Tesla (NASDAQ: TSLA) bears are rejoicing.
Shares of the electric-vehicle maker fell to below $200 for the first time in more than two years, as the company got thwacked by a series of negative analyst notes and concerns about the company's liquidity after CEO Elon Musk warned his staff that Tesla would be out of cash in 10 months if it didn't make "hardcore" cost cuts. Questions about demand for the company's cars have also arisen following a recent price cut.
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Tesla bears responded enthusiastically, calling for the company's demise across social media and elsewhere. The stock has long been a polarizing one. 28% of its shares are sold short, meaning a sizable percentage of investors are betting it will head lower.
However, with Tesla trading near three-year-lows, I took the opportunity to open up a small position in the stock, in spite of the market's recent concerns around the stock. Here's why.
1. Bankruptcy seems highly unlikely
In the email that's alarmed some Tesla-watchers and delighted bears, Musk said he and CFO Zach Kirkorn will "examine every expenditure at Tesla, no matter how small" and emphasized the urgency to cut back on unnecessary expenditures. Taken at face value, the statement may seem like a dire warning, but less than a month earlier, Musk told investors the company would be free cash flow positive for every quarter for the rest of the year, and the company just raised $2.7 billion, effectively giving it $4.9 billion in cash to work with, since it finished the first quarter with $2.2 billion in cash and equivalents on the balance sheet.
What seems missing in Musk's statement is the implicit assumption that the company must be too tight on cash to accomplish all of its goals, which include a ramp-up in production of the Model 3 and Model Y, construction of the Shanghai Gigafactory, development of the Tesla Semi, and other long-term initiatives. If cash burn is faster than expected, one of the non-cash-flow-producing projects will probably have to be delayed, or the company can raise more capital as it just did. It could even shift its business model by selling its battery packs to other carmakers, or licensing its technology, though Musk is clearly reluctant to do that. The idea that Tesla will simply run out of money one day in the next year and shut down its entire business seems a little ridiculous.
Bond markets have responded to the recent news by discounting Tesla's debt further, a sign that doubts are growing about the company's ability to pay it back. Tesla has $1.7 billion in debt maturities over the next year out of about $11.6 billion in total debt, and around $4.9 billion in cash to meet those near-term maturities and run its business. If bond prices stay low, refinancing would likely become more expensive, but Tesla also has the option of selling more stock or convertible debt, which carries a lower interest rate than traditional loans. The convertible debt it just raised carries an interest rate of just 2%.
Equity investors should keep in mind that bonds are largely priced according to risk, and bondholders don't have the upside potential that stockholders do. Considering the stock is down 40% this year, the risk of bankruptcy or taking on more costly debt already seems adequately priced in.
2. The upside potential is still enormous
Even bears have to admit that Tesla has accomplished a number of impressive feats in its history, including building high-performance electric cars at scale, winning numerous awards and customer acclaim, and building a battery business that's significantly ahead of those of its competitors. UBS, for example, estimates that the manufacturing cost of its batteries are about 20% cheaper than the next closest competitor at $111/kWh compared to $148/kWh from LG Chem.
Tesla is a leader in two industries on the cusp of a revolution -- cars and renewable energy. It's clear that the auto market is on the verge of a transformation -- in autonomous vehicles, electric vehicles, and innovations like ridesharing. That is partly why the market has valued "disruptive" transportation companies such as Uber, Lyft, and Tesla so highly while punishing legacy carmakers such as Ford and General Motors, though whether that discrepancy is warranted remains to be seen as Ford and GM are also innovating. The global opportunity for Tesla in electric and autonomous vehicles is huge, and the stock could easily soar if it starts to capture more of that opportunity, especially in China, which already buys more than half of the world's electric vehicles, including plug-in hybrids. The potential for the stock to turn into a multibagger makes the downside risk worth it.
Tesla's vehicles are generally highly rated in driver-assisted technology, and the company recently said that all cars being produced now have the computer and other hardware necessary for full self-driving capabilities, once the software is ready. There's plenty of uncertainty in the future of autonomous vehicles as the technology is still being developed and consumers need to be convinced of its safety, but Intel sees a $7 trillion "passenger economy" evolving by 2050, and Tesla's valuation should reflect its potential role in that future.
Similarly, as more of the world transitions to renewable energy, Tesla's batteries, solar panels, and products such as its Powerwall and Powerpack, which also capitalize on Tesla's advanced battery technology, could see exponential growth ahead. Though sales in its energy generation and storage segment fell 21% in its most recent quarter, the company expects a significant increase in energy revenue for the year as it works through a backlog in Powerwalls and commercial storage orders, and expects an increase in retrofit solar deployments in the second half of the year. Last year, energy generation and storage revenue jumped 39% to $1.5 billion.
3. It's still the best brand in cars
While Tesla's ability to break through and become the first new American auto company in generations is impressive, what's equally noteworthy is that the company did it with essentially no traditional marketing. Legacy carmakers flood the airways with ads, but Tesla's brand is strong enough to create a "pull" effect, generating consistent buzz and demand that has given the company tremendous brand value. Even if its rivals can match Tesla vehicles' performance, other automakers probably won't be able to reach Tesla's brand power.
AutoTrader just named the company the "Most Loved Brand" for 2019, based on a survey of 60,000 car owners, and Tesla owners regularly rave about the cars on social media and elsewhere. Historically, demand for the vehicles has outstripped supply.
Much like Apple (NASDAQ: AAPL) in its heyday, Tesla has built a high-end, aspirational brand that's known for inventing the future. Transitioning that kind of brand into the mass market, the company's next step, isn't always easy, but Apple serves as a model here, as the iPhone maker took what was once an edgy "alternative" brand and made it into the most valuable one in the world, selling billions of iPhones. Whether Tesla can do the same is yet to be determined, but the playbook is clearly there, and Tesla's brand will give it a crucial advantage as it makes that push.
At this point, Tesla's foreseeable future seems as if it will end in one of the following scenarios:
- It runs out of cash and goes bankrupt.
- It continues to struggle to generate sustainable profits, and the stock slides some more.
- It reaches, or reasonably approaches, its near-term production goals, survives the current cash crunch, and looks to have a brighter future ahead.
Of those, the last one still looks like the most likely outcome to me, especially as Tesla's brand value is not going to easily erode.
While the stock is clearly risky and Musk can be his own worst enemy at times, the upside potential seems to make the recent sell-off an attractive buying opportunity for risk-tolerant investors.
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Jeremy Bowman owns shares of Ford, General Motors, and Tesla. The Motley Fool owns shares of and recommends Apple and Tesla. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.