 Welcome back to the Deal Room, the first episode of 2024. So, Stephen, how is it going? And what's on the docket for today? Yeah, good afternoon, Anthony. And happy new year, everyone that's listening. I had a great 45 minutes listening to your predictions, your market's predictions pursued earlier on today. So, great job, Ant and Piers for that. But today, we are going to do a deep dive into Tesla. We thought we'd kick off the new year with a single headline, BYD outstripping Tesla in terms of car volume sales. And then we're actually going to maybe take a bit of a theme from Piers and Ant's episode and talk about the magnificent seven, talk about Tesla's business model relative to the other six, do a little bit of a bull in a bear case and then end up with a bit of a DCF discounted cash flow analysis that we will make available on LinkedIn, on our channels. So, looking forward to it, where do we start? OK, well, let me cover the story that's been in focus this week, which is the headline news that BYD has overtaken Tesla. They've essentially become the world's leading EV seller. And to give this some context with numbers, Tesla did sell more vehicles than analysts predicted in Q4. They sold just under 500,000. But BYD sold 526,000. And this is quite meaningful because actually that's on the EV side. That's battery only vehicles. But if you actually start to take in different things, so hydrogen powered models, things that then hybrid vehicles, things of that nature, BYD actually overtook Tesla back in the first half of 2022. So Tesla have got, they were kind of the, I think Piers always describes it. It's kind of like in cycling, you've got the lead pack and then there's the peloton. But the peloton has quite quickly broken, it's almost splinted off and BYD has sprinted up to catch to Tesla and in fact overtaken it. So one of the main things here is something that you did a great job. Many times last year of emphasizing was the emphasis on cost, efficiencies underpinned by BYD's vertical integration. And that meaning then from the suppliers resources to batteries, computer chips to the fact that actually BYD not only makes cars, its top battery maker means that its status in that arena that it can supply rivals, including Tesla itself and also giants like Toyota, for example. And so rather than dive into those numbers specifically, we're going to talk about these models of how they operate as a business for Tesla's case study, but also the magnificent seven. I mean, you're probably going to prove me wrong when you start talking about Tesla. But I think Tesla is a, I'm going to say it, Elon might be listening. I think it's a fabulous company for the other things beyond cars that it does. But I think that when you start to take into consideration the fact that with China and full state backing, I think BYD is going to go for really big things in the future. Yeah. So why is BYD, let's say the market capitalization of BYD is $79 billion. The market capitalization of Tesla is $740 billion. You've given a really, really good overview of BYD and why it's best place to take advantage of state backing plus technology. Why is it valued at kind of 11% of Tesla? Yeah. I mean, my only guess on that would be without looking at real details is the fact that the ability to access BYD, perhaps the foreign investment into a company like that comes with certain issues, that being that it is highly aligned as these technology firms are in China with the Chinese government. So I think that probably explains a bit of it. I would imagine as well that the Chinese state don't want foreign investment into that company. They want to control it themselves. So yeah, I think that probably explains a large part of it. I think it's quite a nice representation of the difference between a legacy command economy, AKA China, where there's a great deal of centralization in terms of investment and direction from a strategic and technological perspective and then a relatively open market economy that is based largely on the pools of capital that are spread across and directed towards the US. And that may well explain quite a lot of A, BYD's advance but still B, why it's only worth 11% or 12%, the pools of capital are just not as deep. Well, long term, I wonder how those pools of capital will shift because now you have the bricks expanding, taking in countries like Saudi Arabia, for example, and a further alignment with the world's most populous country like India, whose infrastructure, whose education affluence will continue to grow. The foreign capital doesn't need to come from those traditional sources that we've been used to seeing perhaps over the last few decades. Yeah, and look, their trailing price earnings ratio, BYDs, is still pretty punchy relative to the car industry, right? It's still at 20 times. Now, Tesla's is at 77 times trailing, 64 times forward-looking. So that's kind of pretty bombastic, but at 20 times price earnings ratio for BYD, compare that to VW, four times trailing price earnings, GM, five times, Ford, eight times. So it's still achieving a dislocated itself from a traditional car manufacturer's valuation. It just hasn't yet scaled the heights of Tesla. And quite interestingly, 31 out of 32 analysts have a buy rating on BYD. We'll talk a little bit more about Tesla in a bit. Yeah, and then the other one was, what we talk about for an investment, Warren Buffett was actually one of the initial investors. They've actually reduced their stake quite recently in BYD. And one of the things that they said was, they don't wanna bet against Elon Musk. And Charlie Munger, may he rest in peace, and Warren Buffett, they're pretty old school. I mean, they pivoted a lot with the investment now into Apple, you could say with technology. However, it was very interesting to see their comments. They were basically like, don't quite agree with how some of the things that he might behave for Elon Musk. However, he has a solid proven track record and perhaps it takes an ego like his to push the boundaries to reach the heights that he has done with most of the things that he's taken in. So yeah, but they've still got, I think it's about a 2.3 billion holding in BYD as it stands to this day. So still got some skin in the game. That's pretty punchy. So yeah, let's talk a little bit then about Tesla and I'm really interested. Whenever I think about Tesla, it's obviously from an optics point of view, if you're a retail consumer, you just think Tesla cars. So how do you start to value a company like Tesla though? That isn't just cars. Is it an automotive manufacturer? Is it a technology company? And many other things probably in between. So how do you actually, well, maybe we'll start with the business model then we'll get to how do you actually deconstruct that to get a valuation? Yeah. So this is a really interesting question because Tesla tends to be blocked in as part of the magnificent seven alongside six other technology companies. And we've had many experiences where we've created an acronym, whether it's a fang or whatever it might be and one or two of those companies have dropped off or dropped out of that core group of mega caps. And Tesla from a business model perspective is relatively different to all of the other companies within the magnificent seven. Now, this is interesting from a perspective of share price growth over the last year. And I know that you and Piers mentioned it on your pod, you know, Tesla up 110%, Google up 60%, NVIDIA 233%. So they're all going gangbusters. Just before we get into the business model and just to really set the scene of Tesla and how we try to consider the valuation and the forward-looking prospects of the company, the price earnings of Tesla 77 times, price earnings of Apple 30, Microsoft 36, Meta 31, Google 27, even NVIDIA has had this pretty remarkable year, price earnings of 62. So it's already an outlier from its share price divided by earnings per share relative to these other six Goliath companies. So you're thinking, well, I'm thinking, if I'm an investor, what is this secret source? What has Tesla got that the other magnificent seven hasn't in order to be valued at that remarkable multiple? And now when I think about technology companies, the breakout technology companies, the Google, Amazon, Meta, Apple, Microsoft, let's just keep it at those five for now. I think that they, all of them to some extent, take advantage of a number of things that make them worth what they're worth. The first one is high gross margins. And this is kind of anchoring it to some valuation principles and some business strategy principles. Now, everyone wants to run a high gross margin business. High gross margin business essentially means that you add an extra unit of sales and you don't really add much cost. Your cost of goods sold are relatively low relative to your addition of one sales. And obviously you think about a software product, doesn't cost a great deal more to add one node to that software infrastructure. So the gross margins of Meta over 80%. So for every dollar of revenue they generate, only 20 cents is direct costs. Nvidia 74%, Microsoft has increased significantly over the last few years as it's transitioned out of more kind of harder to build things into software and cloud computing and things like that. It's gross margin 71%. And this is what really attracts investors. You turn on the marketing tap and hopefully the profit margins just boom, boom, boom. And you've seen this with the big companies. Now Tesla's gross margin, it's been the subject of significant scrutiny is hovering just under 20% because it manufactures cars. And 83% of its revenue in 2022 was automotive sales. So yes, we can get quite excited about the technology. Yes, we can get quite excited about energy generation and storage. But actually it's gross margin is 20%. In fact, it's gone down from about 24% to just under 20% with the price cuts. So if I'm looking at one of these magnificent seven businesses and I'm looking at high gross margin businesses, then Tesla for me seems to be a bit of an outlier. The only comparable, quote unquote comparable is Apple because Apple manufactures stuff, but it's gross margins 44%. And that's actually increasing as it transitions more away from the hardware and more towards services, which is growing at 15% year on year. So it's a really interesting one to think, all right, why are we valuing Tesla at 77 times trailing price earnings when it's gross margins are only 20%? That would be the first thing that I start thinking about when trying to value this company. So my first rebuttal if I was to test the spokesman would be talking about the data gathering and our advantage to fuel our AI data systems and our models. And that's why they never talk about the car. I mean, the car has a very slow to market new design, the cyber truck, incredibly hard to manufacture. It's not going to scale up for ages. It's not going to be cash flow positive for a long time. It's kind of beside the point. It's just, that's I think more marketing. And then it's about the, it's almost like whilst their cars aren't particularly high quality manufactured against their peers, you just draw emphasis on all of the more sexy of the moment areas of the business, even from the automotive section without all the other things that they do as a company. Yeah, and this is super interesting. So I totally buy your point. I totally buy your point that Tesla could reasonably be valued dislocated from other car companies. But the fact that it's valued so much more than the extremely high gross margin tech companies leads me scratching my head. And yes, you're absolutely right. Artificial intelligence. I know that I was just looking at their earnings reports commission one of the largest supercomputers to accelerate the pace of AI development. This is all good stuff. But is it worth a 77 times trading price earnings multiple? What would be the similar for one of the traditional old school automotive manufacturers? So like a GM, for example, or Ford? From a gross margin perspective, 15 to 20% is the kind of, is the goal. BYD's gross margin is 19%. And then as I've said, the translation into price earnings is pretty grotty. So it's just really interesting. It's not what I would expect. Tesla is not what I would expect to see in a breakout trillion dollar market capitalization business if it weren't for Elon Musk and if it weren't for the legions of retail investors that love this stock. Let me go on. So the second thing that quite a lot of these big tech names have from a business model perspective is network effects. So what is the benefit of being a big tech company? Well, one of them is this thing called network effect. And best described to network effects best described to me by using the analogy of a telephone. You know, telephone network, which is a network while adding one more telephone to the network makes the whole network more valuable and makes that particular telephone access a more valuable network. So if you were the only telephone operator in the world there was no point in having a telephone. And so businesses like Facebook, Facebook is the ultimate network effects business where one additional user makes the whole network more valuable or makes the business intrinsically defensible. It's kind of secret source times X. And these are what, you know, this is again what tech businesses really aspire to be every time a new business lists on Amazon it makes it better for the whole community. Every time a new piece of SEO is optimized or a new thing is uploaded on YouTube it makes it better for the whole community. Tesla doesn't have that or doesn't have it to the extent that I can envisage it at the moment maybe there'll be a future community of Tesla users that contribute data and make the node and the network better. Maybe you could say that the data gathering from each node in the network improves the overall data set but it doesn't have as clear a network effects as some of the other businesses that we're looking at. Is there a translatable brand and marketing network effect by what Elon does by being Elon? Yeah, I mean, so it's interesting. So one of the things that's worth looking at in terms of the financials of Tesla is we always look at gross margin which is really important and Tesla's gross margin is now comparable with the rest of the industry. This operating profit margin is quite a lot higher than its comparables because they don't spend money on marketing. So in terms of when we get to the discounted cash flow later on, in terms of the free cash flow it's not got a pretty chunky line item that many other firms do that have to spend billions of dollars significantly marketing and going through the old school distribution networks of automotive companies. So yes, you could say maybe it's not a network effect but it's certainly an advantage. There's certainly a tick in the kind of crows column for Tesla. Okay, so perhaps you could tell me a little bit then about the technology where we're at and where the advantages are with Tesla and then in comparison then to scale where are Tesla in real terms? So like unit sales and things like that. Yeah, so proprietary technology I would say this is probably a kind of a half tick in the bucket for Tesla. But then again, other car companies as we're discussing today other car companies are catching up from a technology perspective and you mentioned the vertical integration of BYD. Tesla doesn't, it's got manufacturing capability from a battery perspective but it hasn't yet ramped it up. So it's still very reliant on third-party technology providers namely Panasonic. So yes, from a kind of core automotive technology they had a moat or they had a gap. They were at the front of the peloton but it's being closed. I think obviously the most interesting part is the artificial intelligence layer the self-driving capability. When I'm just going to kind of very, very quickly reference the Uberbull, Cathy Wood you might have discussed this seven or eight months ago on the pod. I was just dredging up the $2,500 per share price target 10 times what it is today. And that was based on over 50% of their revenue coming from actually sorry, just under 50% of their revenue coming from robo-taxis by 2027 which is certainly pie in the sky. But this is the kind of mythical always around the corner breakthrough mega technology that Tesla is still probably best place to take advantage of. It's just that it's always just around the corner. It's never quite there and we can never quite feel it. So when we do a DCF analysis it's quite hard to slap on a great deal of future free cash flow to that line item. So Cathy Wood's like the supreme bull. I think she was hoovering up shares yesterday. I think even though BYD is overtaking them and everyone's being quite critical putting them under the microscope Tesla she's like, yep, perfect excuse, some negative narrative I'm gonna enter and load up a bit more. So what's the bear case then on the other side? Yeah, so I would say that the bull case is what Cathy Wood articulates and our investment management articulates. I'd probably furnish that with a little bit of macroeconomic or kind of macro regulatory Biden's industrial reforms discounts for EVs in the US of up to $7,500. There's some good tailwinds there that would crop up the existing valuation of the company. Now remember the Tesla's valued at $750 billion about $238 per share. Now, well, I've got my list of bear case points and I've obviously listed a couple with the business model but I put Musk up there. Is he part of the bear case? What do you reckon? Well, I think the easy answer is always to say that yes he's a liability. However, I sometimes have to check myself and you go through the catalog of calamities that he's said or done or tweeted and here he is. He remains in a position of power that he has. So I think that's lessened. In fact, when I talk about it more from some sort of threat from the board or from regulation, I think he's pretty untouchable on that side. I guess one of the things on him as a bear case is distraction. Does he have other things ongoing where he's a liability because he's not giving it due care and attention? Like what we saw with Twitter, I guess was the biggest example more recently where what it got valued again most recently and it's down a lot. And so you could argue, but I guess no one on the board can because he's Elon Musk of that thing's dead. I don't care what your 10 year X plan is. This company is thriving and we've got competition on our tails. So yeah, I'm a little bit on the fence. I used to be quite, yes, he's a big risk. He's a major bear consideration. I actually don't think he is so much because I think that we would have already have seen that if that were the case, would have already have negatively impacted the shares and it hasn't. Yeah, yeah, well, we'll wait to see how much more he can say and do. It's more extreme than what's come before. So yeah, so we'll put Musk on the fence. I think other bear scenarios before we get into the DCF, Cybertruck production concerns and also product quality concern, there's gotta be in there. I know that a lot of people, I think yourself included might say this, the Cybertruck's more of a bit of fluff, bit of marketing fluff and shouldn't really contribute to the valuation relative to the AI platform, but... Yeah, I saw a good strategist note from one of the banks. Can't remember which one might have been JP or MS and they were talking about that being your like, shiny product that you use to bring in new customers to then deploy to your most top selling vehicles as a strategy. So the Cybertruck was never meant to be a revenue generating product. That doesn't surprise me. It just in terms of the difficulty in producing those windows and the size of the car and I think it's got the biggest commercially manufactured pane of window for an automotive vehicle. So that kind of thing makes it very, very unscalable or difficult to scale at least. So we've got that in the bear case, new president coming, well, maybe. I don't wanna predict this thing, but it might well happen at the end of this year. So that, again, if we pivot to Trump, then that's not going to be good news for the EV industry. I would say, you know, the business fundamentals, if I was to... Oh, I'm not gonna make a prediction because it's impossible to make predictions about Tesla. It feels like they should not be part of the magnificent seven from a core fundamental business perspective, yet they are and they have been for the last 18 months. So I'm not gonna make a prediction. I've got an angle for you. They will remain part of the magnificent seven, purely on the basis of sell side institutions will ensure that they're within that camp to maximize then volume through that particular stock and the subsequent research and interest that it generates. It's too big a story not to be making money from. So I think it benefits sell side institutions as well as Tesla to be part of that. Which is the wonderful irrationality of markets, isn't it? Yeah. There's no fundamentals to suggest that it should stay at a 800 billion plus market capitalization company. Yet, as you say, there's the vested interest in the human element that is probably going to keep it within this magnificent seven, despite what my DCF might say. Okay. So is there any more points to add or is it DCF time? Let's go into DCF. Okay. When do we begin with this thing? Yeah. So I've done a very super, super simple. It's not what you call back of an envelope, but it's a very basic version of a discounted cash flow. But we will make available after this podcast drops. So what I've done is I've taken Tesla 2022 full year financials. It hasn't yet released 2023. I've made a number of assumptions based on looking at historic drivers and also looking at some market analysis. So for example, one of the key drivers to any discounted cash flow, starting with the income statement is revenue growth. Now I've started revenue growth at 20% annually. This is going down slowly to 10% by 2027, which is relatively conservative. So 20% year on year growth in 2023, going down to 10% by 2027. I've looked at slightly improved gross margins across the five years. So a company continuing to eke out economies of scale related productivity gains and margin gains. So that's from a income statement perspective. And you can see net income go from 12.7 billion in 2022, all the way up to about 48 billion by 2027. Again, we will publish this later on. Most importantly, and DCFs are only as good as the inputs and the assumptions that you provide. So most importantly, when looking at a discounted cash flow analysis, the two key things that you really need to look at are your discount rate, which is represented by your weighted average cost of capital, and also the terminal value perpetuity growth rate. How quickly is this company going to grow, assume that it continues forever after 2027? And just tweaking those two numbers is gonna totally change the valuation, right? So I put a weighted average cost of capital for Tesla at 8.8%. That's calculated based on a capital asset pricing model cost of equity. Company doesn't have any debt, makes it a little bit easier, bearing in mind the risk-free rate of 3.91%, et cetera. So 8.8%, which taking a look at some other DCFs is about average, it's maybe slightly on the low end. And then terminal value perpetuity growth rate at 3%, which often you proxy, you look at US GDP growth as your kind of terminal value proxy, so between two and two and a half percent, but we're gonna be slightly more bullish because it is Tesla and there is such a big market to gain and it's still a small player within such a large market. So there is a case for 3% in perpetuity. So when you kind of pull all these numbers together, you pull the five-year projected income statement, you project it out to 2027, then you apply a discount rate that is represented by the weighted average cost of capital, and then you put that perpetuity growth rate terminal value on the end. Guess what? Guess what my implied value per share is? Bearing in mind that Tesla is currently valued at 238 and a half dollars a share. What did my, and by the way, just so you know, I didn't look at, I didn't solve to get close to the valuation. I put it in valuation, share price blind. So what do you reckon I came up with? Something a lot lower. I think it's gonna be, so what was the share price they currently trade? I think 238 and a half. Okay, I'm gonna say you can knock 100 off that. 138. 241 dollars 30. Wow. How nuts is that? Okay. But again, if I lower the perpetuity growth rate, I've just got my model up right now. If I lower the perpetuity growth rate to 2%, then the implied value per share drops to 210 dollars. So this is how sensitive the model is and how you really need to take DCF as a range and as a kind of guide. The assumptions can be challenged and batted back and forth forever from a revenue growth perspective, from a WAC perspective. This is an interesting piece of analysis that actually quite surprised me because I'm not the most bullish on Tesla, but these assumptions aren't ridiculous. I'm not being overly optimistic, I don't think. And look, 241 dollars. It's not the 2,500 dollars that Kathy would suggest it, but I don't think I'm gonna get a job from her, but anyway. If you are working at a sales side bank, so investment bank, and you're doing an ex-research role, they obviously come out with quite, there's kind of a meeting consensus around valuations. However, they are fringe ones. How much of it then is you are given a protocol model or follow to conform to the more bullish or bearish bias or is it, I mean, and how much is it just actually acting on the information at hand and evolving as we go? Yeah, I think there'll definitely be non-objectives, totally rational incentives and cajoling towards a particular outcome within an equity research team. And you do have very, very well-known equity research analysts that are perma-balls or perma-bearers that are going to adjust assumptions depending on their world view or maybe let's extrapolate the house's world view, the bank's world view, but these equity analysts live and die by the quality of their analysis. So if they were totally, if they were kind of pathy wood bombastic and this was clearly a bit of a publicity thing, right? There's not a lot of financial wherewithal in that $2,500 price target. So unless you're someone like Kathy Wood, then you're gonna have to stay within a range. I'm just looking at the buy-sell hold ratings for Tesla at the moment. We've got about 16, I think we've got 16 buys, 31 holds and a couple of cells. So, you know, they're clustering around, around the fact that the valuation is pretty fair at the moment. So it's just quite interesting to do this analysis. Would there ever be a situation where the company could spin off certain parts to improve any of the metrics which you've mentioned or to see value, let's say in one particular component, like the data that comes from an increased amount of users driving their car? Yeah, absolutely. And you know, DCF is not the only way to value a company and a lot of equity research analysts and M&A analysts will do a sum of the parts valuation that will try to look at their discrete business units and value them individually. And then if the overall valuation is 50% higher than the valuation as a collective, then there's definitely gonna be pressure to maybe spin off or to restructure. In the case of Tesla, that's difficult because it does have this, it's not necessarily a flywheel, but it's got the kind of technology, aiding the car selling process, all the quality of cars and the cars providing feedback to the technology. So it probably doesn't feel like a sum of the parts can be done, especially since automotive sales is still 85% of revenue. But yeah, it's definitely something that a more in-depth analysis would take a look at. So Tesla year end 2024, what do you reckon? How much was it out for the year? Last year? 110% wasn't it last, last 12 months, something like that. Yep. You know what? I'm gonna rely on the experts. And I think you guys said the magnificent seven will be up in 2024 and they're probably outperforming the S&P, but not by as much as they did this year, which was obviously a pretty mad year. So I'm gonna say the same. I think that Tesla is gonna be up despite, again, it's so silly, despite all of my rational thinking and it's probably gonna be up, but not by as much as it was last year. Cool. All right, on that note, we'll wrap it up. Thank you, Stephen, good to get the show back up and running for 2024. As you said, we'll find a way to try and share your breakdown of some of these numbers. And please do drop a comment. There's quite a lot of terminology there. If you're brand new to corporate finance, you might not understand all of them. Just ask us on that post, drop a comment and Stephen will be happy to reply, I'm sure. All right, thanks very much, everyone. Thank you, Anne.