One of the joys of writing about publicly listed companies at a very accessible price point is the interaction with other intelligent and curious readers. I routinely learn a lot from these interactions and MBI Deep Dives is a better product because of these interactions.
After I published my Deep Dive on Tesla, Forward Cap diligently read my work and sent me his thoughts. I enjoy Forward Cap's work and I encourage you to read his work on his Substack. I suggested him that we make our interactions public which he agreed.
Full disclosure: as of this writing, Forward Cap owns shares of Tesla and I have no exposure to Tesla.
Forward Cap: Hey – finally got around to reading your deep dive. Great work!! I always love reading a fresh perspective and you have a lot of interesting datapoints, insights, and opinions. Wanted to share some of my feedback:
Your S/X deliveries are off (99k act vs 22k in your model) so the ASP in the article is showing $110k vs $76k actual (lower when deducting reg credits which are also 0 in your model for 2018-19).
MBI: You are right. I linked the cells incorrectly on S/X deliveries for 2018. I have corrected it now on my model and on my write-up. (For regulatory credits, I do not see related disclosure on my database and hence it was zero.)
Forward Cap: I like the comparison to the auto industry from 100 years ago, as there are a lot of parallels, specifically with respect to difficult competitive dynamics which are very real here. However, one thing that is much different this time around that’s critical to my thesis is the legacy business/innovator dilemmas that are materially dragging competitor efforts. Between conflicting interests for management, employees, shareholders, unions, dealers, and more – it’s a very difficult uphill battle for incumbent OEMs.
MBI: I don’t disagree. I am not eager to bet on the ICE incumbents to transition to EV. It’s a tall ask for them. However, I am not super confident that none of them will be able to do it. My lack of confidence comes not from deep knowledge about their initiatives, rather the opposite. I certainly didn’t have time to carefully assess each of the incumbents EV initiatives. I do broadly agree with your thesis that the supermajority of them will likely find it too challenging to transition to EV successfully. However, perhaps a couple of them will be able to do it. We are still way too early in EV to form rigid opinions. We may be in the “1920s” and “Toyota” and “Volkswagen” haven’t even been founded yet. The whole discussion on what happened a century ago was to set the context for lack of predictability and a sense of humility required for a long duration bet.
Forward Cap: You do a good job of highlighting the structural advantages that Tesla has over incumbent OEMs with respect to the DTC distribution vs third party dealers, but I think that often gets mistaken as the only reason why bulls feel that Tesla is differentiated.
Both from a margin and pace of innovation perspective, there are several other reasons why Tesla can innovate more quickly and save on costs relative to legacy competitors:
- Innovative manufacturing methods that reduce complexity and costs (see quotes from competitors here). There is a lot to unpack here, but fundamentally Tesla is building factories and assembly lines from the ground up and willing to take on additional risk to innovate, whereas there are too many legacy facilities/assets and conflicted parties that would allow this at a legacy OEM. Obviously, Tesla’s ability to dedicate 100% of their effort to developing more efficient manufacturing methods also helps, whereas legacy OEMs are still mostly spending resources on ICE. I highly recommend the Munroe Live YouTube channel to learn more on this, as he/his firm are industry veterans with mountains of knowledge.
- Internally developed software, not just FSD, which is an increasingly important aspect of the auto industry. Jim Farley does an excellent job explaining here. In addition to cost and time savings, this allows Tesla to fully capture all of their data, which uniquely positions them for FSD, insurance, understanding vehicle diagnostics/useful parts, and other software-driven applications.
- Ability to attract top talent across the org (more detail here). Tesla is really the only automaker competing with big tech for talent and there’s a litany of reasons for this: ability to live in SF or Austin, equity upside (not common at competitors), less bureaucracy/ability to work on smaller teams, ability to work on more internal software and technology, and more. Tesla can also get more out of its workforce because they are not unionized.
- Localized production. While geopolitical tensions in China present a risk to Tesla, they are the only foreign automaker to ever operate there independently (i.e. without a JV structure). They are diversifying through their factories in California, Austin, Berlin, Mexico, and eventually other areas which all helps further localize production. This helps them save on costs (i.e. tariffs) and time from production to delivery, which helps drive their industry-leading Days of Inventory.
- Economies of scale and first mover advantage. Tesla's lead in EV volumes, specifically domestically and less relevant in China because of BYD, allows them to be more competitive on pricing as a result of lower fixed overhead relative to sales, greater negotiating leverage when sourcing batteries and other key components, etc. Additionally, as a first mover, Tesla’s brand is synonymous with EVs and consumers are proven to check out Tesla specs when considering an EV purchase. This is a big reason why they have been able to scale to a $100B+ revenue business without advertising yet, though I hope they do soon.
- Ability to share key manufacturing methods, proprietary technology, and top talent with SpaceX. This happens quite often and is underrated, as there’s more relevant overlap than meets the eye.
Forward Cap: Great discussion on BYD and I like that you elaborate on them because they are definitely under-discussed. It’s incredible what they’ve accomplished, especially given their presence in mostly just one country, and representative of the much more competitive nature of the Chinese market. BYD has definitely had a negative impact on Tesla’s pricing strategy in China. With that said, I think the article focuses too much on BYD’s volumes and not enough on the differences in market segments (there are pictures but no commentary). A lot of BYD’s volume comes from significantly lower priced vehicles so the volume isn’t exactly apples-to-apples. For example, their top selling cars are the Song starting at 169,800 Yuan and Yuan Plus starting at 135,800 Yan vs Model 3 starting at 259,00 Yuan and Model Y at 263,900. As a result, BYD has and will likely maintain a much lower share of industry profits.
MBI: Yes, given I alluded BYD as the “GM” in today’s EV race, I probably should have expanded even more. I guess I was a bit too self-conscious about the length of the Deep Dive as it was ~15k words already. Anyways, I do think volume is quite/likely the most important element here. If you think EVs not just as “hardware” sales but a potential revenue stream of “FSD, insurance, parts sales” etc., protecting gross margin on hardware may prove to be shortsighted. I think Tesla understands that and they seem quite eager to pursue volume instead of protecting automotive’s gross margins; their recent pricing strategy hints at such an approach. It is to BYD’s credit that they could produce low cost EVs that they could sell and the overall profit pool on LTV basis may be quite compelling despite the initial lower gross margin. Tesla clearly has a willingness to produce even cheaper EVs in the long term (which is critical for mass adoption). BYD is likely to be a major exporter to all other regions (except US?) in the next 3-5 years and therefore, BYD and Tesla seem quite destined to be fierce competitors.
Forward Cap: I agree that China geopolitical risk is a major risk for Tesla. Elon has made it pretty clear in recent interviews that he thinks China will invade Taiwan and tensions will escalate. Pretty wild.
MBI: Yes, even if China doesn’t end up invading Taiwan, I would argue China could still make Tesla’s life difficult if BYD doesn’t get greenlight to operate in the US. The last thing I expect from China is to allow an American company to dominate one of the largest industry’s profit pools when their own homegrown companies are anathema in the US. I know Apple is still there, but admittedly I’m just as equally concerned about their long-term viability there.
Forward Cap: I love and agree with this quote “The range of outcome for FSD is really perhaps the widest of anything I have come across in studying businesses over the last decade!” With the trend in ASPs and gross margins this year, the bull case is becoming increasingly dependent on FSD. Not what I envisioned prior to this year.
MBI: It took me a while to understand FSD’s accounting implications in the financial statements and once I did, I realized it really is perhaps a make-or-break thesis for Tesla shareholders. Elon was indeed right. If FSD “works” eventually, things are likely to turn out to be fine for the shareholders.
On the model:
Forward Cap: Overall, you have very reasonable assumptions. Not far off my volume estimates in 2030 for example.
- I think they’ll gain a bit more operating leverage than you give credit for, but I also think (hope) they will start advertising, so SG&A leverage won’t be as strong as we’ve seen historically.
- You properly show how much value FSD can add without a robotaxi/licensing scenario, though still likely conservative on the GAAP recognition % over time as that is based on available feature set which is expanding.
- The 2% p.a. increase in FDSO is aggressive in my opinion since that has really slowed down recently. For example, FDSO is only 0.1% higher as of Q2 2023 than Q4 2022.
MBI: To be clear, I was just trying to figure out embedded assumptions in current stock price. I agree that looking at history, one can argue I could have been a bit more generous in giving Tesla credit for further operating leverage. Perhaps I have been burned too many times assuming such operating leverage which very rarely plays out. More seriously, I do think more advertising would be required if competition with BYD heats up across the world. I am not sure Tesla cars would be able to maintain the same inherent appeal to potential customers without doing so. Selling cars to “early adopters” vs “early majority” could be a different ball game. Similarly, I do expect Tesla will have to be more generous in doling out SBC and other benefits. The upside for employees joining at <$100 Bn market cap vs ~$1 Tn market cap is different. It is, however, possible that Elon Musk would be far more conservative in hiring than any other big tech. We will see and I agree that my dilution assumptions could prove to be aggressive.
Forward Cap: I think it’s likely that non-core revenue streams today will play a much larger role in the latter part of the decade. They have a very large opportunity in Energy for example and are just now beginning to leverage excess battery capacity towards energy as growth in vehicle business slows, which gives them nice optionality. A few other examples: insurance, long-haul transportation (Semi), battery manufacturing, FSD licensing, Optimus, Dojo. All massive opportunities that are adjacent to current areas of focus. With a company as innovative as Tesla, some things are obviously very hard to predict that far into the future, which is where the market is assigning a lot of its value, but nearly impossible to model today so obviously tough to include in any analysis. I’ve always been the biggest Tesla bull I know and looking back at my models from 5+ years ago it’s insane how much even I under-estimated it. Of course, that’s not predictive of future results, but I think they’ve maintained the same culture that got them to where they are today.
MBI: While I did incorporate some of these opportunities (Energy directly and insurance indirectly in the services segment), I agree that opportunities such as FSD licensing, Optimus etc. are not adequately captured in my model. Valuing optionality for big tech is just incredibly hard and interestingly, almost no other shareholders of other big tech give credit to the companies for such optionality. Google and Meta both are valued based on consolidated numbers despite having large other bets losses (especially for Meta). Similarly, even though Apple is getting into AR/VR and had been working on Car for last 10 years, investors were rarely willing to give these companies any credit for such “investments” until and unless these investments turn into something more tangible. It is possible that Tesla’s shareholder base would act differently here; however, looking at last year's drawdown also gives me pause on that theory.
To read my Deep Dive on Tesla, click here. Thank you for reading.