02 Oct 2023
Craig Bonthron, Fund Manager of the Artemis Positive Future Fund, says Elon Musk may prove to have a greater impact on tackling global warming than any other CEO. He also claims Tesla has the edge over its competitors at every stage of the manufacturing process. So why is he selling out of the company?
As impact managers who invest in companies that aim to change the world for the better, Elon Musk should be something of a poster boy. Last year alone, it is estimated that by driving an electric vehicle rather than one with an internal combustion engine (ICE), Tesla’s customers prevented about 13.4 million metric tons of CO21 from being released into the atmosphere. Even more significant is the profound shift Musk has affected in the global automobile industry, forcing Tesla’s competitors to pivot away from their legacy businesses as it becomes clear the future lies in electric vehicles.
The business case is also compelling. Cynics like to highlight the enormous difference in valuation multiple between Tesla and its legacy peers, but this ignores the superior rate of growth and many fundamental competitive advantages the company has over incumbents. Tesla has significant leadership in electric drive-chain technology and the manufacturing processes required to build these complex new machines at high volume. This combined with ownership and control of their sales and servicing network, their superfast charging network, vastly superior software, artificial intelligence engineering capabilities (which are deployed over the air) and a brand so strong that they don’t need to advertise, is largely lost on those who reduce the investment case to a ‘high multiple’.
Even from this position of strength, Tesla continues to disrupt the industry: the Cybertruck looks set to become a huge success in the US, while its energy storage and solar divisions are also growing quickly. The company should gain market share in its core business and continue to generate superior profit margins, free cash flow and returns on invested capital than any other automobile manufacturer. Meanwhile, I expect that most of its competitors will continue to lose money on electric vehicles for some time whilst also dealing with their combustion engine-based businesses declining and operationally de-leveraging (i.e., lower volumes produced on a very large base of fixed costs).
Getting to this point hasn’t been easy. It has been a very hard road for Tesla and even since my relatively recent first investment in Tesla in 2019, it has gone from a cash-burning and balance-sheet-stretched business to an extremely high margin free cash flow producing powerhouse. Building cars is very capital intensive and Tesla didn’t make a profit or positive cashflow for its first 10 years2 as a public company, yet in 2022 they grew manufacturing capacity by more than 50% whilst also investing in a myriad of other growth projects and still had $1bn in free cash flow left over.3
The reason I made an investment in Tesla when I did was that there was – finally - sufficient evidence that they could mass manufacture cars at a profit. It was the point when the Model 3 had turned from a vision into a reality and when Musk’s ‘production hell’ was turning into real deliveries and happy customers. In the face of cynicism, derision and unprecedented attention from short sellers, the reason to invest in Tesla – for me - was that the company began to deliver on its ambitious long-term mission, ‘to accelerate the world’s transition to sustainable energy’ whilst its competitors were largely acting like disrupted incumbents do – in denial.
Tesla is a case study in disruptive innovation, vertical integration, manufacturing process power and technology leadership in multiple inter-related areas combined with a clear mission and vision.
The first reason is its valuation. This doesn’t mean I woke up in a cold sweat one night on the realisation its P/E (price-to-earnings) ratio is too high – if that had been a concern, I never would have bought it in the first place!
Instead, it reflects our view that the rate of growth in the car business will slow, and the share price will become increasingly dependent on other parts of the business taking up the slack. The probability of success, for example, in autonomous driving and other areas of artificial intelligence (via its ‘DoJo’ supercomputer) has become a larger component of the valuation case.
Whilst much touted, I think full autonomous driving is particularly ambitious and would be surprised if this is genuinely possible in the next five years. If I am wrong, I admit it would create enormous amounts of value and probably merit buying back in shares immediately. As for other AI related businesses, we just don’t know where that is going to go from here and we are happy to watch from the side-lines for now.
However, the main reason for selling out of Tesla is Musk himself. His erratic behaviour is nothing new, but we always felt his interests were aligned with those of long-term investors. This is no longer the case.
It won’t have escaped your notice that Musk bought microblogging site Twitter last year. He claimed the rationale behind this decision was to protect free speech but has since used the platform to parrot conspiracy theories and become increasingly political.
Within reason, the political beliefs of management teams have no bearing on whether we invest in their companies. Yet there is one problem with Musk’s decision to align himself with a particular political narrative - he may alienate his most loyal customers and diminish the valuable Tesla brand.
A recent Gallup poll in the US indicated that 71% of Republican voters would never buy an electric vehicle.4 Presumably, the figure for the most fervent of that group – many of whose members call climate change a ‘hoax’ – is even lower. This compares with 38% of independents and 17% of Democrats.5 Yet rather than trying to court this latter group of likely customers, Musk has spoken of a desire to “own the libs” – or “upset the liberals”, for those not conversant in Tweet speak.
Who knows, perhaps Musk’s recent political positioning is a Machiavellian strategy to expand the Tesla market by legitimising the brand with right wing voters. However, my suspicion is that this is more likely to diminish the brand with its traditional customers.
A recent Bloomberg survey and article provides evidence of this. Titled ‘Love the cars, hate the tweets’, it highlights that Musk holds an ‘unusual degree of sway over Tesla customers’ and that they increasingly dislike his online persona, with a large percentage wishing him to stay out of politics. According to the survey, Tesla owners’ attitude towards Musk has significantly deteriorated since 2019 (when I first invested). The survey comments were emotional, and owners clearly felt conflicted. For example, one quote read6:
“I love the vehicles but do not want to support someone who has such vitriol and low opinion of the very people who made Tesla a success”.
It’s not just customers that Tesla has to worry about. Tesla has been successful - in large part -because of the engineering talent that they have attracted. Tesla reportedly had 3.6m job applications last year (versus the 128k people it employs) and remains top of the rankings7 for engineering students in terms of places to work. Musk has so far been a magnet for engineering talent, but this shouldn’t be taken for granted.
For good or ill, Tesla doesn’t really have the option of ditching Musk, and taking a job or buying a car is an emotional and financially meaningful decision. For many, the Tesla brand is a virtuous status symbol. It would be very detrimental to the company if it instead became a mark of shame.
Musk’s erratic behaviour has yet to have a discernible impact on sales. Recent results again outperformed the competition significantly. I wouldn’t bet against it doing so repeatedly in the future. But when a stock is priced to deliver significant growth in the future - much of which is in areas where it hasn’t yet to deliver any revenue – I need to have confidence that it will deliver. When I initially bought Tesla shares for our clients, it was unprofitable and controversial, but I felt I could clearly see where it was going. The direction of travel from here is less clear. This combined with the additional layer of fog created by Musk’s behaviour means that it’s not a journey I’m comfortable being on anymore, especially at this speed.
1 https://www.tesla.com/ns_videos/2022-tesla-impact-report-highlights.pdf
2 https://edition.cnn.com/2020/01/31/investing/tesla-cash-crunch/index.html
4 https://news.gallup.com/poll/474095/americans-not-completely-sold-electric-vehicles.aspx
5 https://news.gallup.com/poll/474095/americans-not-completely-sold-electric-vehicles.aspx
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