• Elon Musk has hinted at a $420/share go-private offer for Tesla, which would mark the end of an era for Tesla stock.

• We show how short arguments have evolved since 2013 from the lack of appeal of electric vehicles, to the structurally-unprofitable nature of the business model and potential demand weakness owed to impending competition from incumbents.

• With those arguments proved false in Q2 2018 and evidence for booming Model 3 demand, it was time to move to a more constructive short thesis structured around valuation.

• But the relentless distortion of facts by under-the-water short interests and the click-seeking media, and Elon Musk's inability to remain isolated, have compelled the CEO to take Tesla private.

• We show that Tesla has been compounding capital at some 10% since we went long in 2013, and arguably in excess of 20% after proper accounting for expansion of the intangible asset base.

To You, Tesla (TSLA) Short,

From day 1, you committed to the believe that Tesla was bound to fail, that Elon Musk was a fraud. A self-confident startup guy from Silicon Valley with an engineering mindset decided to disrupt the cutthroat automotive industry with silent, battery-powered, electric cars? Oh, please.

Short thesis I

So you proclaimed that electric vehicles would never be more than a niche toy for the environmentally-conscious wealthy, even when all physical and economical trends suggested the inevitable shift towards electric transportation.

When Tesla announced the Gigafactory, you said that in the unlikely event of a shift to electric transportation, it would be fuel cells, not Li-ion batteries, that would become the mainstream storage technology.

Short thesis II

After Dieselgate, with all major automotive groups announcing a strategic shift towards battery-powered electric vehicles, your claims became untenable. So you shifted the script towards Tesla business model being structurally unprofitable, and you felt comforted.

You have spent the last 3 years grasping at straws in Tesla's financial statements, interpreting quarterly volatility as irrefutable evidence of fraud while ignoring consistent 50%+ top-line growth.

You've also obsessed on Tesla's demand-strength being the result of lack of electric vehicle alternatives from the incumbent automakers. If Tesla could not make profits without EV competition, how could it when the likes of BMW, Mercedes or Lexus offered comparable products?

Of course, you missed entirely the point that a car is a car regardless of the nature of the power-train and that Tesla has been capturing market share from formidable competitors from day 1. Before an electric BMW 3er can challenge the Tesla Model 3, it will need to be able to challenge itself by offering better value than its gasoline counterpart, a milestone that should not be taken for granted given that the strength of BMW resides in ICE power-trains.

Committed as you were to your flawed investment thesis, digging deeper and deeper into your hole of mounting financial and reputation losses, the most daring among you went as far as to portray Tesla as a giant Ponzi scheme. Because of course, if Elon Musk's grand purpose in life was to fool naive investors, what quicker way than disrupting the rocket launch industry with high-tech low-cost reusable rockets, and the road transportation industry with electric, software-rich, Internet connected vehicles displayed in company owned boutiques around the world? Setting up an obscure financial or multi-level marketing scheme would have been too much trouble.

Short thesis III

With the "structurally unprofitable Tesla" thesis being definitely debunked in the Q2 2018 earnings conference call (skeptics just need to wait for 2H financials), and Model 3 reviews and demand beyond anything seen before, it was time to structure the short thesis towards valuation.

This, at last, would have been a constructive, legitimate conversation in which we would have been willing to engage.

Going private

But it may be too late now...

Elon musk hints at a $420/share go-private offer for Tesla on 7 Aug 2018 (source: Twitter)

Although pending the Board's final decision and formal shareholder vote, it seems extremely likely that Tesla will be taken private.

Elon Musk's rationale is articulated in the Tesla blog (emphasis ours):

[...] the reason for doing this is all about creating the environment for Tesla to operate best. As a public company, we are subject to wild swings in our stock price that can be a major distraction for everyone working at Tesla, all of whom are shareholders. Being public also subjects us to the quarterly earnings cycle that puts enormous pressure on Tesla to make decisions that may be right for a given quarter, but not necessarily right for the long-term. Finally, as the most shorted stock in the history of the stock market, being public means that there are large numbers of people who have the incentive to attack the company. 

So thank you, shorts.

Thank you for your continuous distortion of facts, thank you for your unabashed foolishness.

Not content with losing your shirt and your reputation, you are going to prevent individual investors from increasing their participation in the future wealth creation of the company (according to the CEO, current shareholders will be able to remain invested through a special purpose fund, with opportunities to cash in every few months, but individual investors will most likely be unable to add to their positions).

You will also obscure outside investors' and academics' access to the financials of one of the most fascinating business stories of the 21st Century after Tesla goes private.

The best news for you is that because you cannot short a private company, your losses and mental agony will at last stop compounding. 

Nice write-up, Investment Works, but look at the financials, you say?

The financials

Sure, let's look at financials.

But without missing the forest for the trees, as you have over the years.

The last 5 years

2013 was the first full-year of Model S production.

It was also the year we added Tesla to the best-in-class IW Portfolio (we have subsequently added opportunistically to the long position in several occasions between 2013 and 2016).

On 31 December 2013, cash and cash equivalents exceeded financial liabilities by $270 million. Common equity was selling at $150/share, with 119.4 million diluted shares. Full-year 2013 revenues were $2,013 million.

Fast forward to 30 June 2018. Financial liabilities exceed cash equivalents by $8,830 million, there are 170 million diluted shares outstanding and a go-private tender offer at $420/share. Last 6 month revenues came in at $7,411 million and we are expecting full year revenues of about $21,000 million, in line with Wall Street analyst expectations.

Net financial liabilities are expected to decline for the remainder of the year, as Tesla realizes positive FCF in 2H 2018, but let's ignore that for the purpose of this analysis.

Capital employed

From the number given above, it follows that between December 2013 and June 2018, Tesla has raised some $9,100 million of debt capital, and this includes absolutely all interest-bearing liabilities.

We expect the company to be FCF in 2H 2018, which would reduce net debt raised somewhat, but for the purpose of this analysis let's assumed that the figure remains at $9,100 million by end of year.

Tesla has also raised some $5,280 million in formal equity issues, but this number excludes share dilution as part of stock-based compensation and the acquisition of SolarCity in 2016.

To play it conservative, we are going to estimate the total equity capital raised as the increase in diluted number of shares (50.6 million) times an average share price of $200, which puts total equity capital raised at $10,100 million.

Our estimate of total capital employed between December 2013 and June 2018 is then $19.2 billion ($9.1 billion debt and $10.1 billion equity).

Top-line growth

Meanwhile, we expect annual revenues to increase by $19 billion, from $2 billion in 2013 to $21 billion in 2018.

Return on invested capital

Connecting the dots, we see that in the 5 years ended December 2018, Tesla will have increased revenues by one dollar for each dollar of capital invested.

If that was everything the company had to show for its investment, that would put return on invested capital (ROIC) at the level of normalized NOPAT margins, likely in the 10% ballpark.

(NOPAT is the net operating profit after tax, and ROIC is the increase in NOPAT divided by the capital invested during the period. Because increase in revenues over invested capital was 1 during the 2013-2018 period, Tesla's ROIC equals normalized NOPAT margin. By normalized, we refer to adjustments for investments in growth that leak to the income statement.)

Beyond financials

But revenue growth does not fully reflect the most important part of the story, nominally, the enormous value of the intangible assets that Tesla has created over the last 5 years.

We are talking about brand equity, consumer mindshare, a pool of exceptional technical and business talent, technological leadership in batteries and power electronics, advances in deep learning, automation software and manufacturing technologies, and the like.

Add those to the ROIC reflected in financial statements and we are likely talking about 20%+ ROIC.

20% compounded over 5 years is 150%, or 2.5x, which incidentally is slightly below the 2.8x stock price appreciation from $150 to $420 that the supposed go-private offer would materialize.

Takeaways and future work

While the story of Tesla the business is in its early innings, we are approaching the end of an era for Tesla the stock.

There are many takeaways from this story.

One is that in investing, reading people is more important than reading financial statements. If you start with the premise that a CEO is ill-intentioned, you can always interpret financials in a way that fits your story, particularly in a capital intensive 50% CAGR company.

Indeed, if we were to portray a caricature of the professional investor with a short interest in Tesla, it would be that of a self-proclaimed "car guy" with limited people-reading skills, a strong accounting background and even stronger pride. Several familiar names probably come to mind.

Elon Musk is the real deal. That was easy for us to see, since we were familiar with his early achievements at SpaceX, thanks to our former ties to the Aerospace industry. So we were lucky that way.

You don't want to short Elon Musk's audacity and ability to build teams of exceptional people. Admittedly, that was much harder to see for individuals with a narrower financial background emotionally disposed to disdain out-of-the-box ground-up approaches to business strategy.

A related one is that in investing, half truths are extremely dangerous. Accounting is just the language, not the science. Financial statements are just the starting point. As shown above, a quick look at the evolution of financials metrics between 2013 and 2018 suffices to debunk the Tesla-as-a-value-destroyer rhetoric.

Another one is that even the most sophisticated analyst can reach the wrong conclusions by obsessing in the unimportant (number of Model S delivered next quarter, Model 3 reservation number) to the detriment of what really matters, what makes or brakes the investment thesis (demand health, technological leadership, capex efficiency).

And of course, that humans are emotional animals, and that pride, peer pressure and sunk reputation costs can prevent us from aligning flawed believes to new facts, magnifying our missery, preventing us from moving on.

To the professional short sellers:

It would be naive for us to expect you to admit that you were wrong, that you missed the forest for the trees. You will likely choose to keep living in denial.

The great thing about financial markets is that in the long term and regardless of personal egos, money eventually flows from those who are wrong to those who are right. So we'll leave it at that.

To individual investors compelled to short Tesla by professional and semi-professional commentators:

Take it as a learning experience about the dangers of shorting a one-of-a-kind company.

Want to be short something? Look for overvalued run-of-the-mill companies with a weak competitive position. Hot IPOs are often a good place to look at.

Or abandon your short career altogether. Short-only traders are more prone to stomach ulcer and irritation. Plus, I bet you'll be better off financially buying and holding wonderful businesses for the long term. Consider the current holdings in our IW Portfolio as a starting point.

To long investors:

We are taking a wait and see approach until the go-private offer is formalized and more details are revealed. After that happens, we don't rule out the stock price temporarily surpassing the $420 mark.  We will update as events unfold, so subscribe to our IW Newsletter to stay tuned.

That's all we wanted to say for now.