Tesla’s Tipping Point

As Tesla’s share price bounces between $300-400 and anticipation for the Model 3 builds, Tesla enters a crucial phase in the company’s history. The short interest on Tesla is overwhelming, and while pessimists have benefited from a recent 20% pullback, they feel their pain as the stock posts a YTD gain of nearly 51%. In what direction will investors catapult the stock as Tesla starts producing its most important vehicle?

Tesla’s rich valuation is based on the assumed success of the Model 3 (below), a more affordable, mass-market sedan gradually coming to market in late July. Tesla stock produces 75%+ runs, but subsequently pulls back as much as 40% as it did in early 2016, and 20% over the last month. TSLA is volatile, and such volatility extends over a period of months instead of just days or even hours. What causes such swings? Anticipation of new products has historically pushed the price up, whereas delivery disappointments regularly weigh the stock. Tesla failed to bring its three existing models to market on time (most notably botching the Model X’s production), and faces its most ambitious challenge as it plans to produce hundreds of thousands of Model 3s in 2018. The answer is obvious, right? Since Tesla must scale exponentially to produce the quantity that its expensive stock price expects, now is a better time than ever to short? Well, maybe…

model 3
Musk at the Model 3 reveal event in 2016 (electrek)

It may be the best time to short the stock

Tesla is likely overvalued as its market cap has surpassed that of GM and Ford; forget the fact that these companies sell millions of cars annually. Last Monday, Tesla announced deliveries 2,000 short of estimates, and Musk muted the bad news via a Sunday night tweet outlining the Model 3’s in-line production schedule. Bringing the Model 3 to market with the scale that TSLA plans is arguably the most ambitious manufacturing task that any company has ever faced. Although the gigafactory (below) has progressed, it is a fraction of its final design and must continue to expand to produce the Model 3 at scale. For some perspective, this facility will have the largest footprint of any building in the world, and will be second in volume only to Boeing’s manufacturing facility in Washington. Although Tesla embarked on the electric revolution about a decade before the rest of the industry, auto manufacturers are moving towards electric quickly, and others already have the infrastructure to produce at scale (Volvo recently announced all models 2019-on will have an electric component in some capacity). Tesla has scaled tremendously, but must continue at its exponential rate to meet its deliverables. Shorting the stock isn’t a bad idea, and you certainly aren’t alone if you’ve already shorted it and taken a loss.

gigafactory
Tesla’s gigafactory last August compared to the final blueprint (Fortune)

While you’d be late to the party, it also might be a good time to buy the stock

The challenge of producing the Model 3 casts a grey cloud over Tesla’s near future. However, Tesla might actually be better equipped to handle this challenge relative to its previous manufacturing goals. When asked about Model 3 options packages at the shareholders’ meeting in June, Elon Musk emphasized that customization would be very basic to start. The first Model 3 owners will only be able to choose between wheel size and color. Other features such as a dual motor and larger batteries will be available at a later stage in the release. This simplifies the manufacturing process and helps Tesla achieve its planned output. In contrast, Musk took full responsibility for the Model X’s manufacturing issues, and attributed the delay to an excess of customization options available right from the beginning that overcomplicated production. Tesla has to focus on mass production, and the company has a better chance to achieve its output goals if it can simplify the product itself as Musk has described. Its recent 20% dip from all-time highs may prove to be a ~relatively~ attractive entry point.

Another reason to buy the stock is Tesla’s ability to provide an end-to-end electric lifestyle, something truly revolutionary that Wall Street has omitted from its valuation in my opinion. Right now, the sustainable energy lifestyle is fragmented. Tesla is the only company that has plans to offer an integrated suite including a solar roof, home battery, and electric vehicle. Tesla’s solar roof will be more robust than a traditional roof, while generating solar and lowering the full cost of replacing a roof after energy savings. If Tesla can market the product as a cohesive package and lever its strong brand, it should dominate a market that is in its infancy today. Young homeowners want to take care of the environment, and the solar roof will give them a perfect opportunity that doesn’t break the bank.

At a recent TED event, Musk was asked why he takes on the challenges that he has embraced at Tesla and SpaceX. He thought for a moment, and described that the laws of economics and limits to natural resources imply that electric cars will entirely replace internal combustion cars within the next few decades (his response). Even disregarding the environmental advantages, Musk says, the market will undergo this transition for economic purposes; it is inevitable. Tesla is on the brink of phenomenal success or moderate disappointment, but its innovative approach and impressive progress towards a transition that will define our era leaves me optimistic as a long-term investor.

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