TSLA and the “B Word”

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TSLA and the “B Word”

Analyzing Tesla’s stock may be beyond traditional analysis, but its recent purchase of bitcoin is certainly something we can assess using standard corporate finance theory.

Three illustrations of this approach:

#1: Reinvestment rates. When I was a single stock analyst one of my favorite C-level questions was “if I gave you $1 bn and told you I would leave it in the firm for 5 years, what would you do with the money?” The answers usually reflected the CEO/CFO’s perspective on which opportunities represented the highest growth/return on capital areas of their business.

This leads us to a relevant question for Elon Musk: does bitcoin have a higher projected rate of return than selling more electric vehicles? After all, $1.5 bn is enough to build the better part of a new EV assembly plant. Why is bitcoin the best use of capital?

Now, the countervailing argument would be that since TSLA has $19.4 bn of cash (YE 2020) it can afford to put some chips down on bitcoin without impairing its CapEx program. That’s fair enough, but we have to also remember that car companies burn a lot of cash during downturns. That did not happen in 2020 because of some unique factors, but it could happen in the future. In fact, I can guarantee you it will.

Takeaway: if TSLA’s valuation pre bitcoin purchase was based on the promise of widespread EV adoption, then does it possibly deserve a lower valuation now because it’s just signaled that the reinvestment opportunities in this industry are potentially lower?

#2: The conglomerate premium. There was a time when equity markets gave valuation premia to companies with solid managements that owned a variety of businesses. The thought was that management was the really scarce societal resource, so a company that could recruit great talent had a sustainable edge.

There are two problems with conglomerates. The first is that they’re unnecessary. Shareholders can replicate whatever combination of industries a multi-line company happens to play in. The second is cross-subsidization. Markets won’t pay the average multiple of a bunch of businesses for very long if any of them earn sub-par returns because the free cash flow from the good ones will end up going to support the lousy ones.

Takeaway: any Tesla shareholder who wanted to own bitcoin could have created that 2-security portfolio without Musk buying the asset for the company. His decision therefore adds no value on its own to TSLA’s shares.

#3: The “vision thing”. Since our first 2 points are somewhat critical, we’ll finish up with a bullish argument for Tesla’s decision.

Let’s start with the very reasonable proposition that Elon Musk is very plugged in to the highest echelons of the global financial system. I’ve not met that many billionaires, but between my experience and those of friends who traffic in these circles I assume Musk gets a really good call about who is going to do what and when.

We also know that Musk’s vision of the future is central to TSLA’s valuation and to maintain that aura he has to continue to get things right. He doesn’t have the luxury of missing Big Tech the way Warren Buffett did. Nor can he hand the reins of the company over to a trusted and deeply talented lieutenant as Larry and Sergey did with Eric Schmidt at Google.

Takeaway: TSLA buying bitcoin says more about bitcoin and keeping the Elon Musk-as-visionary story in high gear than anything about electric vehicles. Sure, he could have kept TSLA’s treasury cash in, well, “cash”. But that does nothing for his brand, and that’s the most important thing to the stock’s valuation.

Final thought (1): this isn’t just about TSLA. The stock is 1.8 percent of the S&P 500, so its capital allocation process and prospective reinvestment rates matter more to the index than JP Morgan (1.3 percent weight) or Disney (1.0 percent).

Final thought (2): while we have no problem with TSLA’s current valuation, the reinvestment question (point #1) really bothers us. Organic growth creates huge multiples for a good reason. Compound interest, as Albert Einstein once noted, “is the 8th wonder of the world”. And the more capital you shove into a compounding machine, the more comes out the other side. When a company signals the compounding machine is full (i.e., can’t use all its cash), valuations usually suffer.

Closing out with a crazy trade idea to consider: long BTC, short TSLA. Because essentially that’s what Musk has just done…