Elon Musk and the Invisible Cloth of the Market

Tesla’s strategic success overshadows its inability to turn a profit. This is incredibly dangerous for the entire green energy industry.

As one of the great innovators of our time, we’re willing to give Elon Musk a lot of leeway. Including the fact that many of his existing roster of companies are unprofitable, or would be were it not for constant investment.

Even Tesla, which is currently one of Musk’s crowning accomplishments, is generating barely any net revenue; earning nothing, and naturally paying no dividends to investors. Sales of Tesla’s expensive electric vehicles are currently failing to compensate for production costs [1] as well as research and development. Worse yet, sales in the US are dropping [2].

Tesla stocks, on the other hand, continue to soar. In many  ways, business for Tesla has never been better: its current valuation exceeds Bank of America and American Express combined in size; in addition,  it recently overtook Toyota as the highest-valued automobile manufacturer. These developments have made estimates of Musk’s personal wealth grow to exceed the estimated net worth of Warren Buffet. 

That’s a lot of money to have been made without ever actually making bank [3].

This begs a question. What exactly is going on with Tesla’s stock price?

One answer is that investors continue pouring liquidity into Tesla expecting a return on investment, and this influx covers production costs but leaves the company barely out of the red. Tesla makes its money from new investors expecting that once Tesla actually starts making money, the payoff will be worth years of waiting. In this scenario, Tesla’s ever-increasing valuation is reflective of solid faith in the company’s ability to pull through and make good on its initial promise of affordable electric vehicles.

It’s not an entirely unreasonable answer, and there’s certainly reason to believe that Tesla is very good at defying common sense, snatching apparent victory from the jaws of impossibility [4]. This narrative of constant progress has gained Elon Musk many fans willing to believe in his success no matter its actual likelihood.

However, that would be the wrong answer. The narrative of constant progress belies a different reality, one in which rampant speculation is both the main boon of Tesla and the reaper waiting to drag it into the grave. The people who are actually making money off of Tesla are profiting from this narrative of invincibility and pushing Tesla stock to ever higher extremes that fail to reflect the actual value of the company because it makes for a fantastic seller’s market. In other words, investors are generating earnings by profiting from new investors hoping to generate earnings. One word for this is ouroboros, a snake endlessly devouring its own tail. And while this seems like a fitting image for a portion of investors, there’s another term that’s even more fitting: Bubble.

Admittedly, this is uncharitable: Tesla, increasingly, manages profitable quarters. Q4 2019 was their most profitable quarter to date, benefiting from a healthy economy and emerging interest in green vehicles. Tesla even managed to limp along and churn out growth in Q1 and Q2 2020 (barely).

2020, however, has more trouble on the horizon. There are a few major challenges to market stability, to put it lightly.

Tesla’s ability to rise in the market is entirely dependent on its exceptional narrative. Elon Musk is, essentially, coaxing money out of thin air as investors exchange his promises at rabid price increases. This has been going on for ten years.

Naturally, this is no issue if you believe in investors’ ability to correctly ascertain the payoffs of companies. However, evidence continues to emerge that this is a bubble. And a rapid collapse of Tesla stock could have ramifications for the entire market of electric vehicles, itself a rapidly expanding industry at high risk of being deemed a bubble [5] [6].

Furthermore, Tesla’s centrality to the electric vehicle market renders the situation even more dangerous. Tesla’s high level of vertical integration has reaped benefits in that they supply 21% of the market for electric batteries; this means that their own vehicles are not the only ones in danger from a downturn in Tesla stock. In effect, an inability to deliver on their batteries would result in price hikes and shortages within the context of a necessary expanding market. Tesla’s hubris is therefore endangering the entire green vehicle market.

This is compounded by issues outside of Elon Musk’s control. Part of the strategy to attain eventual profitability was through shifting some expensive operations (such as the production of batteries) to lower labor cost locations, such as the new gigafactory in  Shanghai. But as tensions continue to rise between the United States and China, the long-term viability of this move is increasingly put into question. Ongoing tariffs and government hostility to operations on both sides could result in the premature collapse of the Shanghai operation, not to mention privation from the Chinese market overall. In fact, this is appearing increasingly likely given the Chinese government’s full-throated support of domestic-based Tesla competitors such as Nio [7] [8]. 

And of course, in addition to all the exogenous factors that could affect Tesla’s rise, there’s internal volatility. The CEO’s well-known affinity for Twitter is a liability; worse yet, Elon Musk has a tendency of creating fights that could have been easily avoided [9]. Even more seriously, his penchant to not sweat what he sees as details has a tendency of putting the company in unfortunate situations. Accusations abound, from the many lawsuits [10] to the treatment of Tesla employees [11]. 

It’s fair to say that Tesla was built on the personal allure of Elon Musk – the sheer weight of a narrative that catapulted him from nowhere to the heights of fortune. But his enthusiasm for a business model wherein profits come last, no doubt a holdover from the world of software where production is more easily scalable, is a serious liability in an era where a single poorly thought-out tweet can wipe out 5% of this company’s value [12] in a day.

Given all of this it seems pretty reasonable to say that the investors have no clothes; in fact, some people are already doing so [13]. Tesla’s current market value is reflective of nothing; not only is it currently smoke and mirrors, but the projection that it will be able to rise to reflect its current valuation is at best blind optimism, at worst wild hallucination. Sales in California are down [14] and between tariffs, disentanglement [15], and a slew of state-funded new competitors in its largest potential market, prospects for growth in China are looking more and more remote [16]. 

Short of a breakthrough, it’s safe to suggest that the writing is on the wall. As of this week, the debate is no longer about whether Tesla stock is a bubble [17]; instead the only remaining question is how much we should worry [18].

Better keep your Camry.

Sources:
1. Lora Kolodny, “Elon Musk emails Tesla employees: ‘Breaking even is looking super tight’”, CNBC, 29 June 2020
2. Graham Rapier, “Tesla sales in California plunged amid the coronavirus — now all eyes are on China to make up the difference”, Business Insider, 17 June 2020
3. Rob Davies, “Tesla becomes world’s most valuable carmaker without making a profit”, The Guardian, 1 July 2020
4. Tim Higgins, “Elon Musk Aims Tesla at Fourth Straight Profitable Quarter”, The Wall Street Journal, 21 July 2020
5. Jeremy Bowman, “Are EV Stocks in a Bubble? 2 Cautionary Tales Investors Should Know”, The Motley Fool, 21 July 2020
6. Mohit Oberoi, “Six Reasons EV Stocks Look in a Bubble”, Wall Street Desk, 5 July 2020

7. Zheng Lichun and Mo Yelin, “For Electric-Vehicle Maker Nio, Government Tie-Up Has Its Benefits”, Caixin, July 10 2020
8. Zacks Equity Research, “NIO Soars More Than 350% in 3 Months: What’s Driving it?”, Nasdaq, 14 July 2020
9. Julia Carrie Wong, “Elon Musk on trial: CEO accused of defamation over ‘pedo guy’ remarks”, The Guardian, 3 December 2019
10. “List of lawsuits and controversies of Tesla, Inc.”, Wikipedia
11. Mark Matousek, “Tesla is transforming how cars are sold. But 27 insiders say the company’s methods mean slashed pay and living in constant fear of getting laid off”, Business Insider, 7 July 2020
12. Will Feuer, “Tesla stock reaches $420 more than a year after Musk’s notorious ‘funding secured’ tweet”, CNBC, 23 December 2019
13. Jasper Jolly, “Can Tesla justify a $300bn valuation?”, The Guardian, 18 July 2020
14. Ankanksha Rana, “New Tesla registrations in California nearly halve in fourth quarter: data”, Reuters, 16 January 2020
15. Keith Johnson and Robbie Gramer, “The Great Decoupling”, Foreign Policy, 14 May 2020
16. Yulei Sun and Brenda Goh, “Tesla’s China car registrations plunge 64% m/m in April”, Reuters, 19 May 2020
17. The Editorial Board, “Lessons from Tesla’s remarkable market run”, The Financial Times, 17 July 2020
18. James Mackintosh, “Beware the Lure of Free Money”, The Wall Street Journal, 25 July 2020

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