Last May – when Tesla (NASDAQ: TSLA) Shares traded for about $ 150 on a split-adjusted basis – CEO Elon Musk opined on Twitter that Tesla’s stock price was likely too high.
Tesla’s stock price is too high
– Elon Musk (@elonmusk) May 1, 2020
As Tesla’s stock continued to rise throughout the rest of 2020, maintaining its massive profits, Musk began to change its tune. By the time Tesla released its fourth-quarter earnings call last week, the stock had more than quintupled from levels that Musk had considered “too high” less than a year ago. Nevertheless, the Tesla CEO put forward an argument as to why the imminent arrival of fully self-driving technology would justify the company’s high valuation.
There is only one problem: Musk’s entire argument is based on a fallacy. Let’s take a look.
Elon Musk Mathematics
Last year, Tesla’s auto sales hit a record $ 27.2 billion, and the company posted GAAP operating profit of $ 2 billion. Tesla expects to grow dramatically from that base. It expects to increase its short-term vehicle deliveries by approximately 50% per year on average as it increases battery and mounting capacity, localizes production and introduces new models.
Based on Tesla’s closing price on Wednesday of $ 864.16 and diluted shares of 1.124 billion shares, the company had a fully diluted market capitalization of nearly $ 1 trillion. Even if Tesla could increase its earnings tenfold, it wouldn’t justify the company’s recent valuation without aggressive expectations for continued growth.
During Tesla’s recent earnings call, Musk believed the stock would remain reasonably valued considering the earnings potential of the full self-driving capabilities Tesla is building.
… [I]f Tesla’s ships are, say, hypothetically, $ 50 billion or $ 60 billion worth of vehicles, and those vehicles are becoming fully self-propelled and can be used … as robotaxis, utility increases from an average of 12 hours a week to possibly an average of 60 hours a week. … [L]Let’s just assume the car becomes twice as useful … that would again double the company’s sales, which is almost entirely its gross margin. … [I]It would be like … have $ 50 billion in incremental profit on that, because it’s just software.
In short, Musk argues that FSD capabilities will make any car Tesla builds significantly more valuable, as it can be used more than a personal vehicle. Musk believes Tesla will capture that extra value as near-sheer profit, allowing for massive revenue twists that could allow the company to make tens of billions of dollars annually within a few years – with plenty of room to keep growing.
Image Source: Tesla.
It’s a big mistake
Unfortunately, this “plan” is based on a misconception. First, while typical car owners may only spend 12 hours a week in their vehicles, taxis are used much more often. In New York City, for example, some taxis are used for double shifts and can run 100 hours a week (or even more). Those vehicles are not more valuable just because they will be used more: production costs determine the selling price of the vehicle more than its intended use.
Second, Statista estimates that the global market for taxis and rides will reach $ 260 billion this year. That presents a significant opportunity, but it will not be easy to achieve sales of $ 50 billion or more. It will be some time before robotaxis disrupts the traditional market for rides and taxis. And even if they do, Tesla will face a lot of competition as plenty of other companies hope to roll out robot taxi services as well.
Robotaxi services can deliver higher margins in the long run than car manufacturers. Musk’s implicit assumption that Tesla could double its revenues with minimal incremental costs – and thus earn pre-tax margins of 50% or more – is clearly incorrect. If Tesla set its robot taxi fares so high that it could earn such high margins, competitors would undercut it and steal its market share. These competitive dynamics will greatly limit the incremental profitability of using Teslas as robotaxis.
Look at the core businesses for Tesla’s value
Many Tesla bulls expect the company to become the largest automaker in the world within 10 or 15 years, with 10 million or more cars per year. If Tesla can do that while hitting double-digit automotive business margins and building lucrative side businesses in solar, batteries, and robotaxis, Tesla’s stock can certainly grow in its valuation over time.
However, investors shouldn’t count on robotaxis as a panacea that will make Tesla hugely profitable overnight. Tesla may be developing a nice robot taxi business, but the growth of the car company will determine whether Tesla’s stock continues to rise or fall back to Earth in the next decade.