Last May – when Tesla (NASDAQ: TSLA) shares are trading at around $ 150 on a split-adjusted basis – CEO Elon Musk believes on Twitter that Tesla’s share price is likely to be too high.
Tesla’s share price is too high
– Elon Musk (@elonmusk) 1 May 2020
As the Tesla share continued to rise for the rest of 2020 and sustained its huge profits, Musk began to change its tune. By the time Tesla held its earnings call in the fourth quarter last week, the stock had more than doubled from the level Musk considered “too high” less than a year ago. The CEO of Tesla nevertheless argued a case why the impending arrival of complete self-driving technology would justify the high valuation of the company.
There is only one problem: Musk’s whole argument is based on an error. Let’s see.
Elon Musk math
Last year, Tesla’s car revenue reached a record $ 27.2 billion and the company earned an operating profit of $ 2.2 billion. Tesla expects to grow dramatically from that base. It plans to increase its vehicle deliveries on average by about 50% annually over the short term, as it increases its battery and assembly capacity, puts production in place and introduces new models.
Based on Tesla’s Wednesday closing price of $ 864.16 and the diluted share of 1.124 billion shares, the company had a fully diluted market capitalization of nearly $ 1 trillion. Even if Tesla were to increase its earnings tenfold, it would not justify the company’s recent valuation without aggressive expectations for continued growth.
During Tesla’s recent earnings call, Musk felt that the stock remains reasonably valued as one factor in the profit potential of the full self-management capabilities that Tesla builds.
… [I]Let’s hypothetically say that Tesla’s ships are $ 50 billion or $ 60 billion worth of vehicles, and those vehicles are fully self-driving and can be used … as a robot tax, utility increases from an average of 12 hours per week to possibly an average of 60 hours per week . … [L]we just assume that the car becomes twice as useful … it will again be a doubling of the company’s revenue, which is almost entirely the gross margin. … [I]t would be like … having $ 50 billion in incremental profits, basically because it’s just software.
In short, Musk argues that FSD capabilities will make any car that Tesla buildings dramatically more valuable because it can be used more than a personal vehicle. Musk believes that Tesla will earn the extra value as an almost pure profit, which will bring about a massive earnings curve that will enable the company to earn ten billion dollars annually within a few years – with enough room to to keep growing.
Image source: Tesla.
This is a huge mistake
Unfortunately, this ‘plan’ was built on a fallacy. First, while typical car owners spend only 12 hours a week in their vehicles, actual taxis are used much more frequently. In New York City, for example, some taxis are used for double shifts and can work 100 hours a week (or even more). These vehicles are no longer valuable simply because they will be used more: the cost of production determines the selling price of the vehicle more than the intended use.
Second, Statista estimates that the global taxi and ride business market will reach $ 260 billion this year. This is a great opportunity, but it will not be easy to reach $ 50 billion in revenue or more. It will take time for robot tax to disrupt the traditional markets for riding and taxis. And even when they do, Tesla will face a lot of competition, as numerous other companies are also hoping to introduce robotic taxi services.
Robotaxi services can earn higher margins than automakers in the long run. However, Musk’s implicit assumption that Tesla can double its revenue with minimal incremental costs – and thus earn tax margins of 50% or more – is false. If Tesla were to set its robotic taxi fares so high that it could earn such high margins, competitors would disrupt them and steal its market share. These competitive dynamics will sharply limit the incremental profitability of using Teslas as a robot tax.
Look at the core business for the value of Tesla
Many Tesla bulls expect the company to become the largest carmaker in the world within ten or 15 years, delivering 10 million or more cars annually. If Tesla can achieve this while achieving double-digit operating margins and building profitable side businesses in solar power, batteries and robotics, Tesla’s inventory could certainly grow to its valuation over time.
However, investors should not count on robot tax as a magic that will make Tesla very profitable overnight. Tesla could develop a good robot taxi business on the side, but growth in the core industry will determine whether Tesla’s share will continue to rise or return to earth in the coming decade.