A few weeks back Tesla's share price rose to a record ~$1,100, taking the company’s market cap to an incredible ~$209 billion. This put Tesla roughly $6 billion ahead of Toyota, making it the most valuable automaker in the world!
And in today's newsletter, we try to piece together the incredible rally that propelled the company's stock price to such stratospheric levels.
The Story
Tesla’s massive ambitions have always hinged on the success of Model-3, an affordable mass-market electric car that was supposed to revolutionise the auto industry.
As Elon Musk outlined in his master-plan memo back in 2006 —
The strategy of Tesla is to enter at the high end of the market, where customers are prepared to pay a premium, and then drive down market as fast as possible to higher unit volume and lower prices with each successive model.
Step 1: Build a luxury electric sports car that could make some money.
Step 2: Use the revenue from selling the sports car to create a more affordable luxury sedan.
Step 3: Once the luxury sedan takes off, use proceeds from this sale to market and sell a truly affordable electric car that hundreds and thousands of people could buy.
And Elon Musk was about to bet the entire company on this little dream.
Manufacturing facilities were upgraded. New factories were built. The company poured money into automation to cut costs across the board and they desperately tried to scale from being a small manufacturer of luxury sports cars to a massive player in the mass market segment.
Eventually though, the expectations went into overdrive. In March 2016, the company started accepting reservations for the Model-3. Within just one week, Tesla received more than 325,000 bookings— roughly $14 billion in implied future sales. It was the single biggest one-week product launch ever.
All the company had to do now was start pushing those vehicles out of the assembly line. Unfortunately, there was a problem.
Production Hell
Musk had laid out the unit economics that could potentially put the company on a path to profitability. He needed Tesla to churn out 5,000 Model 3’s each week to break even — the point at which the company could potentially turn a profit on each car sold.
But when the company originally began producing Model 3’s, they could barely meet this target. There were problems in the assembly line. There were problems with the robots. There were problems with battery manufacturing. And it was taking forever to solve these niggling issues. The company’s automation dreams were falling apart and in an infamous interview with CBS, Elon Musk called it production hell.
As an article in the Wired notes--
Even Musk had conceded that the company’s fully automated factory vision, the “alien dreadnought,” wasn’t working. Workers ripped out conveyor belts inside the Fremont plant. Employees began carrying car parts to their workstations by hand or forklift and stacking boxes in messy piles. At one point, Musk halted production for an entire week to make repairs. On some level, Musk seemed to recognize that he was undermining Tesla. “Excessive automation at Tesla was a mistake,” Musk tweeted. “To be precise, my mistake.” He once told a colleague: “We just have to stop punching ourselves in the head.”
However, as Tesla was trying to grapple with its many problems, the company’s valuation kept skyrocketing. Between March 2016 (when the company first started accepting orders for the Model 3) and July 2017 (when the company shipped it’s first batch), Tesla’s market value soared — from $30 billion to $60 billion. People were still hoping the company would deliver on its many lofty promises and retail investors were willing to gamble on the stock.
But not everyone was sold. Several prominent investors believed the company was burning through cash at a rate that would soon push it to the brink of bankruptcy. They were convinced Elon Musk was driving the company to oblivion and that judgement day was close. They concocted a compelling narrative around why Tesla shares were worthless and began short selling the stock.
The Tesla Short was now at play
Unlike betting on growth stories, shorting involves making money on the back of failures. When you short a company, you are hoping for its stock price to tank. If the stock price dips in line with your expectations, you make a neat profit.
And for most observers, Tesla was an easy short. As Jim Chanos, an American investment manager succinctly put it—
“Obviously this is not being valued as a car company, it’s being valued on Musk … he’s the reason people own the stock. Put it this way. If you wouldn’t be short (betting against) a multi-billion-dollar loss-making enterprise in a cyclical business, with a leveraged balance sheet, questionable accounting, every executive leaving, run by a CEO with a questionable relationship with the truth, what would you be short? It sort of ticks all the boxes.”
And for the most part Chanos was right. Tesla had never turned an annual profit. It was operating in a market where bankruptcies were commonplace. The company had boatloads of debt and it was quickly running out of cash. Meanwhile, Elon Musk found himself in the midst of many controversies and they were many reports about his alleged temper tantrums.
But despite all the troubles, Tesla managed to script an incredible turnaround. Twelve months after launching the Model-3 (in April 2018), the company announced that it had managed to produce 5000 Model 3’s in a week — the coveted break-even target. 3 months later Tesla reported quarterly profits of $312 million. Overall, Tesla sold 146,000 units of the Model 3 in 2018 — a rather spectacular number.
And the short-sellers were running for cover.
The Short Squeeze
The theoretical mechanics of short selling is rather simple. You borrow a certain number of shares of a company from your friendly neighbourhood broker and you sell these shares at the current market price — say Rs.100. At some point in the future when the stock price dips (to Rs.80), you buy the company shares from the open market and return it to the friendly neighbourhood broker. In effect, you make a profit of Rs. 20 from the transaction. However, if a stock price trends higher you might have to buy back the stock at a much higher price whilst closing the bet.
On certain rare occasions, however, multiple short-sellers could be looking to close the bet, trying to buy back the share at a higher price, thereby inflating demand and pushing the price even further. This makes it even more difficult for existing short sellers to hold on to their bet. It’s called a Short Squeeze and Tesla was beginning to squeeze the life out of some of these investors.
2019 was a breakout year for Tesla.
They delivered 367,500 electric vehicles — 50% more than the previous year. They debuted two new vehicles including the uber-cool Cybertruck. They started production in a new facility in Shanghai and finished the year with back-to-back profitable quarters.
The dream run continued well into 2020. The company posted another profit in the first quarter. They launched the new Model Y crossover six months ahead of schedule. Even Coronavirus couldn’t affect sales as Tesla managed to sell 91,000 vehicles— only about 5% fewer than the same period last year despite factory shutdowns.
And all of this culminated in a rather spectacular fashion when the company’s market cap soared to $150 billion in early March. Steve Eisman*, one of the few short sellers that made money during the 2008 crisis had this to say about the incredible rally — “When a stock becomes unmoored from valuation because it has certain dynamic growth aspects to it, and has cult-like aspects to it, you have to just walk away.”
He closed his short position on Tesla around the same time and the company’s market cap is hovering close to $300 billion today.
The Long Angle
Perhaps the biggest takeaway from the story is that this Tesla rally isn’t a by-product of the company’s improving business fundamentals alone. You simply can’t rationalize the company’s stock price by attributing it to tiny profits from a few quarters. Instead, in all likelihood, the rally is premised on the dreams of a man who can seemingly defy all odds. For what it’s worth, Tesla is probably still in the early days of what could potentially be a Facebook or a Google. Maybe Elon Musk will shock us all once again and justify the company’s valuation in a few years. But as it stands today, Tesla is riding a purple patch like no other.
May it live long and prosper!!!
Until next time…
*Steve Eisman's story was a focal point of the Blockbuster Hollywood movie—The Big Short. If you haven't watched it yet, we highly recommend you do so and on that note, we hope you share this story on WhatsApp, Twitter, or LinkedIn because hey... It's about Tesla. Who wouldn't right?
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