To be rational about Tesla is to miss the point
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Look at the numbers; they are borderline insane. For every car it had sold by the end of last year, Tesla Motors had burnt through about $40,000 in research, development and capital expenditure. The company is worth about half as much as BMW, which makes 35 times as many vehicles. Tesla has never made an annual profit, yet investors keep pouring money in.
In early spring, Elon Musk delivered an analysts’ call for the ages. With most companies, these calls are death marches through the footnotes of an earnings report, but the Tesla founder announced that his company would be spending “staggering amounts on capex” and would be worth $700bn, around the same as Apple, in 10 years. Here is how: revenue of $6bn this year, growing at 50 per cent a year for a decade, making a 10 per cent profit margin and valued at 20 times earnings. You hear that in Munich?
It was sweet of Mr Musk to bother with a cash flow valuation exercise, but he may have been patronising his audience. The idea of applying the same valuation to Tesla as you might to Ford makes little sense. This looks more like a venture investment. You do not buy Tesla because you think you know what profits it will make. You buy the stock because you think some new technology such as Tesla’s will change the world in ways that invalidate any such estimate. This is a play on the looming changes in the car and energy industries. To profit from the electric car race, you have to back the winner. Missing out is costlier than backing a few losers along the way.
It is all prone to risk: the novel technology, the competitive threat, the danger of its charismatic founder falling under a bus, taking Tesla’s mojo with him. Hedge funds love the stock because it is so volatile. No one can make up their mind whether it is for real. All that seems certain is that, a decade hence, the company’s value will be nowhere near its current market capitalisation of $28bn. If Mr Musk fails to realise his bold vision, the company might be worthless. If you buy Tesla now and the company delivers, you will have hit a giant home run.
Mr Musk stands at a crossroads of three industries that have always been rich in swashbucklers and hype: energy, cars and technology. Energy has its wildcatters, oil and gas men who build great fortunes starting with nothing but a wide-brimmed hat and a hole in the ground. The car industry has long attracted adventurers. William Durant sold cigars and carriages before founding General Motors and hiring Alfred Sloan to run it. During the 1920s, he became a major player on Wall Street. But he was ruined in the crash of 1929 and ended his life invalided by a stroke and managing a bowling alley in Flint, Michigan. In the late 1970s, John DeLorean, a GM executive who made his name building muscle cars, raised money from his celebrity friends and a British government desperate for an industrial manufacturing success to build the DMC-12, an all-steel, rustproof sports car with gull-wing doors. The venture imploded in 1982 when DeLorean was arrested with 55 pounds of cocaine and charged with trying to sell it to finance his flailing company. His car may have been a clunker, but it was immortalised as a time travel machine in the 1985 movie Back to the Future.
Then there is the technology industry, which rewards absurdly big thinking. You do not get to a Tesla-sized valuation by playing coy. Investors, employees and customers all want to hear you say you are going to be massive. Facebook, Google, Apple massive. That is what attracts the talent and the money.
Mr Musk has done a remarkable job in proving that electric cars can be gorgeous. When you are slung low in one of the Model S’s curving seats, see the giant touchscreen which stands in for all the footling dials on ordinary cars, start it up and hear the murmur of its electrical system stirring to life — when you do all that, you might not mind taking a one-way trip over the financial rapids.
The Tesla chief’s dynamism has hurried along an entire industry. He is keeping Mercedes up at night, as well as an already sleep-deprived Detroit. But to think that he can grow at the rate he proposes and gobble up the car market the way Apple did with smartphones is to misunderstand how cars are bought and sold. People crave choice. As Henry Ford discovered to his detriment, they did not want their cars just in black. They wanted them in lots of colours, with fins, and floating suspensions and giant grilles.
Still, if you try to be rational, you are missing a big point in Mr Musk’s favour. Silicon Valley is currently obsessed with cars. More than that, those who mutter about the lessons of the last dotcom crash could be missing out on the next Amazon. If you had written off Jeff Bezos’ hubris, you would have missed one of the great investments of our age. You buy Tesla today so that in years to come, you can say you were there.
The writer is author of ‘What They Teach You at Harvard Business School’