EV (Electric Vehicle) Valuations

Who will be the next Tesla?

I know very little about the electric vehicle (EV) business, apart from what I’ve read in the press about Tesla. But I am aware that there are several publicly traded early stage EV manufacturing companies trying to break into the business. These are all SPACs which have merged with operating companies and now trade as EV operating businesses. Today’s WSJ published an interesting piece on this topic, which I recommend to you all: EV Startups are in Trouble; Investors Don’t Care (see link below)

The purpose of today’s post is not to discuss the current state of the EV manufacturing business, but rather to comment on the trading dynamics of these companies’ stocks and specifically on their current market valuations. In this post I will discuss how one might think qualitatively about valuing these early stage companies and leave it for you to do you own quantitative valuations of these companies if you wish.

To set the stage, let’s look at the current market valuations of the three big auto manufacturers: Tesla $600bn, GM $85bn, and Ford $57bn. These figures are all equity market caps (share price x number of shares outstanding) and so may not be directly comparable to each other. (GM and Ford have lots of debt and pension liabilities, so their Enterprise Values differ from their Equity Values; they also have large financing operations which complicate the analysis.). But look at the huge disconnect between the equity value of Tesla and that of the two large legacy auto manufacturers. The stock market is clearly telling us something about the future of auto manufacturing, which is not reflected in the current profits of these three companies. GM and Ford shares trade at 10-15x earnings, whereas Tesla (newly profitable) trades at 600x.

Next let’s look at the three newbies profiled in the WSJ article and note their market values: Nikola $6.5bn, Lordstown $1.9bn and Canoo $2.4bn. Each of these companies was a SPAC prior to merging with an operating EV company, so they all started out public company life with share prices of $10 (the standard SPAC IPO price). Nikola shares traded up to a high of $64 and are now back down to $16; Lordstown shares traded up to $30 and are now back down to $10; and Canoo shares traded as high as $20 and are now back down to $10. All of these companies are experiencing operating difficulties which have cast serious doubts on their future business and financial prospects. This is reflected in the big drop in the share prices, of course, but are the now reduced valuations (still in the billions) reasonable?

I really have no idea if these valuations make sense, because I don’t know anything about these companies’ fundamentals and I cannot even remotely begin to forecast for each of them a range of possible future operating and financial scenarios. Without some sense of possible future cash flows, one can’t begin to do any sort of fundamental DCF-based valuation. This was also true of Tesla for much of its life, but it is less true today as Tesla has matured. (“Mature” is a funny word to use for an Elon Musk company, but I digress.) I can’t tell you what Tesla’s future looks like, but there are many experts (analysts and investors) who can and do. Even if they are wrong, at least these folks have informed views which enable them to do DCF valuations based on a range of possible future operating scenarios and then come up with a probability-adjusted intrinsic valuation outputs. And many of these experts are putting up their own money (or that of their clients) to buy Tesla shares, so we should listen to what they have to say.

In the absence of credible financial forecasts with which to do DCF analysis, and without the benefit of near-term profit estimates with which to generate forward P/E multiples (or similar metrics), how can investors go about pricing the shares of these early stage EV companies? Well venture capitalists do this all the time, and in my (very limited) experience they do not get too hung up on the sort of precise valuation metrics that we use to value more mature companies (where I have much more experience). They ask and attempt to answer questions like the following: How big is the future EV auto business likely to be? What will be the key factors that define success and failure? Which companies (or entrepreneurs) have what it takes to be successful? How much capital and what other resources will it take to reach various stages of maturity? How much money might we make if this investment works out? What options do we have to cut our losses if it doesn’t?

Successful venture capitalists are very smart people with a keen eye for risk and return as well as informed views on new technologies and business models, but even they get it wrong from time to time. In fact, they get it wrong most of the time. In a typical VC portfolio only a few investments will be clear successes, but these successful investments will more than compensate for the other less successful investments and those that fail completely. A VC fund can afford to lose all its money on half of its investments if those that do work out earn the fund 10-100x its original investment.

This may be how investors are viewing the early stage publicly traded EV manufacturers, like VCs evaluating a single speculative investment in the context of a diversified venture portfolio. It is highly unlikely that Nickola will ever become the next Tesla or even the next Volvo (a legacy ICE truck manufacturer now investing in EV), but if you think this is even remotely possible then maybe, just maybe, Nikola’s current valuation begins to make some sense. Tesla’s $600bn market cap today is almost 100x that of Nickola; is there a 1% chance that Nikola could ever achieve this level of success? Volvo’s market cap is today about $54bn (converting SEK to USD), about 8x that of Nickola; is there a 12% chance that Nikola could ever hit Volvo’s valuation? If so, then Nikola might be a reasonable (if not overly attractive) investment at today’s reduced price even if the odds are high that it fails completely.

But there are two other ways to think about these current market valuations. One, public investors may be viewing the shares of Nikola and its peers like out-of-the-money stock options, the value of which is determined (in part) by share price volatility and time to expiration (bankruptcy, if the companies don’t make it). If Nikola shares again hit a price of $64, investors who buy in at todays price will make 4x their money, which may not be an unreasonable possibility. But keep in mind that the likely low price for Nickola is no longer bounded by $10 (the SPAC IPO price pre-merger, for a company which held $10 a share in cash pre-merger). The lower price bound for Nikola shares is now zero, a non-trivial possibility, which changes the risk-reward calculation quite a bit.

I suspect however that the best explanation for the volatile market valuations of the EV manufacturers has something to do with the changing composition of stock market investors, particularly in the go-go sectors like EVs. Retail investors now account for as much as 20% or so of all stock market trading and a much higher percentage of trading in the so-called “meme stocks”. This may not be “dumb money” as we used to say about retail investors generally, but I think it is fair to say that retail investing today is not driven by the same sorts of fundamental analysis that we generally (perhaps too charitably) attribute to the institutional investors who used to dominate stock trading. We saw the same sort of phenomena with “day traders” and “dotcom” stocks in the late 1990’s, which did not end well. There may or may not be more substance to what’s going on in the stock market now—only time will tell—but I suspect that we are going to see a lot more blood in the water before this is over, in the EV space and elsewhere.

To learn more about this changing stock market environment, read the recent WSJ article “It isn’t just AMC: Retail Traders Increase Pull in the Stock Market” (see link below).

Links

EV Startups are in Trouble; Investors Don’t Care, WSJ: https://www.wsj.com/articles/ev-startups-are-in-trouble-investors-dont-care-11624075431?mod=hp_lead_pos10

It isn’t just AMC: Retail Traders Increase Pull on the Stock Market, WSJ: https://www.wsj.com/articles/it-isnt-just-amc-retail-traders-increase-pull-on-the-stock-market-11624008602?mod=hp_lead_pos3