or not.

Dr. Adrian Teja said...

clear and concise explanation, two thumb up

Calvin said...

Once again, you have Tesla's margin wrong (you are looking back rather than factoring the margin improvement trend) and you have Porsche's margin wrong.
Your follow on aside, it still takes arrogance to publish what you did without (by your own admission) doing the adequate research.
Maybe you don't understand the technology or you lack the imagination to see the potential future for Tesla.
Market is a discounting mechanism which tries to discount the future.
Tesla could be way undervalued if it can execute on it's five year plan.
There is no reason why Tesla can not become more profitable than BMW which will make about 8 dollars a share next year and has an enterprise value of 109 billion.
THis may shock you nut Tesla will make over 7 dollars a share next year (my estimate).
We will see if I am wrong or right.
If I am right, you can look forward to a lot Of "thank You" emails.
This is one stock you may regret manipulating.

Anonymous said...

I am a Tesla Bull...whatever that means. Maybe Tesla Bulls are just realists and Tesla Shorts are pessimists or ignorant. Ths stock is clearly a different animal than any other stock out there right now, and will be for some time to come.
I believe the Professor has good intentions, but clearly he is a bit ignorant (those who are ignorant on something don't realize they are ignorant by definition) not having even driven the car himself before. Neither did he sufficiently study their battery technology or he'd understand that they own this space for a long time because they are 5 years ahead at least in their battery technology Intellectual Property alone.

Overall, I consider myself a realist and believe Tesla will be a mega cap company within 5 years and the stock will go over 1000 in 5 years.

Stefan said...

Dear Aswath consider my bull case. You very rarely see the same kind of product made with two completely different technologies compete in the market place, unless the two technologies can serve different use cases. That is because if they are to serve the exact same function, one will always be at least slightly better than the other. Electric propulsion used to pretty much only serve a "green niche," but it has evolved very quickly this past decade and now it competes with high class vehicles because of the merits of the powertrain alone. In fact the Tesla electric powertrain is superior by all metrics I can think of (safety, center of mass, acceleration, responsiveness, gearless, service, noise, handling, energy cost) except for charging, range and price. Range is almost as good and charging is not directly comparable to filling up the tank with gas, and some can argue otherwise, but I will argue it is superior because you spend net less time per year charging at a fraction of the price.
As for the price, it has been dropping fast and if it drops below or near the price of a combustion engine powertrain, that propulsion technology will become obsolete, which would leave Tesla with a 5-10 year head start plus a bunch of patents and would completely change the paradigm in the car market. Sort of the Apple-Nokia smartphone scenario.
In my view, the most predictive thing for a company’s success is the quality of its product (price included) and it’s CEO and that's why I bought TSLA 9 months ago. With the specs of the car Elon suggested back then, I could not see how it could not become a huge hit. The same goes for the next generation much cheaper vehicle, Elon says the will initially aim at 500,000 vehicles, but long term I see demand as exceeding that manifold (given the expected specs). The same goes for model S, when everyone gets to know about it there are few reasons to get a BMW for example. Those niche reasons include brand loyalty or loving combustion engine sounds or simply being conservative.
Conclusion, right now (Tesla) electric powertrains outcompete combustion ones on performance, but at a higher price, therefore they will come to dominate performance cars. Electric powertrain prices are still dropping in price and if the trend continuous it will be the propulsion technology of the future.

Calvin said...

This is not that different than evaluating APPLE when the Iphone came out. They kept compering it to Nokia and saying the phone business is worth X amount or this is a fad, they will sell one million at the most.
The rest is history.
This gentleman lacks the vision to see the potential in TESLA.
He has assigned no value to TELA's IP.
They didn't come up with a car that has won multiple awards by accident. Nor is it by luck that TOYOTA and MERCEDES use TESLA as a supplier or that the car price is going up while outselling all luxury cars where available.
Safety and Margin expansion are designed in to the car which of course you can't expect a number cruncher to understand.
I can't count the number of negative articles in Barrons published at the time about APPLE just like the negative articles now about TESLA.
If you are an investor in TESLA, the good news is most analyst have this wrong as well.
Do the math and you'll see how far off the revenue and earning estimates are.
The professor can publish his spreadsheets and get his five minutes on CNBC.
Barrons and WSJ can write as many negative articles as they want.
Revenue and earning growth is ultimately what drives the stock price.
They think it is a "Price game" and momentum play.
That is because they can't even do math.
Tesla is going up cause the estimates are too low. when the analyst finally catch up and raise their earning and revenue estimates and the heard follows, the market has discounted what the investors are discounting today.
Of course the professor will not admit anything, he will stick to his valuation model.
But then again who cares.

At the mean time this will give shorts some legitimacy to push their luck and will result in volatility or maybe even a sell of.
Use it as an opportunity. Companies like TESLA don't come around very often.

Josh H said...

For the 'tesla bulls' out there, I think the biggest concern is how do they get to the third generation mass market car.

From what I have read (granted they are rumors), the current battery pack costs 30k. Battery technology is increasing but I am skeptical that the price could be cut in half over the next few years.

One idea I have seen floated (but not any data/science behind it) is that capacity increases, which then has the added (or secondary) effect of less weight.

I just do not see how the price of the battery packs in total goes to say 15k to have the ability to make the third generation car.

Of course the argument next is if they do get to that cost, are all the cars that Telsa leases worth a lot less?

Tom said...

And here I was thinking after the first post already that the assumptions were very optimistic.

However, I took away the reasons the assumptions were applied, and this is the real valuable input of this post: some took the time to lay out its rationale for picking a number over another.

Do I hold different views, sure, and why not, but I still love to hear with Prof. Damodaran has to say, as it is something I can challange my thinking with.

Anonymous said...

Hello Prof., One doubt on terminal growth assumption. It is generally accepted that terminal growth rate assumption should be in range of 2%-4%.I read your post on linking terminal growth assumption to Risk free rate of that country ( if it has revenue exposure in domestic market. So in that way, in case of Japan; if yield is in range of 0.70%, should we cap our terminal growth assumption to 0.70%. Or in case of emerging market like India; where risk free rate comes to roughly 6.25% ( post adjusting default spread insurance), should terminal growth rate be in range of 6% or 6.25%. What should we assume in such cases, as we should not play with discount rates.

Azam said...

Hello Prof.,
Thank you for the great blog. It seems sometimes you cannot satisfy neither the bears nor bulls.

On another note besides Tesla, your first comment included "I think your odds of finding a bargain are much greater with these companies is greater than your odds with a nice mature company. Of course, your valuation is going to be a lot more precise, but so is the price."

What are the characteristics of the perfect small growth company for you? Can you provide us with names? Kindly note that I am not talking about valuations?

Anonymous said...

Models are great if you know what to put in. But what are reasonable inputs here?

You can more than triple equity value just by changing assumptions, all of which could be reasonable in the context of the disruption of the internal combustion engine.

I am not sure what the inputs should be be, but I am fairly sure that using Gaussian distribution to asses the likelihood of growth an profitability for someting like Tesla is a dangerous.

If anything, this time IS different!

tb said...

All this "name calling" (stupid, idiot, etc) is really an eye opener for how much emotions count when it comes to investing.
Most (basically all) negative comments both on this and the previous post, claim a lot of important factors have been left out. But, up until now, we haven't "seen" a single person stating how much they could be worth (either in the form of a present value or future cash flows). All qualitative factors must be translated into to a number to count. Otherwise, they are totally worthless.
Btw Josh point on batteries is very interesting given only by penetrating the "mass" segment can Tesla's revenues shoot up.
Salutations

Anonymous said...

tb, you are wrong, the name calling comes from the shorts much more so in any positive article written n Tesla.

Josh H,
where do you get this 30k number from? That is entirely wrong as well.

Professor,
It looks like evidence has just come in today of your scenario for above $200 price target I thought was least likely of the three (although still thought it was above 50%).

news: Daimler CEO this afternoon announces they will use Tesla's drivetrain for their compact B-Class vehicle.

Further, you have received quite a bit of civilized attention from Tesla bulls on the Tesla Motors Club board:
http://www.teslamotorsclub.com/showthread.php/21173-NYU-professor-on-TSLA-valuation

Wisdom Guy said...

Looks like you should have educated yourself a bit more on Tesla's business model before you made you $67 prediction of value given that your 3 other valuation models have higher odds of occurring than your model. http://www.streetinsider.com/General+News/Daimler+to+Use+Tesla+%28TSLA%29+Drivetrain/8670904.html

Further, you are still missing the most important share price scenario in your model, where Tesla becomes all three, the disrupter, the oem, and the network dominator.

It's a shame, because now you are on record as calling for a $67 share price and when Tesla becomes the most profitable car company on the planet with the highest margins on the planet, it will make your call on Apple look just like it was dumb luck. Next time, understand the effects of disruptive companies such as Tesla and consider it before making yourself look bad.

Anonymous said...

TROLL:

In Internet slang, a troll is a person who sows discord on the Internet by starting arguments or upsetting people, by posting inflammatory, extraneous, or off-topic messages in an online community (such as a forum, chat room, or blog), either accidentally or with the deliberate intent of provoking readers into an emotional response or of otherwise disrupting normal on-topic discussion.

Experienced participants in online forums know that the most effective way to discourage a troll is usually to ignore it, because responding tends to encourage trolls to continue disruptive posts – hence the often-seen warning: "Please do not feed the trolls".

-------------

Best regards,
Alex

Anonymous said...

Professor has never driven the car?? Hmmm....

Stock Chump said...

I specifically said that I only heard rumors about the cost of the battery pack did not know what the actual price was. I was hoping that someone could give me a better number (even if it is only a logical argument rather then a source or quote) that would make me more comfortable that Tesla could produce third generation cars at 30k and make money.

I spent a little more time searching around and found an article that quotes a Tesla exec written recently (8/2013)

http://www.technologyreview.com/news/516961/how-tesla-is-driving-electric-car-innovation/

Using those number if we were to say that the battery pack today costs 20k (for 200 mile range and 25k for 280 mile range) and the price tag can go down 10% a year, it might be possible to get the battery pack cost down enough to make a 3rd generation car at 30k. I am still skeptical, but less skeptical than before.

I think it is more likely that the car costs 40k (or 50k with a better range), but that is cheap enough for a lot of volume (vs 30k and massive volume).

There will still be a problem with the old cars, does Tesla take a loss on the leased cars? Who wants to buy a 3 year old sedan for 50k (with battery depleted mileage) when you can buy a new car with same or better range at a lower price.

Stock Chump said...

Using the most aggressive assumptions I could come up with, I came up with a valuation of $122.

louis said...

Dear Professor, nice analysis just considering the today auto sales.TSLA is very innovative and they have very valuable patents . Tesla is about future and they continue to innovate. TSLA showed first model-S in 2009,and they are in commercial stage since then. Other auto makers still struggling in research stage and they began to realize that we may not catch up with tesla right away, but let us use the technology developed by tesla (Mercedes Benz for example). which can generate lot of revenues. No body knows How long it will take for other auto makers to catch up... since it has been already 4 years. where is the competition for TSLA? is it still extremely over valued ?

louis said...

Dear Professor, nice analysis just considering the today auto sales.TSLA is very innovative and they have very valuable patents . Tesla is about future and they continue to innovate. TSLA showed first model-S in 2009,and they are in commercial stage since then. Other auto makers still struggling in research stage and they began to realize that we may not catch up with tesla right away, but let us use the technology developed by tesla (Mercedes Benz for example). which can generate lot of revenues. No body knows How long it will take for other auto makers to catch up... since it has been already 4 years. where is the competition for TSLA? is it still extremely over valued ?

Alexander Veysov said...

Dear Aswath,

Please consider this article:

http://www.bbc.com/capital/story/20130904-the-end-of-apple-as-we-know-it

There is some indication that Apple is losing its market edge.

BR

CH868 said...

"Overall, I consider myself a realist and believe Tesla will be a mega cap company within 5 years and the stock will go over 1000 in 5 years."

ROFL !

Anonymous said...

CH868 - ha (smirk), not sure what your laughing so hard about but I hope your shorting it if its that funny, its already 20% there at 20bn market cap...maybe you think Tesla is a one hit wonder? I think the joke is one you if you short it.

Sanola Jerry said...

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Gerard said...

WHY THE ELECTRIC CAR NEVER LEFT THE GOLF COURSE FROM THE 1950S, INDIAN PCO TELEPHONE BUSINESS MODEL KEY?

http://gerardjrego.com/2013/09/19/why-the-electric-car-never-left-the-golf-course-from-the-1950s-indian-pco-telephone-business-model-key/#comment-8

Amit T said...

Prof. Damodaran,
My rather unscientific view of TSLA's valuation is this:

Value without Elon Musk at the helm: $67
Value with Elon= Tesla + vision of future with yearlong vacations to Mars, solar cells on all rooftops, electric cars you can drive around without giving up iPad time+ reusable rockets electric jets, fusion reactors ('they need to be really big to work'), hyperloops and living in SciFi movies= stratospheric.
Would TSLA be trading at $190 (today's price) if Elon said he was walking away from it all to buy himself an island instead of retiring on Mars? Answer: No chance. The vision is worth the extra $123, no?

shahadat hussain said...

By the end of the 1960s, pension funds,
insurance companies and individuals owned 67% of all the shares on the Share Market.
But today they are just minnows next to the global hedge funds that really control Britain's companies.

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Salim Reza said...

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Dany Armas said...

Thanks Professor Damodaran for sharing your valuation. when I made my valuation I found also Tesla was overvalued. Your precise analysis boosted my confident and decided to get short on TSLA. Now I have already paid my MBA with the profit.
Definitely value investment works and thanks again for sharing your knowledge of this fantastic philosophy.

Dany

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Mr. Damodaran,

I so appreciate your writings.

Will you please give me the phonetic description of your name?

Thank you very much.

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