With the Securities and Exchange Commission (SEC) now all in on Tesla Inc. (TSLA) CEO Elon Musk after filing on Thursday its stinging 23-page fraud complaint against him -- the filing is here, please read it if you haven't -- Tesla shareholders have a choice. They can listen to talking heads or listen to the market. I guess I am one of those talking heads, and no one could read my Real Money columns and accuse me of being insufficiently bearish on Tesla stock.
The root cause of that bearishness is the market's valuation of Tesla. Placing an accurate value on an enterprise is the core job of any stock analyst. In a world where instant reactions are legion and the very medium -- Twitter -- that made Musk a phenomenon is now the source of his problems, the numbers always should be your guide.
In the case of Tesla, the overvaluation is easy to spot and the level of delusion among certain so-called experts on the name rarely has been seen in my 26 years of following stocks, specifically car stocks. A very simple valuation metric is to calculate a company's maximum output, tally up the revenues that would be produced at that level, and then figure a profit margin. Cash flow is most accurate, but operating income gleaned from the income statement will suffice. That figure is used to value a business against other companies in comparable company analyses -- "comps," in Street jargon -- or, ideally, to forecast out at least five years and then discount back to divine a present value of future cash flows.
That sounds like an involved process, and it is. You should ignore anyone talking about Tesla this morning who has not undertaken that task. t should be easy to tell who has and who hasn't. One does not have to be a veteran Excel jockey such as me to perform an even simpler calculation on Tesla, though. This reckoning shows that Tesla shares have massive downside from here, and that Tesla's $51 billion valuation as of Thursday at 4 p.m. ET was impossible to justify.
So, here goes:
I am valuing Tesla as a car company. I give no value to SolarCity, which is a charitable decision on my part, because I believe the legacy SolarCity assets are worth far less than their included liabilities. If you want to discuss that offline, feel free to contact me via Real Money but suffice it to say I think SolarCity is a disaster and worth, to paraphrase Bret Easton Ellis, less than zero.
Tesla the car company obviously has value, and Musk has built a brand from nothing, which rarely happens in this slow-moving industry. However, please don't forget that Tesla is a niche player. Tesla is valued at a gigantic premium to other car companies that produce magnitudes more cars, and that just does not make sense.
At current rates, Tesla is producing close to 300,000 units (100,000 Model S/X units and 200,000 Model 3 units) on an annualized basis at its Fremont, California, factory. I believe third-quarter production will come in slightly below that figure, and Tesla's production issues are far too numerous to mention here, but I use that production level as a benchmark. Musk believes Fremont has a theoretical capacity of 500,000 units annually, but Tesla is a glaring example of the difference between theory and practice, so I'll stick with the facts.
At 300,000 cars a year and with 170 million shares outstanding, Tesla at $265 per share (it is slightly above that level in pre-market trading) is trading at $150,000 per car produced.
How does that make any sense? Tesla's products retail for much less than $150,000 per unit and Tesla's average revenue per unit (ARPU) will continue to fall as the Model 3 takes up a greater share of production. Note also that this is an equity valuation; including Tesla's $11 billion of net debt would produce an enterprise value per car of $187,000, which is completely out of la-la land.
So, is the market assuming Tesla has a margin in excess of 100% on its products? Or is there some voodoo math involving hopes for a future that includes full autonomy, artificial intelligence and all sorts of concepts that the people touting Tesla on CNBC clearly do not understand?
It's voodoo, pure and simple. There is no justification for Tesla's valuation, even at today's lower levels. At the end of the day, that is all that matters, not the cult of personality that clearly extends to Tesla's board members who lovingly refer to their CEO as "Elon."