Latepost Valuation Of The Calendar Week 1: A Tesla Test

I taught the starting fourth dimension session of my valuation class, that I previewed inward my final post, today. As part of that class, I exercise what I telephone outcry upwards a “valuation of the week”, where I pick a fellowship in addition to value it in addition to and thence post both my valuation (with the spreadsheet in addition to the raw information that I used) in addition to a shared Google spreadsheet for anyone who wants to accept my valuation in addition to locomote far their ain (by changing the assumptions). I exercise this for ii reasons. First, I believe that you lot acquire valuation past times valuing existent companies inward existent time, non past times talking nearly valuation or reading nearly it. Second, from a purely selfish standpoint, I pick the companies that I notice interesting equally potential investments or equally existent globe representative studies for my valuations of the week. I notice the “crowd valuation” that emerges from this procedure to live useful inward reassessing my ain valuations.

As my starting fourth dimension valuation of the week, I picked Tesla, for 3 reasons. First, equally a technology fellowship inward an otherwise capital-intensive, mature concern (the automobile manufacturing business), it stands out. Second, the fellowship has a charismatic CEO, Elon Musk, an ambitious human being (and I don’t hateful that inward a negative sense) alongside a cracking bargain of imagination. Third,  the stock has taken off inward the final year, upwards to a greater extent than than 500%, fueled past times both positive intelligence on the production front end equally good equally on the fiscal front end (increasing revenues, declining losses, paying downwardly of debt). 

At its electrical current stock toll of $168.76/share, the marketplace capitalization for the fellowship is to a greater extent than than $20 billion. The inquiry for investors, both inward in addition to out of the stock, is non whether the fellowship was a skillful investment over the final twelvemonth (of course, it was) but whether it is a skillful investment today. You tin download the most recent annual in addition to quarterly reports for the company.

Using the measure metrics, the fellowship seems  over valued. With revenues of $1.33 billion in addition to an operating loss of -$217 1 K k over the final twelve months, it seems absurd to attach a value of to a greater extent than than $20 billion to the company. At closed to 15.4 times revenues, Tesla is existence valued to a greater extent than similar a immature technology fellowship than an automobile company. However, these measure metrics are also oft misleading alongside immature companies, since value should live driven non past times revenues in addition to earnings today but past times expectations for these values inward the future.

Expected Revenues

For Tesla to live able to deliver value equally a company, it is clear that it has to scale upwards revenues. On the skillful intelligence front, the fellowship has had a skillful year, alongside the revenues inward the starting fourth dimension 6 months of 2013 of $956 1 K k representing a surge from revenues of $41 1 K k inward the starting fourth dimension 6 months of 2012. While growth volition acquire to a greater extent than hard equally the fellowship continues to locomote larger, the inquiry of how hard cannot live answered until nosotros define the potential marketplace for the company. If nosotros define it narrowly equally electric/hybrid cars, the marketplace is pocket-sized (even though it is growing) in addition to the potential revenues volition receive got to reverberate that. If nosotros define it to a greater extent than broadly equally the automobile market, the marketplace is a huge 1 in addition to Tesla’s potential revenue expands accordingly. 

Since the describe betwixt electric, hybrid in addition to conventional automobiles is a fuzzy one, which volition acquire fuzzier over time, I volition accept the persuasion (optimistic, perhaps) that Tesla is an automobile fellowship that happens to specialize inward electrical cars in addition to mensurate its potential revenues past times looking at the biggest automobile companies today. 

Based on revenues, the biggest companies are those that offering the total attain (from luxury to majority market) of automobiles. It is truthful that BMW in addition to Daimler brand the top 10 list, but they sell far to a greater extent than than merely luxury cars. In valuing Tesla, I am going to assume (and I am for certain that some of you lot volition disagree) that success volition convey them revenues closed to those delivered past times a fellowship similar Audi ($64 billion). While it is conceivable that Tesla’s revenues could approach those of the auto giants ($100 billion plus), I intend the revenue growth required to acquire to those levels would live incompatible alongside the high operating margins that I volition live assuming for Tesla. Assuming that Tesla stays making merely electrical cars, this forecast is an optimistic one, insofar equally it assumes a rapid expansion inward the electrical machine portion of the automobile market.

Profitability

The minute slice of the puzzle inward Tesla becoming a valuable fellowship is that it has to locomote profitable. Based on the reported loss of $216.72 1 K k over the final twelve months, the pre-tax operating margin for the fellowship is -16.31%. It is truthful that this paints also dire a film of the fellowship because the fellowship did pass $306 1 K k inward R&D over the same twelve calendar month period. Assuming a three-year lag, on average, betwixt R&D expenditures in addition to commercial payoff, in addition to capitalizing R&D does trim back the operating loss to nearly -$21.86 1 K k (resulting inward an after-tax operating margin of -1.64%).

To acquire a feel of what the Tesla's operating margin volition be, assuming it makes it equally a successful company, I estimated the pre-tax operating margins of all publicly traded automobile companies globally, dividing the operating income from the most recent 12 months past times the revenues over that menstruum for each company. Since automobile companies receive got volatile earnings, I also computed a normalized pre-ta operating margin for each fellowship past times looking at the aggregate operating income over the final decade, equally a percent of aggregate revenues over that period. The distribution of the both measures of operating margin (the 2013 value in addition to the average from 2003-2012) is shown below:

Note that the sector has depression pre-tax operating margins, alongside the median value of less than 5%. Companies at the 75% percentile generate margins of betwixt 7.5% in addition to 8.5% in addition to in that location are a few companies that generate double digit margins.  One of the outliers is Porsche which reported a pre-tax operating margin of closed to 16% inward 2013, though its ten-year aggregate margin is closer to 10%. You tin download the dataset that includes the fundamental numbers for all auto companies past times clicking here.

For Tesla, nosotros volition assume that its focus volition locomote on to live on high-end automobiles in addition to that is margins volition converge towards the higher terminate of the spectrum. In fact, I am assuming that the technological in addition to innovative ingredient that sets Tesla apart volition allow it to deliver a pre-tax operating margin of 12.50% inward steady state, putting it inward the 95th percentile of auto companies (and closer to the margin for technology companies). I volition assume that the margin improvements occur over time, alongside the biggest  improvements happening inward the close years. The figure below captures the forecasted operating income in addition to margin, past times year, inward my valuation of Tesla:

Based on my estimates, Tesla volition generate to a greater extent than than $8 billion inward operating income past times twelvemonth 10, making it to a greater extent than profitable than all but 3 other automobile companies today (Toyota, Volkswagen in addition to BMW). 

Investment Requirements

Growing revenues roughly 60 crease in addition to improving operating margins to gibe the most profitable companies inward the sector volition involve reinvestment. Some of it volition accept the cast of additional R&D, equally Tesla tries to maintain its competitors at bay, in addition to some of it volition receive got to live inward to a greater extent than conventional assembly lines in addition to factories, equally production gets ramped up. Over time, I believe that the latter ingredient volition come upwards to dominate the former.

In my forecasts, I receive got assumed that Tesla volition receive got to invest nearly a dollar inward working capital missive of the alphabet (in either R&D or plant/equipment) for every additional $1.41 inward revenues. That matches the manufacture average of the sales to working capital missive of the alphabet ratio of 1.41 for USA companies. Since the sales to working capital missive of the alphabet ratio for technology companies is higher (2.66), it is possible that I am over estimating Tesla's reinvestment inward the early on years. However, the furnish on invested working capital missive of the alphabet that I obtain for Tesla inward steady nation (in twelvemonth 10), based on my estimates of operating income in addition to invested capital, is 11.27%, putting it over again at the top decile of automobile companies.

Risk

Tesla is undoubtedly a risky investment in addition to in that location are 3 components of opportunity that I attempted to comprise inward the valuation:

a. Business/ Operating risk: Tesla is exposed to substantial concern risk, some coming from macro economical sources (the forcefulness of the economy, inflation, involvement rates), some resulting from technological shifts (the winning technology inward the electric/hybrid auto concern is yet to live determined) in addition to yet to a greater extent than emanating from the sector (with every major automobile fellowship staking out its claim on this segment of the business). To capture the risk, I assumed that Tesla, equally it stands now, exposes investors to a mix of automobile concern opportunity in addition to technology concern risk. While I assumed a 60% auto/40% technology mix inward arriving at a cost of working capital missive of the alphabet of 10.03%, the value per portion that I obtain is non really sensitive to this assumption:

Treating Tesla equally a purely automobile fellowship increases its value to nearly $74.73, whereas treating it equally a technology fellowship lowers the value per portion to $60.84.

b. Geographic risk: While it is probable that equally Tesla grows, it volition receive got to human face to emerging in addition to to a greater extent than risky markets, I volition assume that its opportunity exposure for the adjacent decade volition come upwards primarily from mature markets, allowing me to role my electrical current gauge of the equity opportunity premium for the USA of 5.8% for the cost of equity/capital computations. 

c. Truncation risk: Tesla, inward spite of its lofty marketplace capitalization in addition to recent successes, is yet a young, money-losing company. H5N1 large stupor to its concern (from a legal setback, a recession or a sector-wide slowdown) could position the company's survival at risk. While that opportunity has declined substantially over the final ii or 3 years, I intend that it yet exists in addition to volition attach a probability of 10% to its occurrence. If the fellowship does fail, I volition also assume that it volition lose a meaning portion of its value inward a distress sale (receiving solely 50% of estimated value).

Loose Ends
As alongside whatsoever immature company, in that location are issue ends to necktie upwards that touching on value. In particular, I would call for to the following:

a. Subsidized debt: Tesla was the beneficiary of subsidized loans from the DOE, amounting to roughly $465 million. While this loan loomed large ii years ago, when Tesla was a smaller fellowship alongside to a greater extent than default risk, it has faded inward importance partly because of Tesla's success (and the resulting access to working capital missive of the alphabet markets). Since Tesla has paid downwardly the loan, it no longer has whatsoever effect on value.

b. Net Operating Loss deport forward: At the terminate of 2012, Tesla had a internet operating loss of merely over a billion that it is carrying forward. I used the NOL to shelter income from taxes inward the early on forecast years, pushing upwards cash flows inward those years. As a consequence, Tesla's income is sheltered from taxes for the starting fourth dimension 6 years of forecasts.

c. Management/Employee Options: Of larger import are the management/employee options that Tesla has been generous inward granting inward the final few years. As of the most recent 10K, the fellowship had about 25 1 K k options outstanding, alongside an average smasher toll of $21.20 in addition to vii years left to expiration. Since in that location solely 121.45 1 K k shares outstanding, the value of these deep in-the-money, long term options represents a meaning drag on value.

The Bottom line

The ingredients that brand a young, money-losing fellowship into a valuable, mature fellowship are no secret: pocket-sized revenues receive got to locomote large revenues, operating losses receive got to plough to profits, in that location has to live plenty reinvestment (but non also much) to brand these changes in addition to the opportunity has to subside. I am assuming all of these at Tesla but my estimated value per portion of $67.12 is good below the marketplace toll of $168.76. You tin download my valuation spreadsheet past times clicking here.

Is the value sensitive to my assumptions? Of course, in addition to peculiarly because Tesla is a immature fellowship inward transition. In fact, replacing my call for estimates for the input variables (revenue growth, target operating margin, sales/capital, cost of capital) alongside distributions yields a distribution of value for Tesla that reflects my uncertainty nearly the future:

Note that in that location are scenarios where the value per portion exceeds the electrical current marketplace toll ($168.76), but I would add together ii cautionary notes. First, at to the lowest degree based on my estimates, the probability that the value exceeds the toll is pocket-sized (less than 10%) Second, the combination of outcomes (high revenue growth, high margins in addition to depression risk)  that would yield these high values are hard to force off. 

You tin bill me of existence also pessimistic inward my assumptions, but the narrative that underlies my valuation is an optimistic one. I am assuming that Tesla volition grow to live equally large equally Audi, piece delivering operating margins closer to Porsche's. Even alongside these assumptions, I cannot run into a rationale for buying the fellowship at today's marketplace toll but that is merely my personal judgment. You are welcome to disagree. In fact, if you lot download my valuation in addition to alter the fundamental assumptions, delight accept a infinitesimal to study your gauge of value per portion inward this Google shared spreadsheet. Let's run into how the crowd valuation plays out!

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