This article first appeared in The Edge Malaysia Weekly on November 20, 2017 - November 26, 2017
ON Nov 7, Alphabet’s autonomous car subsidiary, Waymo, pulled the “safety driver” from its self-driving vans in Phoenix, Arizona. It was a key milestone for the car industry and the advent of connected, electric, autonomous cars. For now, there will still be an employee in the back who can push a button to pull over the car in an emergency. Driverless cars are no longer pie in the sky. They are here and on the road alongside cars with drivers.
If there is one company that is identified most closely with autonomous, connected cars that run on batteries, it is Tesla, though Waymo is slightly ahead in driverless technology. Yet, Tesla is also one of the most polarising large-cap stocks of the current bull market. Ask anyone about the car, and you will have them waxing lyrical about it. Ask them about Tesla the stock, and you will find two groups: those who absolutely hate the stock because they do not see a clear path to profits; and those who just love it. There is little middle ground.
Tesla’s moment of truth arrived recently as shares of the electric vehicle pioneer sank to under US$300, their lowest level in nearly six months, after the company posted a wider-than-expected loss in the July-to-September quarter and missed production targets. Tesla stock is down 21% from its mid-September peak, or officially in bear market territory.
Is Tesla really worth the US$50 billion at which the market currently values it? Does it really have any proprietary technology? Can it compete against auto giants such as General Motors (GM), which are rolling out their own electric vehicles?
“Tesla is the ultimate stock story,” says New York University professor Aswath Damodaran, who has done extensive research on valuations of US companies. Tesla is a both an automaker and a tech company, but deserves a tech-stock-like multiple, he says in a recent blog. He believes Tesla stock should have a value of US$151, with a best-case estimate of US$316. The stock traded at US$304 on Nov 8, or close to the highest end of his valuation range.
Tesla’s proponents say the best way to value the company is look at the total addressable market for automated, electrified and connected cars. “If you look at how big the software and services business is going to be in 10 to 15 years and do a cash flow analysis of this very high-margin business and discount the present value of the cash flow and put a multiple on it, that opportunity today would be worth US$1 trillion to US$3 trillion,” says Catherine Wood, chief investment officer of ARK, an investment manager in New York focused on disruptive technology. Right now, the only way to play in that space is in the private markets, where ride-sharing companies such as global giant Uber, China’s Didi, No 2 US player Lyft, India’s Ola, Southeast Asia’s Grab and others have a combined valuation of US$150 billion.
To be sure, Tesla’s business model is different from run-of-the mill passenger car companies such as Toyota Motor. For one thing, Tesla has made it very clear that it is going for the autonomous taxi network model. CEO Elon Musk has talked about the “Tesla Network” of shared cars, essentially saying that he is trying to sell cars not just to individuals who would own the car but buyers who would eventually share it. Tesla has been misunderstood because it has been covered by auto analysts used to hardware models rather than tech analysts who understand software and services, says Wood. Because auto companies have spent the last 30 years outsourcing everything, the key to Tesla is its vertically integrated Apple-like model combining hardware, software and services.
“Tesla owns both the manufacturing and much of the supply chain, similar to Intel during the 1990s PC era,” says Romit Shah, analyst at Nomura Instinet in New York. “Whereas the limiting factor for PCs was processor performance, for EVs [electric vehicles], it is cost and battery range,” he says, noting that Tesla’s Nevada Gigafactory joint venture with Panasonic makes batteries with the highest energy density at costs that are lower than competitors. Just like Intel captured most of the profits in the microprocessor supply chain in 1990s, “Tesla will capture most of the profits in the electric vehicle value chain,” says Shah.
Toni Sacconaghi, a tech analyst at Sanford C Bernstein, believes Tesla could be a natural oligopoly in its category. “Every now and then, a truly disruptive company emerges that transforms an entire industry,” he says. “Apple’s entry into the smartphone market not only destroyed companies, but catapulted it to become the most valuable company in the world,” he notes. “Amazon.com’s emergence from a niche, online bookseller to arguably the world’s most dominant retailer and cloud computing provider has pressured everyone from mom-and-pop stores to Wal-Mart Stores and IBM.” And Netflix’s disruptive direct distribution and proprietary content development has upended the movie and TV businesses. Billionaire Rupert Murdoch is reportedly negotiating to sell the entertainment assets of his 21st Century Fox to focus on news and sports.
With a visionary and exacting founder like Elon Musk at helm, Tesla looks every bit like Apple, Amazon and Netflix. “The auto market is on the verge of being disrupted, and the source of it is one upstart player — Tesla,” Sacconaghi notes in a recent report on the pioneering EV player. “Tesla’s biggest advantage is its brand and cult-like consumer following, à la Apple.” GM, BMW or Alphabet might eventually make better electric or autonomous cars, but Tesla’s fan boys will still buy Tesla the way Apple users never look at Samsung or Huawei handsets even when they have better functionality.
ARK’s Wood estimates that if Tesla obtained just a 5% share of the global market excluding China, it should be worth about US$200 billion right now. If shareholder Tencent Holdings can help Tesla get a toehold in China, that number could be manifold. Tesla has been in talks to build its own factory in Shanghai. If it does, it will be the first global automaker with a fully owned plant in China instead of joint ventures that its peers have had to rely on. Beijing is trying to a create “a catfish effect” to spur its homegrown champions by bringing in a strong outside competitor.
Data collection powerhouse
Tesla is unique among automakers because it is also a humongous data-gathering machine. “The better data collection and safety profile an automaker has, the more likely it will win,” argues Wood. Tesla has already collected six billion miles’ worth of data and is now collecting more than a billion miles every three months as its installed base increases. Tesla cars collect video data as cars move about as well as data from the radars and data about driver reactions, which helps prevent accidents. Such data is extremely useful as Tesla develops new software to make cars autonomous. Why Uber, Didi or Grab never bothered to put a ton of sensors in their cars or just give away sensors to their drivers so that they could collect a lot of data has been puzzling to investors like ARK. Each day ride-sharing companies and legacy carmakers delay putting data gathering sensors in their cars, they lose competitive advantage to Tesla.
Musk’s company also already has a head start over competitors with over-the-air software updates that help change the performance metrics of its cars. During the recent hurricane season in Florida and Texas, for example, Tesla sent free software upgrades that extended the range of its customers’ cars in the area as they tried to outrun approaching hurricanes. Tesla could do that because it knew exactly where its cars were and it could reach them by just pressing a button from its headquarters in California.
In most US states, it is illegal for automakers to do over-the-air software updates for cars because there is a very strong auto dealers lobby. Tesla sells cars in its own network of showrooms. “Auto dealers make most of their money from maintenance and services,” notes Wood. If Tesla is anticipating troubles with the car and correcting them with software updates even before the car owner knows there is something wrong or enhancing the performance of the car in some ways and preventing a visit to a dealer or a garage, it will continue to have such a huge competitive advantage, she argues. “How are GM or Toyota ever going to get over that?”
Some analysts have argued that legacy carmakers could always pour more of the billions they have on their balance sheets into new technology and outinvest Tesla. Indeed, GM, Nissan Motor Co as well as German auto giants such as BMW and Volkswagen have already invested billions in R&D in EVs. The difference between them and Tesla is that while they are focused on prismatic, or “soft pack” pouch, technology, Tesla uses more advanced cylindrical cell batteries, ARK’s Sam Korus tells The Edge Singapore.
While there are tons of EV battery makers from China and South Korea entering the field, the secret sauce for Tesla has been the design and layout of the battery-pack systems that line the floor of its cars. Legacy automakers used to make fun of Tesla saying it was ridiculous to build a car battery modelled on cylindrical smartphone batteries. Tesla’s battery pack made of hundreds of small cells packaged together at the bottom of its new Model 3 is miles ahead of anything that other automakers currently have. Tesla recently introduced silicon into its batteries, which changes their chemistry. It will help batteries, the heaviest component of the car, become lighter, which in turn means less energy required to move the car and lower costs. Korus notes that there are a lot of tweaks that Tesla can make to the battery pack that could further enhance its efficiency.
China — leader in car tech
The main battleground for new car technology is likely to be the world’s biggest auto market, China, rather than the US or Europe. China is expected to leapfrog peers to become the biggest market for connected, electric, autonomous vehicles. Tencent, China’s biggest company by market value, took a 5% stake in Tesla earlier this year. Roping in Tencent was a huge coup for Musk. While Beijing wants local auto champions such as BYD Co, Geely Automobile Holdings,BAIC Motor Corp or SAIC Motor to be a leader in emerging EV technology, Tencent is betting that Tesla is doing things the right way and would eventually get the government’s blessing as well. Aside from BYD, in which Warren Buffett’s Berkshire Hathaway has a 10% stake, major Chinese automakers have tied up with foreign partners. SAIC has a close relationship with GM; BAIC and Baidu, which is developing an autonomous car on its own, have a strong relationship with Daimler Benz.
Tesla, which lost US$671 million in the last quarter, needs to raise US$5 billion cash by next June, and, indeed, several billion more beyond next year before it can turn the corner. In recent years, Tesla has had to turn to the credit markets to raise money to avoid diluting Musk’s 22% stake but, with the recent US interest rate hikes and its precarious balance sheet, analysts say Tesla is likely to return to equity markets for its funding needs. If it does, it will allow Tencent to raise its stake further to 10% or 20%, and earn a bigger say on Tesla’s future.
Earlier this month, reports emerged that Tencent was developing its own autonomous driving system. That does not mean Tencent is abandoning Tesla and going it alone in automobiles. Because the opportunity in the electric, connected, autonomous car space is so huge, everyone has a multi-pronged strategy with lots of different tie-ups, Korus notes. In the end, the partners will pool their resources and there will only be a handful of players. Because of its first-mover advantage, Tesla will clearly be one of them.
Gene Munster, a partner with Loup Ventures in Minneapolis, argues that Tesla’s recent production issues are temporary. The dream of autonomous electric vehicles will just take a little longer to realise, he argues. Just because Tesla is running one or two quarters behind schedule does not mean it no longer has the competitive advantage against legacy carmakers.
“Investors will eventually be rewarded for their patience as Tesla works through the production difficulties of the Model 3,” Munster says. He expects Tesla to start delivering on the next wave of autonomous cars by 2020 and expects the company to break even by end-2020. Tesla’s detractors, “are missing the forest for the trees”, says Nomura’s Shah, who has a US$500 price target on Tesla, or a whopping 65% upside. Clearly, Tesla shareholders need to develop stronger stomachs as they hunker down for more short-term pain and await long-term gains.
Assif Shameen is a technology writer based in North America
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