The Probability of Tesla Going Bankrupt

Never take advice from someone who doesn’t have to live with the consequences. With every other media outlet talking about Tesla (TSLA) blowing up, that’s precisely why it’s worth taking a closer look at the value on offer. Properly assessing the risks associated with a stock requires one to leave ethnocentric political beliefs and the propensity to engage in petty bickering at the door. Successful investors are opportunists who look past all the noise and emotion to find deep value in places others are afraid to look. And in today’s bear market, surviving is equally as important as thriving.

Pointing to the decline in Tesla’s share price without including a benchmark is a rookie move. Here’s a year-to-date performance for Tesla using several benchmarks.

• Nasdaq Tracker ETF: -32%
• Google: -37%
• Tesla: -57%
• ARK Innovation ETF: -66%

Even accounting for ARK’s ETF holding a 7.5% weighting in Tesla, it’s still a basket of tech stocks that’s down -66% year-to-date. To say that Tesla stock is crashing seems like an overreaction, especially when you take into account their high beta. A higher beta stock is expected to move more dramatically than the benchmark. When shares were going to the moon, nobody had a problem with the high beta. But when they see the same movements on the downside, suddenly the world is ending. With its largest owner selling shares, pressure on Tesla’s stock price should be expected.

Investors in Tesla stock, or potential investors, should be stoked that a quality asset is on sale. The only concern is Tesla’s survivability in the face of a plummeting share price, regardless of the reasons for the fall. Let’s look at how Tesla makes their money and from where.

What Tesla Does

We’ve always refrained from writing about Tesla because the last thing this world needs is another opinion about Tesla. As with many fanboy stocks, pundits will often have an incredibly rich understanding of very granular aspects of the business making it very hard to find a simple explanation of how Tesla makes their money. We’ll use their latest 10-Q as the basis for today’s analysis.

Selling electric vehicles constitutes 95% of the company’s revenues. Americans who manufacture outrage for a living may not be buying Tesla’s vehicles, while they actively attack the brand as much as possible, so there may be some demand drop in the United States where half of Tesla’s revenues come from. Given we’re in a recession, let’s assume there is a demand drop, and revenue growth slows. The same holds true for China where demand is said to be slowing and competition tightening. Given these assumptions, what problems might Tesla run into that would require them to raise money by issuing dirt-cheap equity, or by taking on debt?

Thinking it Through

Although Mr. Musk spends significant time with Tesla and is highly active in our management, he does not devote his full time and attention to Tesla. Mr. Musk also currently serves as Chief Executive Officer and Chief Technical Officer of Space Exploration Technologies Corp.

Credit: Tesla 10-Q

A valid concern being raised by numerous individuals surrounds the attention Elon Musk has been paying towards his latest venture, Twitter, a company that we think has a high probability of surviving, and perhaps even thriving. But honestly, has Mr. Musk ever been without distraction? It’s actually mentioned as a risk in the company’s SEC filings where they note he serves as CEO and CTO of SpaceX. Then there’s the perfume sales, the flamethrowers, boring giant holes, developing brain-computer interfaces, and Zeus knows what else.

Let’s say Mr. Musk pulls an Amy Winehouse and is no longer a variable in the Tesla equation. The stock would temporarily implode, the CEO would be replaced, and life would go on. In fact, there’s a good argument to be made that Tesla should find a new CEO now that they’re firing on all four electric motors.

Perhaps pundits are having a hard time separating the actions of Elon Musk from the daily operations over at Tesla. For example, a great deal of focus has been placed on Musk’s recent share sale.

He remains Tesla’s biggest shareholder with a 13.4% stake, according to financial market data provider Refinitiv. Last month Mr. Musk revealed that he had sold 19.5 million shares of Tesla worth $3.95bn, just days after completing a $44bn takeover of social media platform Twitter.

Credit: BBC

Let’s put that into context. The value of that sale represented just 5% of Mr. Musk’s total holdings at today’s prices. Having such a large percentage of his wealth tied up in a single company’s stock justifies even further sales. That will put downward pressure on the share price.

Mr. Musk is now playing a complex juggling game with his personal finances to reduce debt payments at Twitter, a company he owns 74% of. When considering Tesla, we need to detach Mr. Musk’s personal financial decisions from what’s happening at the company. So, what happens if Mr. Musk gets a margin call on all that Tesla stock he’s put up for collateral?

An article by Bloomberg postulates that Mr. Musk is borrowing money at a loan-to-value ratio of 20%. That means the stock would have to sink much further before he’s in any danger of a margin call. Such an event would likely trigger automatic sales of the stock in a normal brokerage account, but one would expect that at institutional levels, things behave differently. Offloading a massive number of shares results in a lot of downward pressure on the price of a stock, so it’s in the lender’s best interest to go about this more slowly. The big question surrounds the impact on Tesla should Mr. Musk run into personal finance problems. Putting further selling pressure on the price of the stock aside, it doesn’t seem to be much of a risk for Tesla if Mr. Musk’s personal finances go pear-shaped.

Our Take on Tesla

Two and a half years ago, we wrote a piece titled Here’s Why Short Sellers Are Shorting Tesla at which time shares were trading at around $110 a share at a simple valuation ratio (SVR) of 14.5. Four months prior to that, shares traded at $30 representing an SVR of 4 (that was when the Rona impacted the markets in March 2020). Today, shares trade at an SVR of 5.5.

• $475 billion market cap / (Q3-2022 revenues X 4)
  475 / (4 * 21.45) = 5.5

If shares traded at the same valuation as they did when the Rona temporarily wreaked havoc on Wall Street, then shares would trade at around $108 a share. So, there’s certainly an opportunity for further downside, and the media mania around Musk’s sinking gold barge needs to be taken with a grain of salt.

We’ve listed Tesla in our tech stock catalog as a like, though it’s too large of a company to fit our disruptive tech investment strategy. Once a company gets to a particular size – above $100 billion – we start to look at trimming our gains. Google was a company we invested in when it debuted with a market cap of $23 billion and eventually became one of the largest companies in the world (we exited our position when they dove head deep into politics and began hiring adventure cartoonists). We don’t have a dog in the Tesla race, but we know many of our readers and subscribers do. Tesla shares are flirting with historically low valuations, and the falling share price doesn’t decrease the likelihood the company will survive whatever the bear market throws their way. The probability of Tesla going bankrupt seems very low.

Conclusion

Nearly half our audience hails from abroad, which means they’re looking on with curious bemusement at how political the US has become. Saying anything about Elon Musk now implies some political statement, so we need to separate the man from his biggest company, Tesla. He’s always been distracted from focusing on Tesla, whether that’s selling perfume and flamethrowers, drilling giant boreholes, reading monkeys’ thoughts, or firing reusable rockets into space. Is the added distraction of Twitter what finally breaks the camel’s back? Maybe, but Tesla seems in good financial shape to weather whatever storms are being whipped up over in blue bird land or otherwise.