evergreen insights / tesla: ride or die
It seems that every year some team selects a player in the NFL draft who’s been studied tirelessly by scouts, interviewed extensively by team execs, analyzed in detail by coaches turns out to be a total bust. How is that possible? Despite having so much information on a given player, how can such a monumental mistake can be made? We think in many instances it’s the sheer amount of information that's the problem. That's why, at Evergreen, we think good equity research is executed when a company can be distilled down into understandable parts. Said differently, what are you betting on or against when you decide to own or not own a given company? If we cannot confidently identify clear positive/negative catalysts for a stock, we typically avoid them. So to reiterate, the goal of our reports is not to inundate you with all the information on each stock. The internet is a vast resource that can drown you in information if you're not careful. Our goal is strip away all the noise and present you with the key variables needed to inform a buy/sell decision on a company.
profiling the company
Tesla: Ride or Die. The story of Tesla should begin with its namesake. In July of 1856, a brilliant young boy named Nikola Tesla was born in the small village of Smijan, what is now present-day Croatia. He was the son of a priest, the fourth of five children, and grew up on a farm. Tragically, at the age of seven, his brother was killed in a riding accident that would haunt him his entire life. Tesla was supremely gifted in mathematics, performing integral calculus in his head without the need for pencil and paper. Such jarring displays of genius prompted teachers to accuse him of cheating. After contracting Cholera and coming close to death multiple times, he retreated to the mountains to avoid be enlisted into Austro-Hungarian army. There, he read countless books and fostered his fascinating with electricity. After learning Tesla was working from 3am to 11pm, his teachers warned his parents he was going to die from exhaustion. Tesla would later immigrate to the United States, where he’d find himself matching wits with George Westinghouse and Thomas Edison. While he may have had the more brilliant mind, he lacked the business skills of his contemporaries. During his life, he was credited with countless contributions to modern technological advancements, including the X-Ray, alternating current motors, the Niagara Falls power plant, and many other applications within the field of electricity. But, gambling failures and a tormented mind left him broke and bouncing from hotel to hotel in New York City with unpaid bills. Oddly, he’d be seen obsessing over feeding pigeons in the local park. In 1943, he was found dead in room 3327 of the New Yorker Hotel after suffering a blood clot in his heart.
In many ways, the company has parallels with the man who inspired the name. Elon Musk, CEO and founder of the company, is considered both brilliant and maniacal. Musk double majored in Economics and Physics. He was admitted to Stanford for PHD studies, only to drop out after two days. He would start two companies, first a software company (which sold to Compaq) and then another in online payments that left Musk as the largest shareholder of Paypal when it was acquired by eBay in 2002. Today, he’s leading the famed electric car manufacturer, Tesla motors. Known as much for his brash company predictions and Twitter rants as he is for breakthrough developments in the automotive world, he’s polarized the financial community. To many, he’s running a house of cards waiting to collapse. To others, he’s a once-in-a-generation visionary capable of altering the future course of technology.
Civil War of the Roads. For over 100 years, our roads have been dominated by cars that run on internal combustion engines (ICEs). Still today, these make up 98% of cars that are sold. That’s because the major technological limitations of the electric car were deal breakers for most consumers: speed and distance. Almost all electric vehicles were barely fast enough to drive on the freeways and could only drive relatively short distances before needing a charge. But breakthroughs in battery technology have transformed the dynamics of the automotive playing field.
Even with this breakthrough, the electric car has been met with intense skepticism at every turn. How would they charge the vehicle? After all there are 150,000 gas station in the U.S. while EVs initially could basically only be charged in a garage. (Today, there are roughly 50,000 EV charging stations across America.) Drivers were tethered be the electric car’s limitations, and could only use the vehicle to commute locally. Today, the estimated range on an EV is roughly 200-300 miles, compared with 400-500 on an ICE. Tesla claims they even have a model that can make it 330 miles. Anecdotally, every Tesla owner we’ve talked to claims their car doesn’t make it anywhere near the stated range on a full charge. In the small print, you may notice that it states the maximum range is only attained by driving at ideal speeds including sub 50 mph on highways. The entire right lane of our freeways would be full of Tesla owners looking to maximize their range while driving 48 mph!
EV supporters will point to further improvements in technology that will bring the driving ranges to parity in the near future. A friend of Evergreen, who owns a massive stake in one of China’s largest EV companies, has studied battery technology extensively. He recently gave us some interesting insight on this topic, stating that many people have become accustomed to Moore’s law. Put plainly, the principle that computers’ double in speed every two years, creating massive improvements across all technological devices. We all have seen this in our everyday life. Our phones have become exponentially more powerful. Our TVs have superior pictures than 10 years ago. Our cameras take better pictures. You get the point. But, doesn’t your phone battery last about the same time? Now, you could argue that battery has more strain on it as it performs more functions, but the point remains that if battery progress matched computing progress they should both grow. So, we should have phones that do more and batteries that last longer, but we have phones that do more and batteries that last the same amount of time. The point is: battery progress is much more linear than the exponential progress we see in technological computing power. We expect that battery life will continue to be an industry headwind for longer than most expect.
Batteries have issues beyond just their limiting driving range. They are easily affected by the cold. The American Auto Association estimates that batteries operating in 20-degree weather lose their charge 40% faster. Aside from weather, most pure EV (non-hybrid) owners are reliant on power grids to power their cars. Meaning power outages leave them stranded. Folks in California dealing with rolling blackouts may find timing their car charges to be a logistical nightmare. Then there’s the issue of the length of time to complete a vehicle charge. Most vehicles take overnight to charge. If you live in Florida and return home from work, only to learn a hurricane is coming, you can’t head to the gas station and skip town. Instead, you’d be stuck staring at the clock waiting for the EV to recharge. Many EV limitations can be chalked up as inconvenient and mostly avoided but there is a psychological dependence related to “recharging” that some people can’t overcome.
a look at the books
The Noose of Debt. In a recent interview, Elon Musk described running Tesla by recounting a scene in Indiana Jones (Raiders of the Lost Ark) where Harrison Ford is running from a huge rolling boulder through a tunnel and his only option is to jump over a bottomless pit. We assume the boulder is a mounting pile of debt and the hole in front is the graveyard of failed new American car company entrants. Not counting Tesla, the last major car company formed was Chrysler, a mere 95 years ago! Why there hasn’t been a new car company is certainly open for debate. One contributing factor comes from the fact that car companies make significantly more money on parts than vehicle sales. Therefore, the larger your installed base, the better. The average car on the road today is 12 years old, with most warranties lasting 4-5 years. Tesla is trying to break the mold, which cannot be done (you go broke first). Tesla has amassed $10bln in debt from various creditors and many skeptics predict these obligations will spell the end for Musk’s vision.
In a strategic pivot, Musk decided to shift his focus from making luxury vehicles—such as the Tesla Model S and Model X—to making a car for the masses: the Model 3. This created a massive need for capital as he decided that he needed scale if Tesla were to survive. It’s almost unprecedented to have a company with a market cap of $132 billion (as this report is being written) with so many people predicting imminent doom. Many have accused him of hyping his stock and making false promises meant to mislead shareholders. With plenty of evidence to support them, as there have been missed production deadlines, quality control failures, delays in technological upgrades, etc. On the flip side, his defenders have said that to accomplish seemingly impossible feats, you must aim to heights that most would declare impossible. When George Washington set out to defeat the British, how many people thought he’d succeed? Was he lying? Was he dreaming big? When the Wright brothers set their sights on flight, were their volunteers lining up to help them test their planes? When Jeff Bezos, went around raising capital for Amazon, did he say that the odds of his startup succeeding were slim to none – or did he offer a vision that few (if any) besides himself could see?
Musk knows the noose is around Tesla’s neck and the most pressing issue is not whether he’ll be able to create a car that changes the world, but can he survive long enough to prove he can?
Therefore, the first question you must ask before deciding to buy/sell Tesla is assessing their solvency issue. The recent doubling of the stock, as well as strong Model 3 sales for 2019 may have turned the scales in the company’s favor.