Tesla looks so overpriced by all the usual metrics. It made a loss in the 4th quarter of 2016. Its revenues in the last year were about 7 billion and it is selling at a market cap of $40 billion. The stock has been flat for three years and they made that expensive purchase of Solar City. Elon has recently missed many deadlines and the roll out of the $35,000 model looks delayed and money-losing.
And yet Tesla is very likely to be a 25-bagger in a decade. To be a 25-bagger it would need a market cap of $1 trillion, more than any other company in the world today, including the high-flying Apple, which is capped at $700 billion. It will sell for 25 times its current stock price of $250/share in a decade. Maybe sooner, Yup. And then it’ll probably triple from there in another few years.
To understand my logic consider these facts:
We live in a winner-take-all economy.
Winner-take-all has always been the tendency in a free market system, but there is a lot of evidence that it is accelerating. In a March 3rd article in the Wall Street Journal Jason Zweig says that winners are taking it all and it’s time to buy the winners.
. Google dominates the ‘search’ category despite major attempts by competition, like $10 billion spent by BING from Microsoft. Google 75%, BING 15%
. Amazon and Alibaba have destroyed their competition. In India, Flipkart and Snapdeal once considered on-line retail faves have begun biting the dust.
. Uber is valued at $50 billion plus. Next one in this category is Lyft with one-tenth the valuation.
. Apple is the dominant winner in the smart phone business – they got more than 90% of all of the industry’s profits since 2015.
. Facebook is gobbling up the “Attention Space” online with more than a billion users and an exponentially increasing database of user information that it exclusively owns. This monopoly gives it a huge advantage over everybody else in this category.
Other winners include Netflix, Adobe, Google’s You Tube in the video space (5 billion video viewings per day!). This market dominance is not just a feature of high tech – although it is faster and more obvious there. Banks and investment firms, like J. P. Morgan Chase, Bank of America, and Goldman Sachs, are once again concentrating in size and scope – the largest few being behemoths, too large to fail by any account. In Real Estate, Tobacco, Supermarkets and the Insurance sectors the same trends are very prominent.
In their recent book, Play Bigger, How Pirates, Dreamers, and Innovators Create and Dominate Markets, Ramadan, Peterson, Lockheed and Maney point out that 54% of all profits in the last 5 years have gone to the category-leading companies. In the last decade start-up valuations have tripled, they found. But the rising tide doesn’t lift all boats any more. The Category killers got all the action – a six-year start-up that wasn’t yet “King” had an almost zero chance.
The reasons are manyfold. Today the advantages of being large greatly tilt the odds in your favor. In high tech the largest companies get the best talent, attract the largest number of Apps from developers, have the best access to capital and get the biggest free buzz. Companies like Apple, Google and Amazon have a huge gravitational pull across the globe that sucks everything into their category space. Also they have the largest flexibility in growing their categories as well as defining new categories that they can naturally dominate.
So this throws out the wisdom of mere valuation as an investment criteria. Recently I had lunch with my friends, Steve Butler of Pension Dynamics and Blair Hull of Hull Investments, (Blair runs an ETF called Hull Tactical US) and we were discussing this very issue. Steve said that small-cap companies outperform the Dow companies over the long run. Small-cap returns historically, he said, are 12% annually vs 10% for the Dow. I think this is a fallacy going forward. In a winner-take-all market small companies have structural and competitive disadvantages that increase their risk of simply perishing unless they can dominate their category.
How should you invest in such an environment?
One timeless advice which requires minimal effort is to invest in a large cap index, such as the Dow Jones Industrial Average (DJIA) tracking DIA or the S&P 500 Index. The 30 stocks in the Dow tend to be dominant in their category – they represent 30% of the entire market cap of all stocks- and thus have a lot to gain by the advantage that accrues to size. The DJIA has a well-documented 120-year record and has grown 10% compounded for this period, despite the 1929 depression, the dot-com bubble and the 2008 financial collapse. That means that you could double your money approximately every 7 years, beat inflation by a whopping 7% per year, and beat the US GDP growth rate by 3% or more per year! All with near-zero effort.
But you can do better if you can explicitly play the winner-take-all paradigm.
You can do this if you can spot an emerging category with a huge potential market size and then identify the company or players that will dominate it. This will be the potential winner-take-all and if you spot this company early before everyone else jumps in you have a market King with big returns. Many such players are not public yet so the biggest opportunities might lie in the Venture space. This is a hazardous space, not for everyone and not easy to spot the winners.
But there are areas where you might be able to pick up a publicly traded company that meets the above criteria. If you can spot such a company you have a potentially very rewarding investment – a multiple bagger. Tesla is one such dominant company in an exploding market.
So back to Tesla. What space do they dominate – no, it isn’t electric cars. The big, emergent, giant category they dominate is Batteries. Batteries for home storage, solar/wind power generation, peak shifting by utilities and another million uses that will emerge as the price drops. And emergent is the word for this market.
Since mid-2016 Tesla makes their Powerpack (for utilities and industry) and Powerwall (for the home solar market) battery storage units.The price has already come down 15% to about $400 per KWH and they reportedly have $1 billion in outstanding orders for 2017! That’s triple the order rate in 2016. At current prices that means 2,500 MWH of battery storage. Tesla is a leader in this field and it looks very likely that they will break the $100/KWH price target first, at which the battery market goes crazy. This will almost certainly happen in 5 years (by 2022).
How crazy will the battery storage market be? Let’s estimate.
Solar power generation in the US is about 1% of total today – it looks insignificant and below everybody’s energy radar, but it’s doubling every 30 months. It will follow Moore’s law of exponential growth as costs come down and efficiencies of scale kick in. In 5 years it will grow four fold. In 10 years 16 fold. Such is the nature of exponential growth.
In 2016 solar generation in the USA was already at 54 trillion-watt-hours (TWH) which is more than 1.35% of total electricity generation here (about 4,000 TWH). Each TWH is a billion KWH. With prices coming down rapidly solar installations are growing and will continue to grow at about a 35% compounded rate of growth. Thus in 5 years solar will be at over 200 TWH or 4% of US electric output and in ten years at 800TWH or 16%. Wind power will most likely grow more slowly but starts at 200 TWH, four times the amount of solar today.
Both solar and wind produce power intermittently and need batteries to even out the electric usage. If you assume that, as a minimum, one day’s worth of consumption should be stored in batteries, the demand for storage for solar and wind (in the US alone) comes out as follows, according to my conservative calculations:
2022: 180 GWH
2027: 4000 GWH
The cost for storage will drop approximately by 15% per year – so assume that these demands are realized only for $100/KWH of storage cost, about 1/4th of today. That makes the market size for this segment of battery demand to be:
2022: $18 billion
2027: $400 billion.
Batteries for cars, peak-shifting and non-US markets are not included in the above estimate.
Tesla will dominate this market – having a huge first mover advantage. Even at 75% of the market they will sell $13 billion of batteries in 2022 growing to a whopping $300 billion in 2027! Their first mover advantage is huge: a giga-factory in Nevada that will most likely produce 150GWH of battery storage per year, according to Musk. They also are sewing up a virtual monopoly on utility-scale storage with well-engineered, modular and small-footprint units. Other players and better battery technology may emerge to compete, but the likelihood is that Tesla will absorb them into its own orbit, either through acquisitions or collaboration agreements.
Add to this car sales, rooftop solar and other ancillary products for Tesla and we can, conservatively, say that Tesla could have sales of over $500 billion in ten years. This sounds wildly optimistic, but Elon Musk is planning for it and can pull it off. A trillion dollar valuation – a 25-bagger – easy! A decade from now this market will still be growing, it will not have reached a maturity stage. The demand for storage will be immense indeed and will not peak for at least two or three decades. So Tesla should get “growing” company valuations.
There are risks, of course. But such good bets don’t often manifest themselves and frankly we are still ahead of widespread recognition of this market segment and its exponential growth. Winner-take-all thinking in investing is still a new realization and not factored in by many in the market.
Also published on Medium.
Glad to see you’re back blogging. Think I’ll go out and buy some Tesla shares….. Thanks for the insight.
Interesting article indeed. What data supports the notion that winner takes all is more than in the previous years? It has been a mantra and has stayed that way for generations. Is it not? Yes tech is maturing and so it feels more so to us in tech
On the Tesla issue, what happens an alternate battery technology with double the efficiency and half the cost comes to market. Would tesla still be a leader unless they also are an inventor
By all accounts the monopolistic tendency of our markets has increased a lot. Check out http://blogs.wsj.com/moneybeat/2017/03/03/disturbing-new-facts-about-american-capitalism/
Also the book referenced in the article: Play Bigger lays out lots of supporting data.
Good point about the possibility of a disruptive new battery technology potentially upending Tesla. I think such an invention won’t come out of the blue. Tesla having their ear to the ground will sniff it early and either buy into it or collaborate. Of course, if the inventor is, say, China with deep pockets and their own reason to not collaborate then Tesla would have to find an alternate way. By the way, I read in the Financial Times that China is requiring, as a condition of electric car sales in their country, that solar battery technology be turned over to them. Interesting also that Nio of China plans to sell a completely self driving car in the US by 2020. Padmasree Warrior is their CEO based in San Jose! Ashok
How do you feel about LFTRs as an emergent disruptive technology?
Good blog Ashok. Always good to read your write ups.
Let us look at some of the projections
(1) 500 Billion in revenue in 10 years from 7 Billion today? That is a compound growth rate of 64.24%. Can Tesla grow revenue at 64$ compounded for next 10 years? Low single digit probability, may be?
(2) To fetch 1 trillion market cap at 500B revenue, Tesla would have to generate 50 Billion in net income and a 20 PE multiple on that net income. 50B net income on 500B is 10% net margin. Today none of Tesla divisions (car, solar panel, or battery) generate profits. As a reference GM (which is ahead of Tesla with the Bolt) is trading at 0.3x price/sales or 1/6th of your projection your 2x price/sales projection for tesla
Like to hear your wisdom.
Thanks, Bala, for your comments.
My response: The whole point of this article is that dominant companies can grow exponentially, and Tesla under Musk is one such company. Also the market size for batteries will be huge, really huge. Tesla has a immense first mover advantage – they are already a year away from a battery giga-factory with a potential output of 150 GWH.
That alone would produce $30-60 billion per year revenue. Several other battery factories are already in the works.
GM is not in the same class as Tesla. Tesla is not to be thought as a car company. Think Amazon, What is their market value to profit or sales?
Finally Tesla stock has already grown more than tenfold since they went public (5 yrs or so ago). What CAGR is that? Musk sees opportunities in the future before anybody else. Exponential growth persists longer than most people think – how long did Moore’s law continue after everyone expected it to reach its limit?
Nothing is a slam dunk in predicting the future. There is always a risk of the unknown. But if you have ever played poker you will realize that these kind of pot odds are rare.
You are right that there is a probability that Tesla might succeed and could deliver superior to DOW returns (perhaps as much as you say ie 25x). But do you see any probability of Tesla going bankrupt over the next 10 years? or how about investor loosing half of the invested capital.
Comparing to Amazon is OK. But with one difference. Tesla, unlike Amazon keeps relying on diluting shares by making secondary offering to keep financing its operating. Tesla does not have cash flow from operations, Amazon on the other hand has solid cash flow and actually has some free cash flow. AWS is highly profitable.
Sorry the CAGR revenue growth required is 53,25%. Still very very high. TSLA has one thing going => Elon Musk. But there are enormous risks to growth expectations and profitability needs
Also Ashok, it is true that the DJIA has a well-documented 120-year record and has grown 10% compounded for this period, But investors have to be conscious of what valuation they are getting into the DJIA in terms of valuations as there are long period like the 17 years from 1965 to 1982 when the total return on the DJIA was 1.62% cumulative i.e. way lower than the 160% cumulative one would get from 10% compounded.
The period 1965 – 1982 was indeed slow for the Dow. However the index grew at 5.8% annually, compounded. Not 1.62% – you have to add in the dividends which are over 4% in this period. At 5.8% this was still better than most investments in that period. And since 1982 the Dow has grown about 50-fold! Despite the dot.com and the 2008 slump.
True.. What do you think of Berkshire Hathaway. It has beaten DOW, S&P500 and Nasdaq over any ten year period? Granted that Warren and Charlie are getting old but the succession seems to be pretty solid?
From: Jishnu Bhattacharjee:
Great post Ashok. Thanks for sharing.
One more point to think about :
All the “winners” you mention have one thing in common — they are backed by absolutely extraordinary founder / CEOs :
Amazon : Bezos
Google : Larry Page
Facebook : Zuckerberg
Apple : Steve Jobs (yes, we are still harvesting his sown seeds)
So the question is would you consider Elon Musk as a founder with qualities at par / better than the above stalwarts. Probably yes, which further bolsters your ‘buy’ recommendation for Tesla. If not [ is he too innovative. does he have the focus and tenacity to build and execute to a lasting $1 trillion of value. last thing he cared for till date is profit, which is very different than the above winners (yes, even Amazon has great cash flow) ], all bets are off !
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