After its largest one-time sales contract, thanks to Hertz, Tesla’s market capitalization crossed the trillion dollar threshold. How can a car company that makes 1% of the market’s sales be worth more than the 9 other largest automakers combined?
Earlier last week, Tesla made its way into the very restricted club of American companies with a market capitalization above $1 trillion, with the likes of Apple and Amazon.
After having signed a 100,000 order with Hertz, shares of Tesla closed 12.6% higher at $1,024 on 25 October, and climbed even higher the following week to $1,114, bringing year-to-date gains to 52% and reaching $1 trillion market capitalization.
Tesla had overtaken Toyota in July 2020 as the most valuable car company. Its value has increased fivefold since then, making it more valuable than the next nine most valuable public carmakers combined.
A strategic deal
On both sides, the deal makes sense. Hertz’s shares also jumped 10% on the news. The company emerged from bankruptcy four months ago, liquidating 30% of its fleet when car prices were high. Now that it is back above water, Herz is going for an “EV-olution”, which will likely attract EV-curious users, especially as gas prices soar. This is also giving cultural relevance to Herz, differentiating it from other car rental companies. What’s more, its order will take 10% of Tesla’s production capacity, making it very hard for competitors like Enterprise or Avis to replicate.
On Tesla’s end, it is beneficial too. Not only did it boost its 2021 sales and share price, (100,000 cars for the hefty sum of $4.2 billion is one great sale after all), it is also a great step towards EV adoption. After all, this is the ultimate test drive for Tesla. Indeed, renting a car for a weekend getaway is far less intimidating than spending $40k+ on a Model 3. As battery charging is paid by Hertz, the user just needs to enjoy the experience.
Are we valuing a car or a tech company?
So far, only a handful of publicly traded companies surpassed $1 trillion market cap. These are big tech names like Apple, Microsoft, Alphabet and Facebook, a club joined by Amazon last year – after 23 years in the market. What makes this achievement even more impressive is that Tesla is a car company. No automaker was ever so highly valued. But is Tesla really a car company?
It seems that Wall Street already sees Tesla as a tech company, with valuations driven by future profits rather than today’s. In fact, looking at the future, it seems that cars are not even the center of Tesla’s business: more than 75% of expected sales are set come from software and subscriptions. As an EV market leader, Tesla is looking to lay the foundations for hardware, operating systems and autonomous driving, a new form of energy management, and more. Ultimately, Tesla is not being rewarded for the cars it sells, but for its future potential.
Tough promises to keep
Tesla was doubted, and even mocked, for years: how could a company that did not even make money be worth so much? However, it turned things around, returning a net income for nine quarters in a row, and counting.
During Q3, net profit was up 380% from a year ago to $1.62 billion, with vehicle production up 72%. Indeed, Tesla weathered the supply chain challenges by using alternative chips and rewriting software. This helped Tesla maintain a production of around 238,000 vehicles in the third quarter of 2021.
And Mr. Musk aims for more. He ensures that from half a million cars in 2020, production should rise 50% per year, thanks to the expansion of Chinese production, as well as its German and Texan factories. The long-term goal is a production of 20 million cars per year by 2030, double what established competitors like Volkswagen produces today.
However, the numbers simply do not add up in business terms, be that for a car or a tech company. The Hertz sale was worth around $4.2 billion for Tesla and led the stock to gain almost 20 times that ($80 billion) in market value. The company already sold 627,000 vehicles this year, aiming for a million total sales for the year, which would equate to a hefty valuation of more than $1 million per vehicle.
The stock might be priced at too-high a level. Many analysts argue that Tesla’s goals would imply huge volume and industry-leading profitability which would be historically unprecedented. Bernstein analysts even set a 12-months price target of $300 for the stock, implying that it would lose 70% of its value once market reality hits – due to issues like less demand than expected, combined with a chip shortage.
To illustrate this idea, we can draw parallels with two companies: Cisco and Amazon. Cisco’s stock also soared in the 2000 bubble, trading at a multiple of 46. However, the stock quickly dropped to a multiple of 4.6 once the bubble burst. We can contrast this example with Amazon, which is an even larger company. It saw the same situation that Cisco did, with a multiple of 45 dropping to just under 4 times today. The key difference here is that Amazon managed to grow revenues with a wide range of offerings: streaming videos, Alexa, Prime Day and Amazon Web Services. For Tesla to justify such an investment, it would imply that the company manages to innovate and dominate well into the future, much like Amazon did. Not an impossible task, but a daunting one for sure.
Of course, no one can predict the future. Although Tesla looks like a promising company, investors should beware of its high valuation and of the goals it must meet to justify it.
