This article is Part 10 of an 11-part series analysis of Tesla, Elon Musk and EV Revolution. You can read other parts here.
Q3 2019 hedge fund letters, conferences and more
Tesla bears – a lot of them are people I respect; some of them are my dear friends – would point out that there is yet another side to Musk, the (fraudulent) Elizabeth Holmes side.
Holmes was CEO of Theranos, a Silicon Valley startup with a board of directors that was beyond reproach, including two former U.S. secretaries of State, Henry Kissinger and George Shultz. At the height of its hype, Theranos had a private market value of $10 billion. Holmes graced the covers of business magazines, gave a TED talk that was watched by millions, was a role model for young women, and had the reputation of a visionary who was going to improve the lives of billions with a product that would be able to run hundreds of medical tests from a small drop of blood.
Holmes may have had great aspirations, but the difficulty or impossibility (at least today) of what she was trying to do caught up with her and she had to resort to outright deception and fraud. Theranos went down in flames.
Bears argue that we are blinded by the Iron Man side of Musk and don’t see the Elizabeth Holmes side: that on top of making promises he doesn’t intend to keep, he is actually playing a confidence game. Bears point out that Musk committed securities fraud (stock manipulation) when he tweeted that he was taking Tesla private at $420, with “funding secured.” This was a lie to scare short sellers out of Tesla stock.
In another such move, Musk personally called a short seller’s employer, threatening the employer with a lawsuit if the employer didn’t stop the short seller from posting negative research about Tesla on Seeking Alpha and Twitter. (Elizabeth Holmes had resorted to similar tactics).
Tesla bears also point to Musk’s bailout of SolarCity – a heavily indebted, money-losing solar company with a broken business model, run by Musk’s cousin. It would have gone bankrupt in a few months if Tesla shareholders hadn’t bought it. A bankrupt SolarCity would have damaged Musk’s reputation as the Iron Man who succeeds at everything and thus would have tanked Tesla’s valuation and cut off the company’s ability to issue cheap equity. By bailing out SolarCity, Musk heaped a money-burning operation and billions of dollars of debt onto Tesla, which was already struggling to break even.
The bears questioned Musk’s state of mind (sanity) when he called a British diver rescuing Thai kids trapped in a cave a “pedo” in a tweet.
I want to remind you that I started out this essay quoting F. Scott Fitzgerald and explaining that in our analysis of Tesla and Elon Musk we needed to maintain “two opposed ideas in mind at the same time and still retain the ability to function.”
There are a lot of opposed ideas here.
Skeptics have plenty of substance in their arguments against Tesla. History is on their side. Other than Tesla, the last car company to be started in the U.S. and survive to the present day was born in 1930, and two car companies went bankrupt during the 2008 financial crisis. Yes, Musk’s stock manipulation with the “funding secured” tweet was simply immoral and illegal. We can vent about it, but the outrage people feel over that behavior (yours truly included) is irrelevant to Tesla’s future. Musk paid a fine to the SEC and is still running the company. (Any other CEO probably would have been fired and might have gone to jail).
However, the issue raises a more important question: Is Musk an asset or a liability to Tesla? Well, he may be both. On one side, he is a genius and a visionary who deeply cares about Tesla’s success and is willing to sleep in the factory to get things done. But he also is an incredible micromanager and a benevolent dictator who runs four companies. He is overworked and exhausted, and this to some degree explains (though it doesn’t excuse) his erratic behavior and his tweets, too.
If something were to happen to him or he was removed from Tesla, what would happen to the company? Would Tesla turn into Apple after it fired Steve Jobs in 1985 or the Apple of 2011 after Steve Jobs passed away? The Apple of 1985 withered because it did not have enough breadth of products or the depth of management needed to replace a charismatic visionary. Jobs left a vacuum of leadership and vision when he was fired, and John Sculley – a Pepsi executive – was not up to the task.
The Apple of 2011 was in a much stronger position and much more broadly based, with a stronger leadership team. Tim Cook was handpicked by Steve Jobs and groomed for years to replace him. And though Apple as a business has done well since Jobs’ passing, the company’s subsequent innovation has been very evolutionary, not revolutionary. It has mostly improved the categories of products developed under Jobs but has not come up with a significant new product category (aside from the Apple Watch). In fact, it has tried and so far failed at producing a car.
The Apple example shows that replacing a benevolent dictator/visionary is very difficult but not impossible. Success depends on timing, the company’s competitive and financial strength at the time, depth of management, and luck. Tesla today seems to lack depth of management – it’s shedding executives faster than I am losing my hair. Today Tesla is closer to the Apple of 1985 than that of 2011 and can hardly afford to lose its overworked genius/benevolent dictator.
Tesla’s success will be determined by the financial viability of its business: Can the business finance itself? Tesla’s success as a stock will depend in the end on the company’s earnings power.
The bears argue that Tesla has quality and service issues. Some Model 3s that were rushed out to meet production goals were poorly put together. It seems that the Model 3 production quality issues have been resolved. Even one of Tesla’s biggest critics, Bob Lutz, ex-CEO of GM, has raved about the quality of the Model 3’s design and assembly.
Tesla is growing at the speed of a Silicon Valley startup, but in addition to writing a lot of software, it is building Gigafactories, a global Supercharger network, service centers, and stores, and designing its own self-driving processor – all while competing against companies that are better capitalized and on the 50th iteration of their ICE products (and thus have more consistent quality).
Every time Tesla has stumbled, and it has stumbled plenty, it has gotten up, regrouped, and moved forward. My personal experience with Tesla’s service has been excellent. But I read that today Tesla is still experiencing growing pains with its service. This makes sense – its serviceable car fleet has more than doubled over the past year and a half. The Tesla technician who fixed my Model 3 speakerphone told me that his scheduling software still needs work, as he is sent to back-to-back appointments that are 50 miles apart. This doesn’t sound like a permanent issue, though; a quick software fix should resolve it.
One very important thing that Tesla has and Theranos did not is an incredible product and people who are fanatical about it. Tesla cars are superior to other EVs and actually to most non-EV alternatives made by the competition today. Talk to any Tesla owner and he (it is usually a he) will rave for hours about how much he loves the car. I have yet to meet a GM or Toyota owner who has the fanaticism of a Tesla owner.
This is why Tesla spends zero on advertising (while ICE carmakers spend billions) but has a bigger sales force than all GM, Ford, and Chrysler dealers combined – Tesla has passionate owners, and its sales force is growing with every car sold.
Today it is really hard to tell whether Tesla will reach escape velocity and turn profitable before investors and capital markets lose their patience and willingness to finance its losses. By buying SolarCity, Tesla certainly made its journey more difficult. But the company is not sitting still and is trying to cut costs. Here is one example. The Model S had two miles of electrical wire, the Model 3 has “only” one mile, and the Model Y is expected (if it can actually be implemented) to have only 100 meters.
If Tesla is able to increase its production, the incremental cost per car should decline. Let me explain. The cost of a car has two components, fixed and variable. Variable costs include the battery, tires, engine, etc. These costs don’t usually decrease much (though they do decrease some) as a larger number of cars are produced.
Fixed costs, like running a Gigafactory and developing software, decline on a per car basis as Tesla increases its production. Assuming demand for Tesla’s cars continues to increase, the company’s gross margin (how much it makes per car) should increase, and thus it will reach profitability.
However, even in the worst case, if Tesla runs out of money and bond and equity investors lose faith in the company, it is unlikely to follow the fate of failed car companies (think DeLorean or Tucker). It will be bought by an ICE automaker or a Silicon Valley comrade (Google or Apple). It would save them billions in losses on R&D and getting up to scale. Investors would still lose money, of course, because at that point the distressed purchase price would be a fraction of today’s price.
This is just one out of 11 parts of my analysis of Tesla, Elon Musk, and the EV revolution.
You can get complete analysis as an email series, PDF, EPUB or Kindle ebook here or email at tesla-article@contrarianedge.com.
