Elon Musk: Einstein or Icarus?

Joel Anderson  |

Elon Musk sent shares of Tesla (TSLA) jumping on Tuesday when he teased a big announcement coming that afternoon on Twitter (TWTR). The announcement wound up being that the Model S and Model X could now be equipped with a new, 100 Kwh battery pack that allowed the Model S to go from 0-60 in just 2.5 seconds, making it the third fastest in the world behind the LaFerrari and the Porsche 918 Spyder, and extended its max range for a single charge to 315 miles.

It’s perhaps fitting that those two things were highlighted on Tuesday: acceleration and long-term range. Because they tend to highlight both the excitement and trepidation surrounding Tesla. As far as acceleration goes, Tesla and Elon Musk have it in spades. The company has always, always kept its foot planted firmly on the accelerator, driving ahead towards a big, bold future as quickly as it can. The company’s stock is worth more than six and a half times what it was at the start of 2016.

It's the range, though, that has always kept a lot of people skeptical. Sure, Tesla has built itself into a hot stock. But can it build itself into a truly successful company? For all of the energy surrounding the construction of the Gigafactory and the hype surrounding every new product launch, Tesla has a long way to go until it’s selling enough of, well, anything to really support the valuation it’s already hit. And, perhaps more importantly, it’s at least starting to seem possible that, even if Elon Musk’s vision of a future littered with autonomous, self-driving electric cars plugging into solar rooftops with a home battery system comes to fruition in our lifetimes, Tesla’s not going to be the company that builds and sells all those things.

Faith in Tesla’s Stock Means Faith in Elon Musk

Let’s start with a simple premise: the only way you could possibly be willing to buy Tesla’s stock at this point is if you genuinely, truly believe in every piece of Elon Musk’s vision for the company’s future. Or at least, that would be the only reason to do so at its current price.

The current market cap for Tesla is just short of $33.5 billion, a level that’s a little under 20% below its 52-week high but still firmly in large-cap territory. Why should that number stick out? Well, it’s a little eye-popping when you consider just how small a company Tesla really is. At this point, Tesla is still a niche car company that sells a very small number of very expensive cars to a very small audience. The Model S and Model X are pretty clear examples of that, with the Model S P100D starting at $134,500 and the Model X P100D starting at $135,500.

Granted, Tesla has every intention of changing this reality. They’re growing their production capacity as rapidly as possible, planning on growing its production capacity from 50,000 last year to some 500,000 by 2018. The Gigafactory, an enormous plant producing lithium ion batteries in the Nevada desert, is expected to not only aid the company in mass-producing cars, but it’s batteries are being slated for a number of other potential uses as well, from home power systems to utility-scale battery farms. And the Model 3, expected to start deliveries in late 2017, is a $35,000 sedan that could potentially penetrate a much broader market.

Sure, Tesla is a company that clearly has a bright future. It’s whether or not Tesla’s stock will have a bright future that gets a lot murkier.

A Valuation That’s Built On Sand?

Tesla’s valuation of $33.4 billion is actually pretty close to that of the major auto manufacturers. Ford (F) comes in at $49.1 billion, at present, just a little behind General Motor’s (GM) $49.7 billion. However, that should actually act as a huge red flag for anyone thinking that a ten-fold increase in production in a 3-year period means buying Tesla now makes sense.

Tesla’s valuation is about two-thirds of what Ford or GM are right now. However, when you start comparing the other metrics about these companies, that starts to become a really absurd figure. Tesla pulled in a little over $4 billion in revenue in 2015, compared to $149.6 billion for Ford and $152.4 billion for GM. Tesla made 50,000 cars in 2015, compared to over 3.2 million for Ford and over 6.5 million for GM.

Simply put, even if Tesla can, in fact, start producing 10 times as many cars over 36 months, it would still represent just 15.6% of what Ford does or 7.7% of what GM does. Really, Tesla HAS to hit its production targets to make its stock anything less than a complete albatross.

When Evangelism is No Longer Enough

Granted, a lot of this is really in the realm of your classic comparison of an early-stage company to two late-stage ones. The valuation of any young company seems ridiculous when compared to its established industry counterparts. Tesla’s valuation says more about its year-over-year revenue growth, which is both robust and consistent, than it does anything else. This saga has played out over and over again with varied results, and Tesla vs. Big Auto is just another chapter.

However, the concerns come in when you consider the degree to which the valuation of Tesla seems to rest completely on the continued belief in its founder, Elon Musk. A lot of the reason why people continue to be willing to invest huge sums of money into a company that has never been profitable is because they really believe in that pot of gold at the end of the rainbow. Once any company starts to show cracks and give markets reason to believe it’s not quite going to make it to that promised land it’s been desperately promising, well, things can start to go downhill fast. Just ask anyone who bought into Twitter the day after it IPOed.

And in Tesla’s case, Elon Musk continues to ask for a lot of faith from his believers. Tesla is taking on a lot of debt to ensure that it finishes that gigafactory and has any chance to hit those production targets. The company already has a reputation for missing those targets, and it’s only a matter of time before people start to wonder if Musk is really capable of delivering on this vision he keeps peddling. The Model 3, in particular, has been billed as the company’s master stroke. Whiff on that 500,000 figure by 2018 and it could be the moment you start to see the Tesla narrative unravel.

What’s more, even as some people might be starting to get a little more conservative just to ensure that they can deliver, Musk appears to be going bigger and bigger. In particular, his attempt to fold SolarCity (SCTY) - the home solar system company in which he’s the largest shareholder and Chairman - into Tesla is a deal that has raised serious questions. While Musk insists that it’s all a part of his grand vision, the market remains extremely (and understandably) dubious.

Best case scenario? Musk’s grand vision is achieved, and he can vertically integrate a company that produces solar panels for your roof, a battery for your garage to store the power they produce, and the car that you charge up each evening from that battery. Worst case scenario? Musk is using his already teetering car company to buy some time for his solar company that already appears to be in serious trouble.

Elon’s Dangerous Game

SolarCity may, in fact, be an omen of what Tesla could be in trouble of becoming if the next year or two don’t go well. The company expanded too fast, borrowed a lot of money to do so, and is currently in desperate need of cash to keep things going. It’s not entirely dissimilar from SunEdison (SUNEQ), another solar company that grew too fast, lost the faith of the markets, saw its stock plummet, and finally entered bankruptcy.

A buyout for SolarCity ultimately makes a lot of sense. If the company can get the infusion of cash it needs, it’s operating in a high-growth industry with a ton of potential. With the resources necessary to complete its massive solar panel plant in Buffalo, it’s not hard to imagine the company getting through its current stage and ultimately reaching profitability and major success.

But that’s just the thing: SolarCity has a lot of the same issues Tesla does, just a bit more advanced. Tesla has its hands full putting together the cash necessary to fund its own massive expansion plans, let alone taking on SolarCity’s to boot. The sort of synergies the two companies offer as one entity seem to mostly just be the batteries Tesla produces that can be used both in the car and, ultimately, as a compliment to a home solar system.

And the deal starts to get even ickier when you consider Musk’s personal involvement on all sides. Merging two companies in which you’re the largest shareholder into each other when there isn’t a lot of business reason for doing so is not something that looks good on paper. And Musk didn’t help anything on Wednesday when he bought up over half of the $124 million in “Solar Bonds” SolarCity was offering, a move the company didn’t mention in its recent Q2 earnings report.

All told, Musk is placing the burden of an enormous amount of the success of this entire venture on his own reliability in the eyes of the investing public, and then increasingly testing everyone’s patience with his antics. Anyone trying to convince investors that merging their two debt-ridden, unprofitable companies together at a time when one appears to be teetering on the edge of solvency is playing fast and loose with their reputation, let alone someone who has already staked so much on his personal vision.

Pioneers Don’t Always Reap the Benefits

This becomes especially troubling when you consider that, even if Musk is right about the future of our energy economy, he might not be right that it’s his companies that will deliver said future. He may have been the first one into the space, but that doesn’t mean he’s going to be the one to capture it.

For starters, there’s a lot of evidence that, while there’s clearly a niche audience for the sort of technology Tesla and SolarCity are bringing to the market, it’s definitely not something that’s expanded to the mainstream. It may, in fact, take a couple decades before the American public is really ready to fully buy in on driverless cars or electric cars. If that’s the case, Tesla’s rapid expansion stands to hit something of a ceiling in the next few years.

And if that’s the case, it could mean that the array of massive competitors with decades of market experience lining up to start competing with Tesla will have more than enough time to carve out their own share of the market. Mary Barra has done excellent work at GM, including producing the Chevy Bolt, an electric car available at similar prices to the Model 3 and arriving earlier. There are myriad companies from a variety of sectors that have set their sights on driverless cars, from Google (GOOG) to Uber to, again, GM.

Even in the field of batteries, Tesla can’t necessarily guarantee that getting there first means it’s going to be alone at the moment the biggest opportunities arrive. Plenty of attention has been paid to the rapid expansion of the home solar industry, with a number of small and large competitors alike popping up. SolarCity’s biggest issue has been just how competitive the market has gotten, with cost of sales driving a lot of the company’s cash problems. Throw in the entry of industry stalwarts like General Electric (GE) in the battery market and things only get darker.

Can Musk Avoid the Fate of His Company’s Namesake?

This is all to say that being the first person to have the vision to anticipate the future is a far cry from being the entrepreneur who cashes in on that vision. Just ask the company’s namesake, Nikolai Tesla.

Elon Musk is currently playing a dangerous game, one where he leverages his own personal brand to buy his companies the runway they need to achieve success. If it works, it’s great news for everyone from his investors to the American people as a whole. However, it also means that it really, really has to work. If doing things like merging SolarCity and Tesla or buying up most of SolarCity’s bond offering end up with a spectacular collapse, it’s going to leave a lot of people in the lurch and make him personally responsible in a way few other entrepreneurs are.

With a company so reliant on being able to keep raising capital to fund expansion, rising so high so fast is a huge risk. A high profile failure suddenly has much higher stakes than normal, in that it could hurt the public perception of him as a visionary, which, because he’s melded that perception onto the very business model of Tesla, begins to chip away at the company’s very foundation.

Increasingly, Elon Musk is becoming an all-or-nothing bet. If Tesla ends up falling even a little short of the truly grand vision he’s laid out for the company, it’s likely to wind up burning investors. Modest success may wind up being great for the company in many ways, but it’s still not going to be enough for a stock that’s been built on tremendous potential for massive gains. And that’s a situation that Musk doesn’t appear to be doing anything to avoid.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer.

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