Tesla: The Bull Case, The Bear Case, And My Case That Charlie Munger Seems To Be Agreeing With

Saying Tesla, Inc (TSLA) has been on a wild ride in the recent past is an understatement. On December 31, 2019, the share price closed at $418 and then more than doubled to over $960 by February. If that was spectacular, what is even more spectacular is its fall from the 52-week high of $969 to just $542 on March 25. It’s difficult to think of a stock that has received the attention of short-sellers and bears than Tesla in the last 10 years. But, at the same time, I can’t think of another company that continued to outsmart the bears and punished them for being on the wrong side as well. When I looked into the company in early-2018, I hardly found no reason to not short Tesla; the company had a humongous amount of debt, wasn’t generating any free cash flows at all, profitability seemed a distant reality, and by far was the company with the highest short interest. For reasons I will discuss below, I found the risk-reward profile not attractive to initiate a short position on Tesla. At the same time, I couldn’t find a reason to buy TSLA as well because of its significant business risk. I continue to wait for a better opportunity to either buy or short sell Tesla. I’m still neutral to the prospects of the company and as far as I see it, Charlie Munger nailed what to do with Tesla shares. 

This is not a bull or bear article on Tesla. Rather, I will discuss both these extreme ends and reason out why I opt to stay in the middle still. Investors with varying opinions on the company, risk tolerance, and investment time horizon might as well decide to do otherwise. This analysis has three sections to it; the bull case, the bear case, and my case.

The bull case

If investing never involved numbers, I would have had many reasons to buy Tesla shares. Let’s start with the outlook for the industry in which it operates. Generally, when an industry is expected to grow exponentially within a couple of decades, the leading companies of that industry reports stellar numbers. This is exactly what is expected of Tesla. 

Global electric vehicle sales have grown at double-digit annual rates in the last decade.

Source: Virta

The future looks even better. Understandably, there’s a significant variance between the annual sales growth projections among leading research institutions. There could be a few reasons behind this. First, no analyst is able to predict the market prices of electric vehicles with any degree of precision. Among other things, this will be largely impacted by the manufacturing capacities and the demand for EVs. Right now, electric vehicles are expensive than their conventional peers. Second, the cost of batteries used in EVs has an impact on the sales of the industry as this could determine the overall cost of a vehicle. Once again, due to dynamic developments that change the outlook for battery prices, it has become difficult for analysts to agree on the sales figures for the next few years. 

One thing, however, can be predicted with some degree of certainty; EV sales will grow.

Source: Quartz

Even in the bear case (Exxon’s predictions), EV sales will grow by double-digits. There’s massive leeway for industry-wide growth as EVs accounted for just 2.2% of global passenger vehicles in 2019, according to data from Virta. This expected growth, in return, will translate into higher unit sales for Tesla. This is because of the market-leading position of the company.

Source: Statista

China presents a massive opportunity for Tesla as well. In early January, Tesla delivered its first China-made Model 3 units to its employees in China. This East Asian country is the world’s largest vehicle market with an estimate of 200 million vehicles at the end of 2020. However, as Statista reports, there are only 200 vehicles for 1,000 inhabitants in China in comparison to 800 vehicles per 1,000 inhabitants in the United States. Considering the projected growth of household disposable income in China resulting from continued economic growth and the rise of a middle-income society in the country, the demand for passenger vehicles can only increase in the coming years. Because China is the largest EV market in the world, chances are that a high proportion of the increasing demand for vehicles will be directed toward electric vehicles. With the newly opened Giga Shanghai factory, Tesla, arguably, is positioned well to benefit from this projected demand for EVs. For bulls, this projected growth in EV sales on a global scale is at the core of the thesis. 

Government support, including incentives, will also play a critical part in the growth story of the EV industry. In 2019, 49% of the new vehicles registered in Norway were electric vehicles, which is the highest penetration across the globe. None other than the Tesla Model 3 accounted for the highest sales in Norway in 2019 as well. It’s no secret that government incentives were behind this phenomenal growth of EV sales in Norway. Exemption of purchase tax and VAT, free parking at selected public parking spaces, exemption from tolls, and free access to ferries connecting national roads are some of the initiatives implemented in Norway to incentivize buyers of electric vehicles. All these measures taken by the Norway government are part of a plan to become a zero-emission country by 2025. Tesla bulls bet that these types of incentives and government support will be a feature in many countries in the not-so-distant future. 

The bull case is centered on the belief that higher EV sales worldwide, and the governments’ push to accelerate such sales, will lead to significant demand for Tesla’s products. Such a robust demand is expected to help the company remain persistently profitable.

The once highly unprofitable Tesla returned good numbers in the last couple of quarters. In addition to earning positive net income for two straight quarters, Tesla even made free cash flows as well, which was considered unrealistic just a few months ago. Tesla, in every sense, has defied the odds. The question is whether this positive trend in earnings and cash flow will continue in the future. Not surprisingly, the bears don’t think so.

The bear case

As much as the bull case for Tesla is about the story, the bear case is about numbers. That is what has made this battle a fascinating one between the bulls and bears. The massive debt burden is one of the primary reasons why many investors believe that Tesla would not see light at the end of the tunnel. At the end of 2019, the company had $14 billion of total debt outstanding and net debt of over $8 billion when the cash balance is taken into the equation. This can only get worse as it would take years before the company generates sufficient cash to facilitate the manufacturing of vehicles. It’s no secret that the automobile industry is one of the most capital intensive industries in the world. Bears argue that Tesla will eventually succumb to its debt burden as a result of running out of options to refinance the debt or generate cash to honor these obligations. 

Debt maturity schedule

Source: Company filings

Bulls counterargue that the maturity schedule is favorable as the bulk of repayments are due beyond 2023, leaving the company with ample time to service the debt.

It may not be just numbers as well. Many bears are critics of Elon Musk and believe that he should be ousted from his position as CEO. Musk is famous for the controversial Tweets that had the potential to jeopardize the future of the company. For instance, the “funding secured” Tweet in mid-2018 eventually led to an investigation by the Securities and Exchange Commission. The Tweets by the CEO has led to significant market volatility and this is likely to be a feature for a prolonged time. Musk has a notorious reputation among investors, and despite his massive success in the past, he is believed to have claimed the impossible and even lied to investors when he deemed fit.

The expected uptick in competition to gain market share in the EV industry is another argument made against Tesla. General Motors, Toyota, Nissan, Ford, Honda, and Mitsubishi are all in an uphill battle against Tesla, and many of these companies have made it clear that the bulk of their new models will be electric vehicles by 2025. Competition from big names is expected to impair the probability of Tesla earning consistent profits in the long run. 

Another factor that has fueled the thinking of bears is the continued dilution of shareholders. Despite confirming that Tesla does not have any capital requirements, the company announced another stock offering in February as well. Even though investors have provided funding whenever the company needed it, there’s a common belief that this will come to an end. Bears project this to happen sooner rather than later, pushing Tesla to bankruptcy. 

As far as I see, the bear case for Tesla is built on two classes of opinions;

  1. No business is worth an infinite price so an investor could lose money by investing in a good company at the wrong price even if the company continues to grow.
  2. The business model of Tesla is broken and if the debt burden or the continued cash-burning doesn’t do it, the competition will kick the company out of business operations.

Regardless, underestimating Tesla has proven to be a costly mistake. Even though the company has a history of guiding for seemingly unrealistic targets, the company has a track record of meeting such expectations as well. Think about how the company smashed its 5,000 Model 3 cars per week target in mid-2018.

Bears also argue that government subsidies and incentives are a thing of the past as many countries, including Norway, are slowly but surely beginning to claw back some of the incentives declared earlier.

For me, picking out the winning or losing companies is a combination of a story and numbers. In Tesla’s case, there are many stories, and numbers can be manipulated to reflect either side of these stories. This makes me worried and I am yet to come up with a model that can truly reflect where Tesla would be in a few years. As an investor and an analyst, however, I do not think that accepting my inability to value Tesla with some degree of precision is a failure. Rather, this could save me (and maybe my readers) from getting burnt. This leads me to my case for Tesla.

My case

It seems good to be teaming up with the likes of Charlie Munger. My case for Tesla is to avoid it altogether until I can observe a catalyst that would drive the shares higher or lower. For now, there’s not enough data for me to figure out which of the above cases will come out on top. I don’t like to be a bull of Tesla who ignores the valuation of the company altogether and assumes that growth companies would and should be rewarded at any cost. Neither do I want to be a bear who ignores the massive runway ahead for Tesla, which would enable the company to deliver robust numbers depending on its ability to fine-tune the business operations and deliver the promised goods in a timely manner. A lot could go right for the company and an equal lot could go wrong as well. 

At the annual meeting of Daily Journal Corp. in February, when asked about the wild ride of Tesla, Munger said:

I would never buy it and I would never sell it short. I think Elon Musk is peculiar, and he may overestimate himself, but he may not be wrong all the time. Tesla shares went up because Elon has convinced people he can cure cancer.

This statement is a close representation of my thinking behind Tesla as well. Due to the lack of an identifiable catalyst that would address all my concerns, I opt to watch Tesla closely and do nothing for the moment. This might attract a lot of criticism from both the bulls and bears as there seems to be a lot of money to be made on Tesla, according to both these parties. 

If an investor thinks that “doing nothing” is not a strategy, Mark Cuban begs to differ. In a recent interview with CNBC, Cuban said:

While all the selling seems to be based on China and the price of oil, I really don’t know what the long-term implications for our stock market is. So I follow the number one rule in investing. When you don’t know what to do, do nothing.

The number one rule that dictates the investment decision-making process of the billionaire investor is to do nothing when you’re not sure. This, exactly, is what I’m doing right now. However, if I do find a reason to believe that Tesla shares will most definitely head one way, not the other, I am ready to pounce on the opportunity as well. I’m planning to pay close attention to the comments section of this article to figure out one. 

I have often considered using a long straddle during times when Tesla reports financial results as well. The significant volatility around earnings dates increases the chances of either one of the options ending up on the winning side. For investors not familiar with options strategies, a long straddle involves buying both call and put options with the same strike price. If the stock price makes a substantial move, either up or down, the trader could end up earning a handsome return. The breakeven price is the value of combined option premiums. This is the maximum loss as well. Here’s an illustration of a long straddle.

Source: My Journey To Millions

I plan on updating readers if I initiate a position on Tesla to discuss what led to a change in my thinking.

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