Market Cap Part 2 (A look at GM and Tesla)
I am not an investment adviser. Nothing in this post is meant to be interpreted as investment advice.
Here are some market caps of auto manufacturers.
Tesla Motors: 24B
General Motors: 59B
Ford: 64B
BMW: 74B
Daimler AG: 101B (manufacturer of Mercedes, plus some other things; a business built on manufacturing luxury cars that gets revenues from other places too)
Toyota: 239B
The first thing I notice on this list is that Ford and GM have practically identical market caps even though one of them has utterly failed as a business recently and was revamped by the government which doesn't typically do a good job of managing assets. The market seems to be valuing these two companies more on the fact that they have approximately equivalent brand appeal, approximately equivalent market saturation, and approximately equivalent markets than it does based on their prior performance as businesses. I don't know if this is smart, but it doesn't seem particularly wise to me. (Also GM is valued at a much higher P/E than Ford is.) I haven't looked too much into the restructuring and bankruptcy of GM, but if I recall, the government intervention did a little bit more to protect existing labor agreements than what would be expected in a typical bankruptcy process... On the other hand, GM was able to restructure itself because of its issues, and Ford never really had the opportunity to do that, so Ford is entirely saddled with whatever pre-recession agreements it had; whereas, GM has revised them somewhat if not entirely. So while, my gut response is to say that I think it's odd that GM and Ford have the same valuation, I would want to do little more research before acting on that gut response in any way.
But I didn't really want to write this post about GM, and Ford. I'm more interested in analyzing Tesla, because it's valuation is interesting. (I wouldn't buy at it's current valuation. I would probably sell if I had purchased earlier, but I certainly wouldn't short. If something happens and Tesla gets hammered, I would buy at 12B, unless whatever happens suggests that Tesla aught to be hammered e.g. they miss their production targets for when they expect to be ready to ship their next vehicle by a lot.)
Tesla isn't profitable right now, and doesn't look particularly likely to become profitable in the near future. They aren't being valued on their immediate potential to generate profits, but they are instead being valued on what people expect Tesla to eventually do.
Basically, the data is suggesting that the market gives Tesla about a 1 in 3 chance of becoming as profitable as BMW. (Or a 1 in 10 chance of eventually becoming about as profitable as Toyota or a 40% chance of eventually become as profitable as Ford). Since all companies are expected to grow into their valuations, it's a little unclear how to value the superposition of expectations. For example, Ford seems to be valued on its current productivity; whereas, Tesla is entirely valued on expectations of future growth.
Some of these comparisons seem more reasonable than others. Ford and GM both have businesses that involve selling a huge number of vehicles and making very little profit on each of those sells. BMW and Daimler sell fewer vehicles but have a much more profitability per vehicle. Toyota and Volkswagen (which I didn't list, but which is the second most valuable auto maker in the world) are a lot more similar to GM and Ford than they are to BMW and Daimler. They just do it better. If Ford or GM somehow get's its act together perfectly and cuts costs enough to allow it to have similar profitability per vehicle to Toyota without increasing the price of its vehicles, it could conceivably grow to be like Toyota. (I don't think this is going to happen.)
Tesla really doesn't seem like it has the potential to grow to be like Toyota, nor does it seem to have the potential to grow to be like GM and Ford. They do plan to have a "mass market" car by end of year 2017, but "mass market" for Tesla means a car in the $30-40k price range. They really can't aim much lower than that. For one thing, they build their vehicle's structural components out of aluminum, and they are building a brand around assurances of quality rather than around competitive pricing.
GM and Ford are in a much better position to eventually produce some sort of cheap substitute for iron in the structural components of their vehicles than Tesla is. (Something along the lines of carbon-nanotube reinforced silicone.) Volkswagen, Toyota, and some of the Korean, Chinese, and Japanese auto manufacturers that I haven't mentioned are even more likely to do this sort of thing. It fits better with their markets than it does with Tesla's.
A fairly accurate way to read the current valuations of Tesla is to say that the market knows that Tesla is either going to become profitable like other luxury auto manufacturers or it's going to go bankrupt. If it does become profitable, it seems like it ought to become about as valuable as BMW or Daimler. The market's giving Tesla about a 1 in 3 shot of becoming about as valuable as BMW and a 1 in 4 shot of becoming about as valuable as Daimler.
This valuation seems optimistic to me. But I do think that if Tesla becomes profitable without compromising its current approach, returns on Tesla ought to outperform returns on BMW by about 300%. Both companies seem like they ought to have similar prospects. When Tesla acknowledges its many risks, one of the biggest is that it's business model requires it to be able to cut costs very aggressively to produce profitability. It has quite a bit of impressive proprietary technology, but so does every auto-manufacturer. We've already seen by looking at its place in the market that Tesla has room for about a factor of 3 to 4 growth (relative to established companies) if everything goes well for it. The question is whether it has a better than 25-33% chance of hitting that target. And it seems to have a lot of potential to fail.
I don't know how much to credit Tesla for being entirely electric or for having its own re-fuel network, or for selling components that other manufacturers are using in their attempt to make electric cars... however, it seems to me that they are doing all of these things by being extremely upmarket, and they are trying to move downmarket from there. Apple has done very well being the upmarket option (but for a relatively inexpensive product -- compared to cars -- that is subsidized by another market -- phone carriers). Very few other companies have ever managed to do this. One way that Tesla might become a profitable company without growing into its valuation is if it becomes a successful components supplier. People are valuing Tesla on its potential to become a successful auto manufacture not on its potential to eventually become a profitable supplier of components (which is a market which much less room for high margins).
Next time, I'll look at two companies that I think are in a similar position, except that the market is giving them room for a factor of 10 growth if they happen to succeed instead of a factor of 3 growth.
Here are some market caps of auto manufacturers.
Tesla Motors: 24B
General Motors: 59B
Ford: 64B
BMW: 74B
Daimler AG: 101B (manufacturer of Mercedes, plus some other things; a business built on manufacturing luxury cars that gets revenues from other places too)
Toyota: 239B
The first thing I notice on this list is that Ford and GM have practically identical market caps even though one of them has utterly failed as a business recently and was revamped by the government which doesn't typically do a good job of managing assets. The market seems to be valuing these two companies more on the fact that they have approximately equivalent brand appeal, approximately equivalent market saturation, and approximately equivalent markets than it does based on their prior performance as businesses. I don't know if this is smart, but it doesn't seem particularly wise to me. (Also GM is valued at a much higher P/E than Ford is.) I haven't looked too much into the restructuring and bankruptcy of GM, but if I recall, the government intervention did a little bit more to protect existing labor agreements than what would be expected in a typical bankruptcy process... On the other hand, GM was able to restructure itself because of its issues, and Ford never really had the opportunity to do that, so Ford is entirely saddled with whatever pre-recession agreements it had; whereas, GM has revised them somewhat if not entirely. So while, my gut response is to say that I think it's odd that GM and Ford have the same valuation, I would want to do little more research before acting on that gut response in any way.
But I didn't really want to write this post about GM, and Ford. I'm more interested in analyzing Tesla, because it's valuation is interesting. (I wouldn't buy at it's current valuation. I would probably sell if I had purchased earlier, but I certainly wouldn't short. If something happens and Tesla gets hammered, I would buy at 12B, unless whatever happens suggests that Tesla aught to be hammered e.g. they miss their production targets for when they expect to be ready to ship their next vehicle by a lot.)
Tesla isn't profitable right now, and doesn't look particularly likely to become profitable in the near future. They aren't being valued on their immediate potential to generate profits, but they are instead being valued on what people expect Tesla to eventually do.
Basically, the data is suggesting that the market gives Tesla about a 1 in 3 chance of becoming as profitable as BMW. (Or a 1 in 10 chance of eventually becoming about as profitable as Toyota or a 40% chance of eventually become as profitable as Ford). Since all companies are expected to grow into their valuations, it's a little unclear how to value the superposition of expectations. For example, Ford seems to be valued on its current productivity; whereas, Tesla is entirely valued on expectations of future growth.
Some of these comparisons seem more reasonable than others. Ford and GM both have businesses that involve selling a huge number of vehicles and making very little profit on each of those sells. BMW and Daimler sell fewer vehicles but have a much more profitability per vehicle. Toyota and Volkswagen (which I didn't list, but which is the second most valuable auto maker in the world) are a lot more similar to GM and Ford than they are to BMW and Daimler. They just do it better. If Ford or GM somehow get's its act together perfectly and cuts costs enough to allow it to have similar profitability per vehicle to Toyota without increasing the price of its vehicles, it could conceivably grow to be like Toyota. (I don't think this is going to happen.)
Tesla really doesn't seem like it has the potential to grow to be like Toyota, nor does it seem to have the potential to grow to be like GM and Ford. They do plan to have a "mass market" car by end of year 2017, but "mass market" for Tesla means a car in the $30-40k price range. They really can't aim much lower than that. For one thing, they build their vehicle's structural components out of aluminum, and they are building a brand around assurances of quality rather than around competitive pricing.
GM and Ford are in a much better position to eventually produce some sort of cheap substitute for iron in the structural components of their vehicles than Tesla is. (Something along the lines of carbon-nanotube reinforced silicone.) Volkswagen, Toyota, and some of the Korean, Chinese, and Japanese auto manufacturers that I haven't mentioned are even more likely to do this sort of thing. It fits better with their markets than it does with Tesla's.
A fairly accurate way to read the current valuations of Tesla is to say that the market knows that Tesla is either going to become profitable like other luxury auto manufacturers or it's going to go bankrupt. If it does become profitable, it seems like it ought to become about as valuable as BMW or Daimler. The market's giving Tesla about a 1 in 3 shot of becoming about as valuable as BMW and a 1 in 4 shot of becoming about as valuable as Daimler.
This valuation seems optimistic to me. But I do think that if Tesla becomes profitable without compromising its current approach, returns on Tesla ought to outperform returns on BMW by about 300%. Both companies seem like they ought to have similar prospects. When Tesla acknowledges its many risks, one of the biggest is that it's business model requires it to be able to cut costs very aggressively to produce profitability. It has quite a bit of impressive proprietary technology, but so does every auto-manufacturer. We've already seen by looking at its place in the market that Tesla has room for about a factor of 3 to 4 growth (relative to established companies) if everything goes well for it. The question is whether it has a better than 25-33% chance of hitting that target. And it seems to have a lot of potential to fail.
I don't know how much to credit Tesla for being entirely electric or for having its own re-fuel network, or for selling components that other manufacturers are using in their attempt to make electric cars... however, it seems to me that they are doing all of these things by being extremely upmarket, and they are trying to move downmarket from there. Apple has done very well being the upmarket option (but for a relatively inexpensive product -- compared to cars -- that is subsidized by another market -- phone carriers). Very few other companies have ever managed to do this. One way that Tesla might become a profitable company without growing into its valuation is if it becomes a successful components supplier. People are valuing Tesla on its potential to become a successful auto manufacture not on its potential to eventually become a profitable supplier of components (which is a market which much less room for high margins).
Next time, I'll look at two companies that I think are in a similar position, except that the market is giving them room for a factor of 10 growth if they happen to succeed instead of a factor of 3 growth.
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