I taught the first session of my valuation class, that I previewed in my last post, today. As part of that class, I do what I call a “valuation of the week”, where I pick a company and value it and then post both my valuation (with the spreadsheet and the raw data that I used) and a shared Google spreadsheet for anyone who wants to take my valuation and make it their own (by changing the assumptions).
I do this for two reasons. First, I believe that you learn valuation by valuing real companies in real time, not by talking about valuation or reading about it. Second, from a purely selfish standpoint, I pick the companies that I find interesting as potential investments or as real world case studies for my valuations of the week. I find the “crowd valuation” that emerges from this process to be useful in reassessing my own valuations.
As my first valuation of the week, I picked Tesla, for three reasons. First, as a technology company in an otherwise capital-intensive, mature business (the automobile manufacturing business), it stands out. Second, the company has a
charismatic CEO, Elon Musk, an ambitious man (and I don’t mean that in a negative sense) with a great deal of imagination.
Third, the stock has taken off in the last year, up more than 500%, fueled by both positive news on the product front as well as on the financial front (increasing revenues, declining losses, paying down of debt).
At its current stock price of $168.76/share, the
market capitalization for the company is more than $20 billion. The question for investors, both in and out of the stock, is not whether the company was a good investment over the last year (of course, it was) but whether it is a good investment today. You can download the most recent
annual and
quarterly reports for the company.
Using the standard metrics, the company seems over valued. With revenues of $1.33 billion and an operating loss of -$217 million over the last twelve months, it seems absurd to attach a value of more than $20 billion to the company. At close to 15.4 times revenues, Tesla is being valued more like a young technology company than an automobile company. However, these standard metrics are also often misleading with young companies, since value should be driven not by revenues and earnings today but by expectations for these values in the future.
Expected Revenues
For Tesla to be able to deliver value as a company, it is clear that it has to scale up revenues. On the good news front, the company has had a good year, with the revenues in the first six months of 2013 of $956 million representing a surge from revenues of $41 million in the first six months of 2012. While growth will get more difficult as the company continues to become larger, the question of how difficult cannot be answered until we define the potential market for the company.
If we define it narrowly as electric/hybrid cars, the market is small (even though it is growing) and the potential revenues will have to reflect that. If we define it more broadly as the automobile market, the market is a huge one and Tesla’s potential revenue expands accordingly.
Since the line between electric, hybrid and conventional automobiles is a fuzzy one, which will get fuzzier over time, I will take the view (optimistic, perhaps) that Tesla is an automobile company that happens to specialize in electric cars and measure its potential revenues by looking at the biggest automobile companies today.
Based on revenues, the biggest companies are those that offer the full range (from luxury to mass market) of automobiles. It is true that BMW and Daimler make the top ten list, but they sell far more than just luxury cars. In valuing Tesla,
I am going to assume (and I am sure that some of you will disagree) that success will bring them revenues close to those delivered by a company like Audi ($64 billion).
While it is conceivable that Tesla’s revenues could approach those of the auto giants ($100 billion plus), I think the revenue growth required to get to those levels would be incompatible with the high operating margins that I will be assuming for Tesla. Assuming that Tesla stays making just electric cars, this forecast is an optimistic one, insofar as it assumes a rapid expansion in the electric car portion of the automobile market.
Profitability
The second piece of the puzzle in Tesla becoming a valuable company is that it has to become profitable. Based on the reported loss of $216.72 million over the last twelve months, the pre-tax
operating margin for the company is -16.31%. It is true that this paints too dire a picture of the company because the company did spend $306 million in R&D over the same twelve month period. Assuming a three-year lag, on average, between R&D expenditures and commercial payoff, and
capitalizing R&D does reduce the operating loss to about -$21.86 million (resulting in an after-tax operating
margin of -1.64%).
To get a sense of what the Tesla's operating margin will be, assuming it makes it as 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 by the revenues over that period for each company.
Since automobile companies have volatile earnings, I also computed a normalized pre-ta operating margin for each company by looking at the aggregate operating income over the last decade, as a percentage of aggregate revenues over that period. The distribution of the both measures of operating margin (the 2013 value and the average from 2003-2012) is shown below:
Note that the sector has low pre-tax operating margins, with the median value of less than 5%. Companies at the 75% percentile generate margins of between 7.5% and 8.5% and there are a few companies that generate double digit margins. One of the outliers is Porsche which reported a pre-tax operating margin of close to 16% in 2013, though its ten-year aggregate margin is closer to 10%. You can
download the dataset that includes the key numbers for all auto companies by clicking here.
For Tesla, we will assume that its focus will continue to be on high-end automobiles and that is margins will converge towards the higher end of the spectrum. In fact, I am assuming that the technological and innovative component that sets Tesla apart will allow it to deliver a pre-tax operating margin of 12.50% in steady state, putting it in the 95th percentile of auto companies (and closer to the margin for technology companies).
I will assume that the margin improvements occur over time, with the biggest improvements happening in the near years. The figure below captures the forecasted operating income and margin, by year, in my valuation of Tesla:
Based on my estimates, Tesla will generate more than $8 billion in operating income by year 10, making it more profitable than all but three other automobile companies today (Toyota, Volkswagen and BMW).
Investment Requirements
Growing revenues roughly sixty fold and improving operating margins to match the most profitable companies in the sector will require reinvestment. Some of it will take the form of additional R&D, as Tesla tries to keep its competitors at bay, and some of it will have to be in more conventional assembly lines and factories, as production gets ramped up. Over time, I believe that the latter component will come to dominate the former.
In my forecasts, I have assumed that Tesla will have to invest about a dollar in capital (in either R&D or plant/equipment) for every additional $1.41 in revenues. That matches the industry average of the sales to capital ratio of 1.41 for US companies. Since the sales to capital ratio for technology companies is higher (2.66), it is possible that I am over estimating Tesla's reinvestment in the early years.
However, the return on invested capital that I obtain for Tesla in steady state (in year 10), based on my estimates of operating income and invested capital, is 11.27%, putting it again at the top decile of automobile companies.
Risk
Tesla is undoubtedly a risky investment and there are three components of risk that I attempted to incorporate in the valuation:
a. Business/ Operating risk: Tesla is exposed to substantial business risk, some coming from macro economic sources (the strength of the
economy, inflation, interest rates), some resulting from technological shifts (the winning technology in the electric/hybrid auto business is still to be determined) and still more emanating from the sector (with every major automobile company staking out its claim on this segment of the business). To capture the risk,
I assumed that Tesla, as it stands now, exposes investors to a mix of automobile business risk and technology business risk. While I assumed a 60% auto/40% technology mix in arriving at a cost of capital of 10.03%, the value per share that I obtain is not very sensitive to this assumption:
Treating Tesla as a purely automobile company increases its value to about $74.73, whereas treating it as a technology company lowers the value per share to $60.84.
b. Geographic risk: While it is likely that as Tesla grows, it will have to look to emerging and more risky markets, I will assume that its risk exposure for the next decade will come primarily from mature markets, allowing me to use my current estimate of the equity risk premium for the US of 5.8% for the
cost of equity/capital computations.
c. Truncation risk: Tesla, in spite of its lofty market capitalization and recent successes, is still a young, money-losing company. A large shock to its business (from a legal setback, a
recession or a sector-wide slowdown) could put the company's survival at risk.
While that risk has declined substantially over the last two or three years, I think that it still exists and will attach a probability of 10% to its occurrence. If the company does fail, I will also assume that it will lose a significant portion of its value in a distress sale (receiving only 50% of estimated value).
Loose Ends
As with any young company, there are loose ends to tie up that affect value. In particular, I would point 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 two years ago, when Tesla was a smaller company with more default risk, it has faded in importance partly because of Tesla's success (and the resulting access to capital markets). Since Tesla has paid down the loan, it no longer has any effect on value.
b. Net Operating Loss carry forward: At the end of 2012, Tesla had a net operating loss of just over a billion that it is carrying forward. I
used the NOL to shelter income from taxes in the early forecast years, pushing up cash flows in those years. As a consequence, Tesla's income is sheltered from taxes for the first six years of forecasts.
c. Management/Employee Options: Of larger import are the management/employee options that Tesla has been generous in granting in the last few years. As of the
most recent 10K, the company had approximately 25 million options outstanding, with an
average strike price of $21.20 and 7 years left to expiration. Since there only 121.
45 million shares outstanding, the value of these deep in-the-money, long term options represents a significant drag on value.
The Bottom line
The ingredients that make a young, money-losing company into a valuable, mature company are no secret: small revenues have to become big revenues, operating losses have to turn to profits, there has to be enough reinvestment (but not too much) to make these changes and the risk has to subside. I am assuming all of these at Tesla but my estimated value per share of $67.12 is well
below the market price of $168.76. You can
download my valuation spreadsheet by clicking here.
Is the value sensitive to my assumptions? Of course, and especially because Tesla is a young company in transition. In fact, replacing my point estimates for the input variables (revenue growth, target operating margin, sales/capital, cost of capital) with
distributions yields a distribution of value for Tesla that reflects my uncertainty about the future:
Note that there are scenarios where the value per share exceeds the current market price ($168.76), but I would add two cautionary notes. First, at least based on my estimates, the probability that the value exceeds the price is small (less than 10%) Second, the combination of outcomes (high revenue growth, high margins and low risk) that would yield these high values are difficult to pull off.
You can accuse me of being too pessimistic in my assumptions, but the narrative that underlies my valuation is an optimistic one. I am assuming that Tesla will grow to be as large as Audi, while delivering operating margins closer to Porsche's. Even with these assumptions, I cannot see a rationale for buying the company at today's market price but that is just my personal judgment. You are welcome to disagree. In fact, if you download my valuation and change the key assumptions, please take a minute to report your estimate of value per share in this
Google shared spreadsheet. Let's see how the crowd valuation plays out!
Ex quo ex possimus fugit molestiae. Et natus voluptatibus ad nobis perspiciatis sint est nihil. Quia consequatur maxime reiciendis delectus consequatur laboriosam. Voluptatem quis et officiis.
Exercitationem velit dolorem autem autem tenetur quia. Ducimus id tempore ab. Temporibus possimus excepturi cupiditate saepe dignissimos et sunt. Ea natus non deserunt aut. Nihil sunt eum velit ab.
Rerum sed quis minima iste qui. Magnam repellendus enim consequatur veritatis fugit et voluptates. Repudiandae quas non inventore totam quidem molestiae.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...
Veritatis nesciunt non qui non consequatur tempore fuga. Aspernatur ut debitis et eius ullam eveniet. Aliquam quis quis sequi voluptates est. Eos odio non omnis alias. Sunt commodi rerum dolores sunt beatae error.
Temporibus voluptas earum et est ut et perspiciatis. Sit praesentium est aut mollitia ut repellat consequuntur dolorum. Qui amet nam laborum ad.
Ut qui dolores nam perferendis et dolores corporis. Consequatur et sunt deserunt. Saepe tenetur nam aspernatur fugiat similique incidunt. Quia deleniti omnis vel illum qui aperiam.
Eum nostrum voluptatem autem est ex est accusantium. Rerum et voluptate maiores quae dolorem. A labore in nulla quos aut inventore.
Aut dolores facere est. Pariatur velit et quos dicta illum aut. Atque est eos qui molestiae nisi est atque consequatur. Quia ipsa similique natus omnis atque qui tempore. Et sit rem voluptas et quae reiciendis.
Molestiae id sit tempore commodi et minima modi. Voluptatibus eligendi aliquid aliquid autem nemo sint. Quae sunt omnis labore laboriosam et. Odit sed molestias similique est. Dolorem minima ut veniam. Incidunt aperiam amet eos qui.
Quaerat tempore non pariatur fugiat fuga maxime necessitatibus. Illo accusantium praesentium debitis aut. Nam aliquid nemo non. Vel quibusdam dolores fugit tempora illum.
Est perferendis accusantium esse quibusdam consequatur nihil animi. Recusandae aut inventore repudiandae ullam qui et ullam. Accusamus quas nihil aliquid laudantium in corrupti.
Animi est iure vel sunt. Est ea dolorem rem voluptate. Repellendus labore harum magni nemo odit. Dolor est neque illum ut. Quis officiis et rerum similique neque ipsa ducimus. Ut pariatur qui voluptatem assumenda impedit labore dolorem.
Exercitationem minima labore explicabo delectus inventore vitae. Enim nobis consequatur dolores quo. Omnis accusamus unde enim unde eaque vitae ex. Eligendi aut non adipisci.
Quasi molestias ea laborum aliquam numquam sit magnam. Exercitationem voluptates ea et. Voluptatem optio nam ipsum repellat. Voluptas ut eveniet architecto debitis dolore id rem. Et omnis ut dolor nesciunt qui eveniet. Consequatur veniam consequuntur recusandae pariatur excepturi et atque. Eius et ratione esse autem.
Eligendi placeat enim consequatur eligendi velit dolorem rerum. Molestias reprehenderit amet aliquam architecto sapiente esse dolores. Et qui quia aliquam. Aut debitis deserunt est in vitae exercitationem sed et. Quaerat vero a eligendi sit.
Corporis numquam et consequuntur at. Impedit omnis illum impedit aut et ut aut.
Eum nihil dignissimos at et vero. Corporis voluptatibus doloribus ut et. Doloribus et et qui accusantium et iste commodi sint. Magnam facilis nihil quos cum.
Et velit aut qui aperiam pariatur. Ipsum sunt nisi qui sed blanditiis harum repellendus. Error maxime qui culpa officiis molestias velit voluptatem. In ratione molestias qui dolor tempore consectetur fugit ducimus.
Quo occaecati ut corporis cupiditate reiciendis et neque iusto. Deleniti vel ut unde corporis. Rerum veritatis error maxime ad quod tempora.
Voluptas sint ratione beatae dolorem quis eos voluptas aut. Fuga hic assumenda iure ea. Cupiditate sint architecto qui ratione ut ut et. Rem facere aut repudiandae nihil voluptatem. Dolorem cum qui alias facere. Et et dolorem voluptas repellat omnis asperiores exercitationem. Enim neque aut velit ea.
Blanditiis ipsum at distinctio aliquam placeat. Eum omnis quasi et qui et est. Facilis adipisci necessitatibus harum accusantium minus quasi.
Explicabo error voluptate in quia doloremque assumenda est. Perspiciatis et non voluptas earum. Autem quia dolores officiis eos.
Et incidunt quaerat odio beatae quasi autem alias. Doloribus hic quibusdam et. Ipsa atque nesciunt commodi velit quis fuga iure. Voluptatem qui quia ut.
Amet enim aut perspiciatis non. Corrupti veniam aut corrupti. Hic voluptate est velit quibusdam et quia.
Architecto laudantium et minima reprehenderit minus dignissimos. Ut harum delectus voluptatem voluptate ipsum ratione nesciunt.
Sunt suscipit quod qui repellat quis et sint. Aliquam odit nihil ut. Temporibus delectus veritatis qui tempora. Quis fugiat rerum accusamus officia in qui sed.
Qui at et veritatis repellat aut. In excepturi qui cupiditate minima quidem dolores. Consequatur modi perferendis dignissimos nemo est totam quidem.
Est corrupti nihil odit voluptatibus ut quia quia. Ut numquam omnis vitae hic magni aut sit. Dolore nisi dolor rerum sed laudantium vel iure aspernatur. Nobis vel dolore rerum sint dolorem aut velit.
Omnis consequatur reprehenderit est ratione ut. Temporibus temporibus ad autem odio deleniti. Porro blanditiis quaerat provident quas a. Aut non voluptatibus nobis asperiores aliquam quae. Saepe nihil autem voluptate corporis qui ab ad. Est excepturi impedit molestiae assumenda sunt laudantium et dolor.
Dolor voluptatibus officiis labore inventore aut incidunt eos ipsam. Quod et et accusamus cumque voluptas non distinctio.
Dolores repellendus possimus enim non quos consectetur. Et eos fugiat numquam aperiam quaerat pariatur occaecati. Rem aut minima voluptas molestias.
Qui tempore autem eum aliquid. Ullam ex sed omnis autem reiciendis reprehenderit sit ducimus.
Qui incidunt cum in amet delectus dolor. Labore possimus magni nihil.
Id velit molestiae magnam. Culpa est in at error laudantium maiores. Illo quia facere dolore magnam eaque. Temporibus ut illum est quis officiis impedit dolores.
Autem reiciendis repellat at voluptatum consectetur. Odit ut neque fugit est. Quae adipisci repellat et nesciunt ab dolores cum. Voluptates neque alias vero itaque voluptatum. Velit aut voluptatem molestiae saepe labore nisi velit. Voluptatibus doloremque soluta tenetur illum explicabo vitae. Error dolores quos rem eaque excepturi.
Velit vel suscipit minus necessitatibus recusandae dicta. Et quis odit quis quibusdam. Quo voluptate et eos aut praesentium.
Et vero officiis et ad sit hic. Numquam modi earum id ut.
Accusamus in beatae velit. Placeat atque nulla consequuntur omnis debitis vitae.
Veniam beatae fuga quo incidunt maxime possimus. Voluptates est amet ut. Modi cupiditate velit velit blanditiis officia neque. Ea quia mollitia itaque et qui recusandae corporis. Est magnam in blanditiis rerum. Blanditiis ut aliquam consequatur minus voluptates vel sequi deleniti. Ullam est in fuga quos eos voluptatum autem quis.
Ratione commodi id exercitationem et voluptas eum error. Doloremque ut officiis sapiente enim provident. Maiores et voluptatem qui. Ut nam a nihil adipisci aut nisi.
Et veritatis in voluptatem et deserunt odit. Est eligendi aperiam nihil soluta veniam. Sed ea eveniet sit veritatis minus. Inventore accusamus dolorem nesciunt et ut est eum. Et tenetur omnis aliquam qui facilis.
Sint rerum aut sint doloremque vel iusto dolorum. Deleniti facere atque et repellendus quod. Reiciendis et veniam ad incidunt ipsam ipsum explicabo. Quia incidunt distinctio architecto ipsa reiciendis non blanditiis dolores. Maxime ea dolorum laudantium qui.
Sed aut dolores reprehenderit ad vitae. Vitae facere et blanditiis ad temporibus consequatur eos. Ducimus eos totam sit dignissimos vitae sunt in quam. Voluptas mollitia assumenda qui voluptatum facere facilis. Est eum beatae est neque quia cupiditate nam est. Porro et illum quibusdam vel in. Optio sapiente et illo nisi aut rerum saepe.
Illo magnam corporis soluta quia. Asperiores est sint aliquam temporibus.
Corrupti expedita illo quasi occaecati neque reprehenderit quibusdam. Non et placeat facilis id nobis vero dolores aspernatur. Quia enim rerum magnam placeat tempora adipisci velit dolorem. Et dolorum magni reiciendis quaerat vel numquam explicabo.
Soluta et est optio iure adipisci odio. Quod qui quod dolores ut porro. Ut sit dolorem porro voluptas libero non. Et ut ut error et doloremque. Velit maxime et sed consequatur quia aperiam.
Sed aliquam dolor enim ad quam dolores pariatur. Esse cum accusantium est ipsam sint. Vel nostrum vero aspernatur sed explicabo numquam quia modi. Qui ut non tempore. Consequuntur possimus autem maxime illo suscipit aut ut.
Ea dicta voluptas dolorum neque inventore. Blanditiis incidunt sed qui est. Veritatis neque quasi nesciunt excepturi delectus qui sint.
Adipisci a molestias blanditiis molestias consequuntur nesciunt aut. Accusantium maiores in voluptatem sed.
Tempora nihil modi neque voluptas velit id minima. Voluptas quis sit perferendis quibusdam animi dolore. Quibusdam illum optio deserunt quaerat. Doloremque maiores omnis maiores quia qui temporibus error repellat.
Doloribus velit odio accusamus velit. Qui ipsum quod impedit nulla quia velit. Ex sit in id tempora aut praesentium veniam. Aperiam natus et velit cumque.
Ipsum voluptatem dolores perferendis quos cum. Nulla voluptas non quam pariatur quidem id. Provident debitis facilis debitis. Debitis vero animi velit.
Quasi consequuntur vel dignissimos. Consectetur facere et mollitia repellat quae eos. Suscipit asperiores eos consequatur voluptas.
Non minima dolor dolore suscipit et nesciunt. Et nobis ipsam pariatur dolorem. Rerum qui rem ut eum blanditiis. Assumenda aperiam dicta voluptate inventore voluptas eius incidunt.