Tesla’s Headed for a Crash
Tesla Motors is back in the news again.
In the past year, the company has been on a continuous roll. In August, it opened an assembly plant in the Netherlands, and it now as has a functional cross-country supercharger network in the U.S. In the fourth quarter, it sold about 6,900 cars, more than expected. It ended 2013 with 22,477 cars sold, worth $2.5 billion, and a projection that it would “deliver over 35,000 Model S vehicles in 2014, representing a 55+% increase over 2013.”
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As the chart below shows, the company’s stock has soared more than seven-fold, from about $35 in late February 2013 to about $250 this week, giving it a market capitalization of $31.1 billion, compared with $58 billion for General Motors and about $60 billion for Ford.
This week, investors were, um, charged up, by two simultaneous bold strokes. On Monday, February 26 Tesla announced it would capitalize on its momentum by selling $1.6 billion in convertible notes (a sort of debt/stock hybrid). Even better, it would use the funds to construct a futuristic $5 billion battery plant. The Gigafactory would be built somewhere in the southwestern U.S., and could employ up to 6,500 people. Taking a page from Henry Ford’s book, Tesla founder Elon Musk decided he can cut costs and gain greater control through vertical integration. Tesla has said that its ability to produce cars has been constrained by a lack of batteries from suppliers. By building its own power sources – and by building them in huge volumes – Tesla can bring the price of these vital components down sharply. What’s more, as an optimistic Morgan Stanley analyst noted, the batteries produced in the factory could have applications in related fields like energy storage and utilities.
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The next day, Tesla’s stock shot up another 31 points, or 14 percent.
I’m far from a Tesla hater. I’ve championed the company as an archetype of American-style innovation, self-belief, and swagger. Founder Elon Musk has been brilliant not just in devising a new product, but in negotiating complex systems to maximum advantage – taking U.S. Energy Department loans (and then loudly paying them back years ahead of schedule), reaping significant revenues by selling zero-emission production certificates to other carmakers, and funding production by taking big deposits from customers well in advance of delivery. Tesla’s success has forced other carmakers to up their electrification game in ways that will benefit consumers and the environment.
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But Tesla is getting bubbly. And we could be entering dangerous territory.
Bubbles – be they in single stocks on in entire sectors – have a predictable, repeating pattern. (I actually wrote a book about this several years ago.) Bubbles don’t get dangerous when founders and entrepreneurs get very optimistic. They get dangerous when Wall Street analysts get extremely enthusiastic about a phenomenon – after there has already been a huge run-up.
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It’s one of the great ironies of modern finance that the highly paid professionals tasked with following financial trends often seem to be the last to know. The release of Federal Reserve minutes from the 2008 crisis period earlier this week reveals the economists who were supposed to spend all day figuring out the state of the economy had no idea the economy was in recession and a crisis was about to explode, even as many (cough, cough) were loudly warning that a recession had already started. Ratings agencies like Standard & Poor’s tend to downgrade credit ratings of entities like Puerto Rico -- long after the bond prices fell.
And big Wall Street firms tend to slap very optimistic buy ratings on stocks only after they’ve enjoyed an immense run-up.
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That’s what is most troubling. This week, Morgan Stanley analyst Adam Jonas issued a very bullish report about Tesla. Previously, Jonas had a price target of $153 for the stock (a barrier it blew through in last August.) Now he was suggesting the stock, which has risen 600 percent in a year, could rise to $320.
The report was more than just an examination of Tesla’s balance sheet. Rather, it was a philosophical meditation on progress and the future. "Tesla’s quest to disrupt a trillion $ car industry offers an adjacent opportunity to disrupt a trillion $ electric utility industry," Jonas wrote. (h/t Business Insider) "If it can be a leader in commercializing battery packs, investors may never look at Tesla the same way again." As for its core car business, the sky was the limit – production could rise to 370,000 cars annually by 2020, and to 1.1 million in 2028. What’s more, Tesla could help usher in a new golden age in which every car drives itself. By 2026, a chart he included noted, we could have “100% autonomous penetration, utopian society.”
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Now, think about all the rules of math (and human nature) that would have to be violated to reach these goals. To get to 370,000 cars by 2020, Tesla would have to enjoy a 50 percent compounded annual growth for seven straight years. And in 12 years, we’d have a system in which all cars drive themselves and we’ll live in a utopian society. Keep in mind, the U.S. can barely keep its government open, fix a pothole, or move a train 45 miles in an hour in this country.
But this is the sort of mentality that comes to the fore in a bubble. To justify the current high price, analysts have to project really powerful, uninterrupted growth endlessly into the future. To seize attention amid a string of positive results, you have to issue a wildly optimistic forecast. If you’ve been behind the curve, as analysts have generally been about Tesla, you strain to get ahead of the curve. And when a company has proven itself to be capable for several years, you start to forget that others – like car companies, utilities, governments, start-ups – may not just sit back and let Tesla expand its market share forever.
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Some wags have pointed out that there may have been more practical considerations underlying the Morgan Stanley analyst’s idealistic projections. Morgan Stanley was named one of the underwriters of Tesla’s convertible bond offering, meaning it will share in fees that could amount to $100 million or more. Of course, Morgan Stanley would likely have played a role in the offering in any event. But it never hurts an investment bank’s cause when one of its analysts is cheerleading loudly for a potential client.
The pop culture enthusiasm, the Wall Street love after a sharp run-up, the bold projections, the ever-larger sums of money raised and spent, and the messianic aura – these are the sorts of phenomena one sees in a bubble. Tesla may well hit all these fantastic projections. In ten years time, we may all be driving Tesla sedans, using Tesla battery-packs to power our homes, and buying Elon Musk action figures for our kids. It’s possible.
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But dreams and visions have a way of getting impaled on the sharp lance of economic realities. Recessions and financial crises happen. Competitors rise up. There are plenty of ways in which Tesla could blow a tire. And when that happens, look out below.
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