Should I YOLO Everything on TSLA?

Topics: TSLA, Valuation, Elon Musk, Pricing for Perfection, EV Market

I hate being another finance person talking about Tesla, because I read something about them from almost every news source I subscribe to every day. Frankly, it's annoying, especially considering the lack of depth most news articles share. So, instead of complaining about it, I decided to evaluate the merits of Tesla for myself.

Investment Summary: Do you like roller coasters, cooking without recipes, or working in excel without saving your file every 2 seconds? If so, Tesla could be great for you, as it'll take you on an adventure with some high highs and low lows. Based on my analysis, presuming no fraud and no serious recession/depression, Tesla has solid upside, but does not warrant a complete YOLO given the impacts of Musk potentially diluting shares, an impending recession, the potential dethronement of Tesla's Technoking, and the large amount of price volatility.

To Catch You Up to Speed

Elon decided to YOLO in 2022 and buy Twitter for a cool $44B ($13B of debt, the rest in equity). Since announcing the acquisition of Twitter, Tesla's shares have taken a big L because:

• Elon had to sell shares in TSLA to finance the acquisition of Twitter

• Elon is CEO of Tesla, SpaceX, and now Twitter

• "Macroeconomic Uncertainty"

Here's a pretty chart with some high-level points on what's happened with Musk's acquisition of Twitter:

Elon's Electrification of Economic Environments

The man knows how to make an impact... Good thing all publicity is good publicity, right?? Hopefully it's good, because either he or SBF are on the front page of the WSJ pretty much every day. I would know. Anyways...

The current narrative is that Tesla and Twitter's fates are intertwined given the amount of Wealth Elon has that is tied to both entities. Financially, Elon can choose to default on Twitter's loans and walk away without any financial repercussions because Twitter's loans are secured by the company, not by Musk. Outside of receiving a reputational beating and sacrificing his equity investment thus far, he'd be fine. In case he needs more money to finance Twitter's significant debt burden, he owns 423.6M shares of TSLA and can access 279M more shares by exercising his options on TSLA shares.

Operationally, Elon is currently acting as CEO of Tesla, Twitter, and SpaceX (Technoking and Chief Twit, sorry), which has caused Tesla investors (and one Elizabeth Warren) to grow concerned (jealous) because apparently running three companies is harder than running just one. Elon has been the visionary behind Tesla and shareholders should be worried until he decides to captain just one ship; Musk recently decided that he would step down as CEO of Twitter, which should give Tesla investors some cause for relief. This is an obvious issue for Elon, as his focus is divided between numerous companies with an economic recession impending.

I Like My Cash Flows Like I Like My Bookshelves: They Gotta Be Large and Continually Expanding

Healthy. Tesla's growth and margins are healthy. I'm a big value investor, but telling me a company has strong margins and strong growth is an automatic head-turner for me. That, paired with low debt, is very nice. Their revenues are growing, their margins are expanding, and they are becoming more efficient with their asset base, all while reducing the amount of debt they have outstanding. We love to see it.

Without diving more into their financials, companies with similar types of margins, growth, and low debt typically trade at significant valuations (Intuitive Surgical keeps coming to the top of my mind, though they have a larger economic moat).

Okay, So What's Tesla Worth?

Well, its share price is sitting around $110 (for now), down from ~$400 to start the year. But in terms of intrinsic value, it's ballparking around $100-$300 depending on who you ask.

If you aren't a fan of valuation and don't want to stick around for my TED talk, here are some quick and dirty points for you:

• The average analyst price target for TSLA (per Koyfin) is $235 per share.

• I ran a DCF based on mean analyst estimates (per Refinitiv), which led to a price target of $143.

• If Musk dilutes TSLA shares by exercising his options, TSLA's price based on mean estimates would fall to $132.

• If you take base case estimates and solve for revenue growth based on TSLA's current market value, you'd be buying Tesla assuming they have average annual revenue growth of 15%.

• I ran a Damadoran-inspired DCF (IYKYK) that produced a valuation of $177.

If you ARE a fan of valuations (which I hope you are hehe), then here are the juicy details:

1) Average Analyst Price Target

2) Mean Analyst Estimate DCF

These are our assumptions:

Here's our WACC:

Our Terminal Value:

Our fair value calculation:

*Debt amount is pulled from Refinitiv for currently outstanding debt*

3) Base Case + Musk Dilution

From what I've read, Musk has 279M in options outstanding. Based on analyst forecasts and prevailing discount rates, the fair value is $131.50 assuming he exercises those options.

4) Break-Even Revenue Growth Case

If we take the prevailing TSLA stock price of $110 and apply it to our DCF to solve for revenue growth, we'll get a revenue growth figure of 15%. That revenue growth figure sets the cash flows so that the discounted free cash flows of TSLA equate to the current stock price.

Said differently, when you buy TSLA, you're buying projected revenue growth of 15% for the next five years (at least), assuming target margins are achieved.

5) Damadoran-Inspired DCF

Aswath Damodaran, Andrew Lo, Dwayne Johnson, and Ryan Reynolds are my professional inspirations, in no particular order.

Dr. Damodaran has been developing valuations on Tesla for almost a decade now, with his latest being published in November of 2021. A summary of his valuation can be seen below:

I, too, forecasted my cash flows out to 2032 based on our 15% growth rate and came up with a revenue number of $320M. Despite my operating margin being 24%, my projected equity value was only $560M, versus Damodaran's forecasted $769M for that revenue and margin target. The difference is in the discounting...

His 5-9% discount rate is much lower than my 17.7%; in part due to the change in the market and in part due to a difference in calculating discount rates (he used medians of public comparables, while I created my own WACC independently).

Also, my terminal value is fairly large (largely because of the 20x EBIT). Most traditional auto companies don't fetch this, but given Tesla's growth prospects and scale, I thought it reasonable (though it's worth sensitizing). I also mitigated this by blending the Gordon Growth terminal value with the multiples terminal value.

Before We Wrap This Up

As we talked about in my 2022 market summary post on valuation, discount rates can make all the difference. The discount rates used in my valuations are likely high relative to what the street is using. I do, however, err on the side of caution, particularly in environments like this, as my risk-adjusted returns need to be significant, especially when talking about a company as financially, operationally, and culturally (Musk's Twitter presence) volatile as Tesla. It may have been reasonable to lower my discount rate, but the fact that the DCFs show that Tesla is undervalued even when applying such high discount rates proves a compelling argument: Tesla is undervalued.

Here are other things to note:

• Tesla was just upgraded from BB+ to BBB by S&P on operational improvements and solid cash flow prospects.

• Tesla cut prices on their Model 3 and Model Y; both models are eligible for a $7,500 tax credit.

• The EV market is becoming more competitive, with many mature car companies (Ford, Volkswagen, GM, etc) producing electric vehicles to rival emerging EV firms (Rivian, Lucid, etc).

• Tesla is claiming its self-driving program was a failure, not a fraud. There are also claims of financial fraud.

• Production in Tesla's Shanghai facility was suspended throughout part of December and January, likely due to lower demand (which could have prompted the lower of Model 3 and Model Y prices).

In Conclusion...

Despite there being many bearish arguments for Tesla's stock, if the claims of fraud are baseless, then I am cautiously bullish on Tesla. Though I would strongly advise against betting the farm on Tesla, its low valuation relative to future growth prospects could be a strong opportunity for investors with a long time horizon. It's plausible that Tesla shares fall further, as Tesla's significant volatility and future potential headwinds will make it very hard to time perfectly, though, for the long term, Tesla could electrify your returns (you're welcome haha).

Summary:

• Tesla has been directly impacted by Elon Musk's acquisition of Twitter financially and operationally.

• Tesla's financial performance has been very strong, though allegations of fraud and reduced outlooks for growth have diminished optimism.

• Valuations based on recent analyst expectations show that Tesla is likely trading below its intrinsic fair value (depends who you ask, of course).

• If you're scared to buy Tesla, you should be, because everyone is. If you have a very long-time horizon and a very high-risk tolerance, Tesla could be a good stock to hold for the long term.

Happy investing :)