Barriers of entry – Tesla friend or foe?

Topic: Tesla & barriers of entry (plus the difference between stocks and companies)


Find something you love and do it with focus and abandon

This website is about the joy of exploration and knowledge — sometimes for practical use (enabling increased personal comfort and expanding degrees of freedom), sometimes for the sheer pleasure of enhanced perspective. It’s all about making you resilient in your pursuit of happiness in a world of accelerating change and an increasing divide between human biological instincts and our artificial environment.

You can read more about these thoughts in this post about the meaning of life (and a few related ones as well — links in the post), or through my podcast Future Skills.

Today, however, I’ll write about finance, and Tesla, again. It’s not a hardcore investment article, but still, if you’re not interested in economics and stocks there’s probably precious little for you here today. The post is about whether Tesla is inside or outside the car industry’s high barriers of entry.


Topic: Tesla & barriers of entry (plus the difference between stocks and companies)

Conclusion: be careful what you wish for; you might find yourself on the wrong side of those coveted protective barriers to entry

Trigger: a comment about high barriers to entry in the EV industry (implicitly, and wrongly, benefiting Tesla)

Length: ten minutes?


It’s a car company!

Tesla is a company that produces vehicles for human transportation, a “car” manufacturing company. In order to develop, design, manufacture, deliver and maintain its products Tesla has chosen to design and manufacture the following (among other things):

  • Electric motor
  • Battery pack
  • Car body and chassis
  • Assisted driving software
  • Battery chargers

Tesla designs, develops and manufactures these parts and then assembles them in “car factories”. Their competitors within (cars and) EVs do more or less exactly the same. Those competitors include companies like BMW, Porsche, Jaguar, Volkswagen, Audi, Volvo, General Motors, and many more. Actually, it’s probably safe to say that ten years from now all car companies will be EV companies, but up until now Tesla has been more or less alone in the market for upscale EVs. As of mid-2018 and going forward, Tesla is trying to enter the mid market, at the same time as it’s most competent industry peers are entering Tesla’s home turf of upscale cars.

So, whether you consider EVs a separate market from gas cars or not, which I don’t, at least not long from now it won’t be.

Remember that the main part of Tesla’s stock market valuation is based on profits and cash flows occuring beyond that ten-year mark. So, if you think competition ten years from now is irrelevant, think again.

Tesla’s operations are currently worth about 70 bn USD, of which some 10bn is debt and 60bn is equity (share price 350). Most analysts expect Tesla to keep losing money throughout 2018 and 2019, and at most make annual profits of a handful of billion a year after that. Let’s say profits go from negative to zero to 5bn/year pretty linearly. In that case Tesla’s total profits 2018-2027 amount to around 20bn. The remaining 50bn of value, not even counting the discounting effect, need to come from the year 2028 and after.

Please note that this is not meant to be a professional forecast*, just a way of picturing when and how much value needs to be created in order to warrant the current share price. I’m fully aware that a profit of 4 800m in 2027, that is growing by 12% a year, by then could be worth 20x, or a 100bn (which generously discounted to today at 7% per year could actually be close to the needed 50bn. You would, however, still need to explain how and why Tesla would grow profits that quickly in competition with every car manufacturer in the world, including potential newcomers).

* Actually, I don’t think Tesla in its current form will make any profits ever (except through very creative accounting for a single quarter or two)

The point here is just to show that you can’t disregard competition in what might seem like a distant and irrelevant future, if you actually want to value the company rather than just speculate in its short term share price movements. Tesla’s value most certainly lies beyond the 10-year forward mark, and must be created in competition with formidable players that have streamlined their best practices (and political lobbying) over the last half century or more.


Barriers to entry

Some of the barriers Tesla is facing include but aren’t limited to the following

Access to capital: Tesla is already overreaching finacially, with several billion in negative net working capital (suppliers can only be pushed so far, no matter if they are “fans” or not. Soon they will have other paying EV clients requesting delivery — guess who they’ll prioritize), half a billion of client prepayments (deposits for cars they may never see, and that in any case are significantly delayed which with increased competition could mean clients switch to more reliable alternatives), not to mention 7bn in net debt before recent and coming losses during 2018. Volksvagen, GM, Porsche, BMW, Audi and many more are actually profitable and have ready access to capital Tesla might soon find out it doesn’t

Production best practices: Tesla has tried to take short cuts around established processes and methods with poor results and lost time and money. Tesla tried rapid automation and failed. Tesla is currently trying throwing massive amounts of manual production staff and round the clock manufacturing on the problem, with its predictable quality issues and production stoppages. It takes years to create prototypes, perform test drives, streamline a combination of automation and manual oversight in order to create the beautiful and robust machines cars need to be. Vehicles are emphatically not “basically a motor and a shell”, they are masterpieces of engineering — and there is a reason there are such things as “legendary quality management officers” within the car and truck industries. The only thing really legendary about Tesla’s officers is how quickly they jump ship once they see what’s going on there.

(additional barrier: attracting competent senior officers)

Lagging battery technology: In order to save time and cement its lead in EVs and batteries, Tesla entered into a huge battery purchase agreement with Panasonic. I don’t know this for sure, but “according to sources” Tesla needs to buy 16bn dollars worth of battery cells of a certain – now obsolete – kind before it can source the cells elsewhere. Meanwhile Tesla’s competitors are free to buy modern cells from any battery manufacturer they like, including Panasonic. It will take years, or likely billions in compensation, before Tesla has worked through this first mover disadvantage backlog.

Lagging driver software technology: Tesla’s “autopilot” is ranked last or next to last by industry researchers. The most recent “keep hands on wheel at all times” update seemed to only cement that position. Recent communication from Tesla indicates Tesla is about to start from scratch as its current software is beyond fixing. Tesla may have been first in AP for a while, or at least regarding the audacious promises Musk dared make, but now the company is finding out reality tends to win against fantasy, and that being last means you’re outside the moat and walls with little chance of getting in.

From first to last within chargers: Chargers tell much the same story as batteries and software: Tesla was first off the blocks, but that also meant building in technological cul-de-sacs and spending money on dead ends that second movers could avoid. Much of the story of Tesla is about Musk blazing the way in a glorious attempt to save the world and make history, but wasting too much money and making too lofty promises he can’t keep. Several competitors are building networks of more numerous as well as more efficient chargers. Once again Tesla will find itself outside the barriers to entry, not benefiting from the security inside it hoped for.


But, but, but… barriers to entry and such

I got a comment the other day saying Tesla is worth a lot since the barriers to entry for the EV industry are so high and protective. Yes they are. The problem is that Tesla finds itself outside those barriers and my assessment is that they’ll never manage to climb over them. I imagine Tesla bulls think Tesla is already inside and more or less alone there.

Sadly, nothing could be further from the truth.

Tesla is the new kid on the block; the block being car manufacturing, not some fantasy “EV” or “tech” castle. As the newcomer Tesla needs to come up with at least as good design, testing and production practices as its super experienced peers. Tesla needs to find ways of effectively procuring the products it doesn’t necessarily have to produce itself.

So far, Tesla’s real claim to car manufacturing fame is betting on a high performance electrical engine and putting it into a beautiful but expensive metal body. Tesla’s early adopters had nothing to compare the S and X models to, and I understand why they view Tesla and Elon Musk through rose tinted glasses. The S model was definitely before its time, and Musk could just as well have been a robot sent back from the future to save mankind from global warming.

It was a good try, and it could have worked, I think, if it weren’t for subsequent short cuts and the predictable first mover disadvantages that tend to befall trail blazers.


On the wrong side of an alligator moat

Today, Tesla has an average engine, a poor body job, costly and lagging chargers and batteries, not to mention huge debts and other obligations. Despite being first and making cars consumers and politicians loved, Tesla has run larger and larger losses and cash outflows. Starting now, effectively debt free and massively cash producing competitors, with their subsidies ahead of them, not behind like Tesla, show who’s on the inside the barriers to entry and who’s not.

The stock is a whole different story (currently at 354 USD/share), but mostly without consequence for Tesla’s real life operations and expected longevity. Sure, Tesla might be capable of another stick save in the form of a share issue at all time highs, and/or bond conversions to equity. That would buy Musk and other Tesla longs some time.

No matter, it’s not a few billion here or there that are critical; it’s whether Tesla can produce fully functional cars at a profit in competition with experienced players in one of the most important and competitive industries on Earth. Given the Game Of Thrones Wall-high barrier of entry I find it highly unlikely. Until reality rears its beautiful and effective head, enjoy the imaginative stock price journey signed one of our time’s greatest dreamers: Elon Musk.

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Patience and equities – shorting story stocks like Tesla

Topic: How long is a long time being alone and wrong on the stock market?

Discussion: Just two months can be torture when you are the only one seeing and saying the emperor is naked, not to mention two years. Yet, you have to be prepared to wait as long as six years even if you’re right

Conclusion: Tesla is still a zero; and just to be clear, the wait has hardly even begun. Calling shorts “wrong” this early in the game based on the share price is just ignorant and short sighted.

Tip: Check out this post about Tesla too


Tesla’s only assets are its fans, but they will soon fade when competitors surface

I didn’t think Tesla was a zero when I started looking at the stock about three years ago. I just thought it was about 10x overvalued. I was aware from the beginning, however, that I’m often a bit more negatively inclined than most equity investors, and thus prepared for the stock just falling by 75% rather than 90%.

When the stock halved from around 280 to 140 in the second half of 2015 and beginning of 2016, I thought gravity had finally* caught up with Tesla’s share price and that it was due for another 50 per cent leg down to 70. Boy, was I wrong! From that temporary hickup the price almost tripled in a straight line, peaking on September 18, 2017 at 389.16 USD per share.

* “finally” – I should have known better than thinking I’d be proven right within 18 months from my first look at an epic short case like Tesla. To be fair, I didn’t really consider it an epic short back then, just a very expensive car manufacturer but one that just might be able to grow into its valuation over a very long time.


From just expensive to just nothing

Since then, the Tesla short story has become more and more epic fundamentally. Back in 2014-2015 I just thought it was an expensive but very cool and promising company, but now it’s turning more and more into a Theranos-like fraud with zero value. Every day there is new craziness regarding Tesla’s technology, production process, employee policy, senior executive exodus, broken promises, delayed product launches, dangerous software, CEO jokes, car crashes and client, supplier and analyst abuse, not to mention increasing losses and negative cash flow.

Over the last ten years, Tesla’s CEO has promised again and again that the company will be profitable next year or even next quarter, or that a certain product is already on its way or that the company won’t need new financing. Time and time again those promises have been broken.

Right now Tesla has about 10bn in debt and is burning an additional billion a quarter. Its clients have deposited many hundred million dollars in advance — for cars the company claims will put it in bankruptcy if it were to actually manufacture and deliver them. Even Tesla’s most ardent supporter, Goldman Sachs, says Tesla won’t make profits or become cash flow positive until years after when Tesla claims it will. Tesla has kept postponing the deadline for ramping production of the Model 3 to 5000 units a week, but not even an expensive move to round the clock production has lifted the pace more than halfway.

Four years ago, Tesla was just another promising but expensive glamor stock. Four years ago, Tesla hardly had any competition, and it had extremely satisfied Model S customers. Tesla was starting to look like Apple around the launch of the iPhone – expensive but not entirely impossible. Today Tesla’s a dead man walking. What’s most amazing with Tesla is that the stock (316 USD) is still close to its all time high (389 USD), and close to where it traded when I first laid eyes on the stock, despite the barrage of negative news over the last twelve months.


Patience takes more than just a few years

I’ve heard so many times in various investment situations that I’m wrong and just don’t get it, even though it’s only the share price and only for a few years that’s been going against me.

If I’ve learned one thing from my 20+ years (1994-2014) as a finance professional it’s patience. Twelve months is nothing when it comes to waiting for the market to price in fundamentals. Actually, four years isn’t a particularly long or reliable time period either, but rather a kind of average expected waiting time, give or take a few years.


Fingerprint was an unusually fast win, and yet those two months were pretty tough (social media has a tendency to shrink the time horizon)

Tesla reminds me of the Swedish company Fingerprint Cards that for a short period of time in the fall of 2015 was Europe’s most traded share.

Three years ago I thought FING looked expensive. However, given its rapid growth in sales and profits I also thought it was hard to time a share price peak. In any case, the third quarter earnings report showed a slowing S-curve that together with a cautious Q4 guidance pointed toward a share price peak around the turn of the year. I said as much on TV in September 2015, just two months before the subsequent all time high (136 SEK; now it’s trading at just 6 SEK per share).

Just to be clear, Fingerprint exhibited amazing growth in sales and profits, and it was the undisputed global leader in fingerprint technology. It was a great company, but with a ridiculous valuation and a crazy following. I just called out the valuation-fundamentals discrepancy, not in any way that the company itself was flawed. The semiconductor industry in general, and the mobile phone sub supplier industry in particular are fiercly competetitve and cyclical. Hence, not only was the valuation of actual profits many times too high, the profits per se were soon likely to fall rather than keep growing rapidly. And here we are, just three years later the stock price is down by 95-96% and sales and profits are much lower than at the peak.


Fingerprint was a real company, unlike the Tesla of today

Fingerprint was a good company with plenty of cash, strong profits and very good cash flow, whereas Tesla is heavily laden with debt, broken promises, even more promises that are impossible to keep, and facing more competent and fierce competitors than Fingerprint ever faced. Tesla has experimented (taken shortcuts) with radically new production processes in an industry that has perfected its quality control policies over a century and now it seems to be about time to pay the piper.

I say “about”, because keep in mind that even if Fingerprint’s share price came back to Earth in just two-three years, there are no guarantees Tesla’s will. However, given Tesla’s fundamental problems of poor production, low quality, lawsuits, lagging technology in all areas (batteries, chargers, chassis, autopilot and so on) and its urgent need of new financing, I dare forecast a shorter time from highs to -90% than for Fingerprint.

So, before the end of November 2019, I think Tesla will trade below 39 dollars per share. You think that’s too long to wait? Then maybe you shouldn’t be involved in equities :D

The November 2019 forecast discounts the glacial pace of stock markets taking fundamentals into account. Secretely I think the process will over a little faster, but then again, I’m often hoping for too much too fast on the downside. Fingerprint reached its ATH just months after taking of in earnest; let’s call it 9 months. From there it took another 9 months or so to really break the story and commence the 18-month slide to oblivion. Tesla took off in the first quarter of 2013 and didn’t reach its highs until Q2-Q3 2017, so maybe it will take many years to approach restructuring round zero. On the other hand, Tesla is in desperate need of refinancing just to stay in business the coming 6-12 months.


Summary – Buy or sell, how patient and how independent are you?

Do you dare to be contrarian? (Just because Tesla is the most heavily shorted stock on the planet doesn’t mean going short isn’t contrarian)

Alternatively, do you dare go long a company without anything going for it other than hundreds of thousands of bigger fools that will keep refinancing a sure loser no matter what?

Om Tesla, Hennes & Mauritz och osäkerhet

En stor smäll verkar ha kickstartat universum från ingenstans för ett antal miljarder år sedan. Många anser att det var ganska onödigt och vi dras än idag med materian och naturlagarna som stelnade vid själva rummets fasövergång.

En del av arvet från Big Bang är att framtiden är osäker; dvs verkligheten är genuint slumpmässig och kan alltså inte förutspås. Ett alternativt sätt att uttrycka det är att fler saker kan hända än som faktiskt inträffar. Osannolika saker händer inte bara en liten del av gångerna utan inträffar t.o.m. riktigt ofta. Om du inte tror mig kan du fundera på var lotterivinster kommer ifrån.

Om man ska investera i den här verkligheten bör man använda ett robust system med felkorrigering och minimering av oacceptabla utfall som t.ex. att förlora allt . Det viktigaste av allt är att komma ihåg att man aldrig kan vara helt säker på ett framtida utfall. På grund av ett antal evolutionära genvägar kan vi faktiskt inte ens lita på att vi uppfattat befintlig information korrekt.

Alltså, vi vet varken var vi är eller vart vi ska och ändå är vi ofta tvärsäkra. Inte konstigt att både apor, slemsvampar och fyrkantiga algoritmer springer i åttor runt de flesta av oss på aktiemarknaden…

Läs resten av artikeln om att  blanka Hennes&Mauritz och Tesla här på Vontobels webplats.