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Point/Counterpoint: The Case on Tesla

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(C) Reuters.

By Yasin Ebrahim and Geoffrey Smith — Shares of electric car maker Tesla (NASDAQ:TSLA) seem be be on an unstoppable rally, rising more than 140% over the last three months and around 500% over the last year and investors think that there could be more gains ahead even as short-sellers remain skeptical of the company and its unconventional CEO Elon Musk. The company is due to report its latest quarterly earnings on July 22 and if it posts a profit it would would mark Tesla’s first cumulative four-quarter profit, paving the way for its addition to the S&P 500.

Yasin Ebrahim argues that short sellers look set to continue piling up losses, while Geoffrey Smith counters that Tesla shares simply do not justify their current valuation. This is Point/Counterpoint.

Tesla Puts $18 Billion Squeeze on Bears as ‘Shortville’ Burns

The eerie noises emanating from ‘Shortville,’ a fictional place inhabited by Tesla short sellers, are the sound of the bears being squeezed to the tune of $18 billion.

Traders betting against (shorting) Tesla are down $18.08 billion in year-to-date, mark-to-market losses, according to data from S3 Partners.

Unfortunately, the wreckage in Shortville will continue as Tesla, which has more than tripled this year, has many power ups ahead not least in China, the company’s second biggest market.

Last year, Tesla rolled out its first factory, the Gigafactory 3, in China as part of efforts to build on growing demand in the country, which turned out sales of about 1.6 million last year, dwarfing the 330,000 sales in the U.S.

With locally-made Teslas rolling off the conveyor belt, averting the hefty 25% import duty, the company has not only been able to compete with local competitors such as NIO and Lixiang, but steal market share.

Sales of Chinese all-electric vehicles slumped 40% year-on-year to 67,000 units in June, while Tesla grew market share by 23%, the Chinese Passengers Car Association said Wednesday.

Tesla is also cooking up a million-mile battery at its Gigafactory in China that experts hail as a game charger.

“We believe that the China growth story is worth at least $400 per share in a bull case to Tesla as this EV penetration is set to ramp significantly over the next 12 to 18 months, along with major battery innovations coming out of Giga 3 (million mile battery remains an elusive goal now in the grasp in our opinion),” Wedbush analyst Daniel Ives said.

The bears, however, have pointed to valuation as a source of comfort for their bearish bets.

Tesla’s market cap at over $280 billion, is above that of Toyota, the leading automaker in terms of output, and General Motors (NYSE:GM), the leading automaker in the U.S., combined.

But expected earnings or other measures of valuation have no place in the Tesla story. “With Tesla, it is always the story that drives the stock not the news, or the fundamentals,” Professor at NYU Stern, Aswath Damodaran, also known as Dean of valuation, told CNBC in an interview earlier this week.

The mounting losses suggests Damodaran is onto something. But only time will tell whether or not the bears get squeezed into submission.

For now, Musk is in the ascendancy, while the bears may have to settle for the limited-edition red satin short pants on offer from Tesla.

The bear case

More than any other stock in the world, Tesla has become completely divorced from reality in recent weeks.

This is not to say it doesn’t have an excellent product and a formidable brand, whose power is evident in how it has grabbed 15% of the market for electric vehicles in China since starting its factory in Shanghai.

No, this is all about valuations. There is no conceivable justification for the 60% rally in the share price in merely two weeks, which is chiefly the product of arcane activity in the options market, fueled by free money from the Fed and other central banks.

True, it delivered more cars in a supremely difficult quarter than seemed possible. But to add $108 billion of market cap to a company because it sold, what, $600 million of cars more than expected in a quarter? Without any indication of whether it turned a profit? Seriously?

Sure, its inclusion in the S&P 500, if and when it happens, will expand the number of forced buyers of the stock. But that does not a value proposition make. Ask Nordstrom (NYSE:JWN) or Harley-Davidson (NYSE:HOG).

As Morgan Stanley analysts wrote this week, the price is being sustained by “the power of hope” – a supreme euphemism coined by an analyst whose real thoughts about today’s buyers, if committed to paper, would alienate clients forever. Even at $1,400, they noted, the stock implies a tenfold expansion of production over the next decade, and an EBITDA margin of 20%.

“We’re not saying these are assumptions are not possible, but they are a very big leap ahead from what the company has proven to date and implies a level of commercial success in a global EV market at less than 2% penetration today,” Morgan Stanley’s analysts said.

To achieve that kind of growth, the company will need free and unfettered access to the Chinese market, which, together with Europe, will still account for 72% of global EV sales by 2030, according to Bloomberg New Energy Finance.

But it is hopelessly naive to think that the promise of a few thousand local jobs will protect Tesla from the whirlwind of Chinese retaliation as we progress beyond what Henry Kissinger calls “the foothills of a new Cold War”. It is almost as naive to think that the French and German governments are going to stand by and let Tesla satisfy all the demand for EVs in Europe.

Nor is ‘Level 5 autonomy’ – the stage where steering wheels and brake pedals become obsolete – anything more than a pipe dream for now. Elon Musk’s boasts this week of it coming in the near future are hollow. People have already died proving that Tesla’s Autopilot is a misnomer. Should Musk succeed in persuading the NHTSA that he has achieved Level 5, the consequence could be a death toll that dwarfs that of the 737 MAX.

Tesla still faces a mountain of execution risk before it can justify its current valuation. The supply of greater fools to sell to is elastic, but not infinite.