Tag: Innovator's Dilemma

12 Things People Don't Understand About Tesla

Note: This is not investment advice. At heart, I’m a value investor, and Tesla is no value investment. I view it as a binary venture-type bet. I am a shareholder.

I believe that Tesla is one of the most misunderstood (and most exciting) tech companies right now.

After I rented a Model S for a weekend in 2017, I started following the company more closely. I turned from skeptic to enthusiast. (I even almost bought one, and would immediately buy one if I really needed a car).

Here is what people don’t understand:

1. It’s all about battery supply

It’s 2020. Companies like Daimler, Volkswagen or Jaguar are slowly and painfully realizing that the limiting factor of electrification is battery supply:

Image by Teslarati

Meanwhile, Tesla has a multi-year head start:

Tesla acquired Maxwell Technologies in 2019, which has impressive technology.

Elon Musk is remarkably transparent about this:

“So, the thing we’re going to be really focused on is increasing battery production capacity (…) we got to scale battery production to crazy levels that people cannot even fathom today. That’s the real problem.”

Tesla Q4 2019 Earnings Call

As a result of all this, Tesla not only has the best cell chemistry, but also the highest battery production capacity, resulting in superior energy efficiency:

Table by matty_mogul

2. Gigantic ambition

Rendering of Tesla’s Gigafactory Nevada

Tesla’s mission is to accelerate the world’s transition to sustainable energy.

https://www.tesla.com/about

Elon Musk has repeatedly said that he won’t stop until all cars are electric. Tesla ultimately wants to produce millions of electric vehicles per year, if not tens of millions.

“A few years ago, I said in my estimate, that Tesla would grow at an average compound annual rate in excess of 50%. I still hold to that belief.”

Tesla Q4 2019 Earnings Call

In 2006, Elon Musk published his master plan:

Build sports car
Use that money to build an affordable car
Use that money to build an even more affordable car
While doing above, also provide zero emission electric power generation options

https://www.tesla.com/blog/secret-tesla-motors-master-plan-just-between-you-and-me

By 2018, they accomplished what they said they would do.

In 2016, they published the master plan, part 2:

Create stunning solar roofs with seamlessly integrated battery storage
Expand the electric vehicle product line to address all major segments
Develop a self-driving capability that is 10X safer than manual via massive fleet learning
Enable your car to make money for you when you aren’t using it

https://www.tesla.com/blog/master-plan-part-deux

If there is no major catastrophe, like Tesla or Elon Musk dying, I’d say the chances are pretty decent that they’ll achieve part two as well. The only question is when.

3. Healthy gross margins

The common belief is that Tesla is losing money on each car they sell. This is wrong.

Tesla’s automotive gross margin is ~20% (source). Exactly the same as Volkswagen’s (source).

This is okay, but of course very low compared to technology companies like Microsoft, with a gross margin of 67% (source).

However, Volkswagen’s customer fleet, due to its maturity, has many more cars that are out of warranty, allowing them to sell high-margin spare parts and service.

Internal combustion engine cars have a lot more moving parts. Image credit

Tesla, on the other hand, is achieving the same gross margin with a much smaller percentage of out of warranty cars (70-80% for traditional car makers vs. less than 20% for Tesla, according to Elon Musk).

Lastly, electric cars need much less maintenance, which will put major pressure on the old guys, who rely on this source of revenue.

Tesla is outselling the competition, and it’s not even close. (via HyperChangeTV)

4. Software and in-app purchases

Tesla is not just a manufacturer. It’s also a software company. This is where the future superior margins will come from:

  • Full self driving is a $7000 add-on.
  • In-app purchases offer simple upgrades like the $2000 acceleration boost, which is delivered over the air.
  • Premium connectivity for $9.99/mo to enjoy video & music streaming.

It’s pretty clear to me that software will become a major part of Tesla’s business, and that the list above is just the beginning. Also, as those products become better, the adoption rate of new, as well as existing customers, will increase.

5. Investing as fast as possible

Tesla is not cash-constrained. On the contrary, they invest as fast as they possibly can. Elon Musk:

“Well, we’re actually spending money as quickly as we can spend it sensibly. So if there’s any sensible way to spend money, we’re spending it. There is no artificial hold back on expenditures. Anything that I see that is what looks like it’s got good value for money, the answer is yes immediately.”

Tesla Q4 2019 Earnings Call

Tesla generated $1.1 billion in free cash flow in 2019, so they have turned from a cash-burning to a cash-generating business.

The main constraint is not money, but engineering talent. Even though SpaceX and Tesla are #1 and #2 for engineering students, you just cannot scale an R&D operation as easily. You not only have to find the talent, but also integrate it into the organization in an effective way. (Source)

Back in 2010, when Tesla has just delivered a total of 1400 cars (!), they bought the former GM-Toyota NUMMI factory. How crazy was that at the time. Fast forward to today. In 2019, this factory delivered 367,500 vehicles.

6. Exceptional customer satisfaction

Most people who have an opinion on Tesla have never owned or rented one. This is a mistake. I highly suggest renting one for a weekend, and see for yourself.

Unlike Theranos, where the product was a mirage, Tesla’s products are very real. Customers love them: Nearly 99% of Model 3 Owners Recommend Tesla to New Customers, says Bloomberg Study.

You just feel that Tesla has put its heart and soul into the product. It’s not an ordinary product. It’s a product of love. By people who care.

Even Germans are jumping ship. I know multiple Germans that have become raving Model 3 fans. Completely forgetting their BWMs and Audis. Out of sight, out of mind.

Each Tesla customer is an ambassador. Gladly offering test drives. I’ve both driven a Model S and Model 3 from friends. They love to spread the experience.

The Tesla fleet is growing exponentially, and so are its ambassadors.

7. Direct to consumer

A Tesla can be ordered in less than 2 minutes from a phone. Try to do that at any other major car company. I tried, and the user experience is so much worse.

More importantly, Tesla has no dealership structure, removing a middleman and major source of complexity. The Innovator’s Dilemma with it’s inherent path-dependency is making it all but impossible for the others to go direct to consumer as well.

The dealership structure will be a major burden for big auto, especially in an electrified, low-maintenance world.

8. Startup DNA

Tesla fundamentally has startup and Silicon Valley DNA. They move fast. They iterate fast. They have tight feedback loops.

This is not just theory. Here are the results:

  • Gigafactory Shanghai went from ground-breaking to start of production in 10 months (and to first deliveries just 2 months later)
  • Model Y went from prototype-unveiling to start of production in 10 months (first deliveries are expected in March 2020)
  • Countless over-the-air updates, many based on customer feedback: for example Dog Mode and Joe Mode

Compare that to mature and bureaucratic companies, with mercenary managers. Who will innovate faster? Who will get things done quicker?

9. High degree of vertical integration

In the early years, Tesla had trouble to convince established auto suppliers to work with them. Who would work with a startup with bad survival odds, when you can work with established companies?

Out of necessity, they had to “vertically integrate, or die”. (Source)

They survived this difficult challenge, and now reap the rewards: much less complexity, much tighter feedback loops, more innovation.

10. Ride sharing

I could have put this under “software”, but this could be such an important business line, that it deserves its own section.

Tesla will add ride sharing capabilities, which will enable it to earn a cut (usually 20-30%) from rides on their network.

The end game is to offer fully autonomous robotaxis, but they will start with regular ride sharing before that. Elon Musk:

“it probably will make sense to enable car sharing in advance of the robotaxi fleet because the car sharing can be done before Full Self-Driving is approved by regulators.”

Tesla Q4 2019 Earnings Call

That means that Tesla will not just make money from cars and software, but also make money from each mile that is driven on its ride sharing network.

The only question is, how big will this get? If they don’t solve full self driving, then this will just be another version of Uber/Lyft or Zipcar or Turo. It can be substantial, but probably not huge.

But if, and this is still a big if, they solve full self driving and can offer fully autonomous robotaxis, this can become gigantic, especially if they are the first ones. This is not unlikely, because they have the largest fleet and by far the most data to train their neural nets.

11. Solar and energy business

Tesla is not only a car, software and tech company. They also have a major solar and energy business.

Tesla Solarglass Roof V3 is just starting to hit the market, and is ramping up fast.

They have simplified their solar panel offering and are beginning to scale this as well.

Add to that Powerwalls, Powerpacks and Megapacks (Tesla Energy).

I fully believe that the energy business can become as large as the car business, with likely much lower margins, until they achieve a huge scale.

The synergies are obvious. People love Tesla’s mission, so adding solar and Powerwalls will be a no-brainer for many customers. And of course, Tesla’s superior battery technology will power cars as well as their storage solutions.

Utility-scale Powerpacks and Megapacks are quite successful so far as well: Tesla’s massive Powerpack battery in Australia cost $66 million and already made up to ~$17 million.

As with cars, this business segment requires massive battery production capacity. Until this capacity is built, Tesla Energy will continue to be battery constrained. I’m sure they could sell much more storage if they had the batteries for it.

12. Level 5 leadership

After Elon Musk dies – which is hopefully many decades away – he will be remembered in a similar way as Rockefeller, Edison or Steve Jobs.

Yes, he is quirky and eccentric. But more importantly, he is a Level 5 leader:

Level 5 leadership is a concept developed in the book Good to Great. Level 5 leaders display a powerful mixture of personal humility and indomitable will. They’re incredibly ambitious, but their ambition is first and foremost for the cause, for the organization and its purpose, not themselves.

https://www.jimcollins.com/concepts/level-five-leadership.html

Apple nailed it in their “Think Different” campaign, describing those kinds of visionaries:

Here’s to the crazy ones, the misfits, the rebels, the troublemakers, the round pegs in the square holes… the ones who see things differently — they’re not fond of rules… You can quote them, disagree with them, glorify or vilify them, but the only thing you can’t do is ignore them because they change things… they push the human race forward, and while some may see them as the crazy ones, we see genius, because the ones who are crazy enough to think that they can change the world, are the ones who do.

— Steve Jobs, 1997

Conclusion

I intended for this to be a “quick blog post”. I ended up spending much more time than anticipated. However, this analysis is by no means complete, and by no means bulletproof. It just is my summary of the things I believe are most misunderstood, from almost 3 years of following the company.

What about valuation? I think that ARK Invest has done an excellent job of building an open source valuation model. Based on their model, and my own intuition, I don’t see a reason why Tesla shouldn’t have a chance of becoming a $1 trillion market cap company, possibly multi-trillion, within the next 10 to 15 years (here’s the latest update of ARK’s research) . Or of course, in true venture-style, they could still go bust (as nearly happened in 2018), because they will keep taking risks and betting the company.

Credit: ark-research.com

The timing of publishing this is not optimal, as Tesla’s stock is currently experiencing a strong rally. I am the first to agree that the current run-up and enthusiasm is exaggerated. However, just 8 months ago, it was quite the opposite. Would I buy shares today? Probably not, even though a 10+ year bet might still work out. But again, this is not investment advice, so do your own research.

Tesla is the most shorted US stock. Image credit: Shortsight

Tesla remains the most shorted US stock. While I never short stocks (nor buy on margin), I get why some investors do it. Most new car companies fail. So on average, short sellers probably make money. But it‘s wrong here. Morally wrong. Founders like Elon Musk are super rare. Instead of wanting them to fail, we should cheer them on, and wanting them to succeed. I do. With all my heart and soul.

Additional Resources

The Tesla community is amazing. Here are further resources that I can highly recommend:

If you have comments or feedback, let me know on Twitter.


Posted on by Remo Uherek

Investing Lessons from Running a Startup

[This is an edited version of a talk I recently gave at a MOI Global event.]

I’d like to share some of the lessons I learned from being a startup founder, and how these can be applied to investing:

Lesson 1: I’m a better investor because I was a founder

As Warren Buffett famously said: „I’m a better investor because I’m a businessman. And I am a better businessman because I am an investor.“

This rings very true to me, and I can confirm it based on my own experiences.

I was in the middle of my startup, back in late 2008, when I discovered Warren Buffett and Benjamin Graham. My main takeaway for my business was that I realized how bad our gross margins were. At the time, our gross margin was around 30%, and we were burning money. Then, when applying this insight over a period of 3 years, we were able to double the gross margin to 60%, which helped us to achieve break-even and ultimately lead to selling our business. Without those gross margin improvements, it would have been much more difficult.

Lesson 2: “Creative accounting”

The second lesson is what I call „creative accounting“.

We were sending our investors monthly updates. But, brained-washed by the venture capital industry, and suffering from our own insecurities, we believed that everything that didn’t go „up and to the right“, was hurting our story. So we made a conscious effort to keep the story going, by applying what we called „creative accounting“.

We took advantage of the grey areas, and applied somewhat loose and not very consistent accounting practices. We played with the capitalization of certain expenses, to move them off the profit and loss statement. We recognized revenues in different ways, sometimes at the start of a project, sometimes in the middle, and sometimes at the end of a project.

In good months, we rolled over revenues to the next month, to have a head-start and create a cushion. In bad months, we scrambled to recognize everything we could, to avoid reporting bad news.

So based on these experiences, I’ve learned to become more skeptical of accounting statements, because there is always room for “creativity”: adjusted numbers, not expensing stock options, playing with accruals, playing with revenue recognition, and similar tactics.

Lesson 3: Seek owner-operated businesses

The next thing I learned is what it means to be an owner-operator.

I’ve been a founder of my own startups, but I’ve also managed startups that other people have founded. A founder is an owner-operator. He holds a large stake, and the whole responsibility lies on his shoulders. There is „skin in the game“ and a sense of „ownership“. It’s a different quality than managing someone else’s company.

When the company is mostly you, you cannot escape. You have to „go forward or go under“.  We had very tough periods in our startup. On multiple occasions, I was very close to giving up. But I didn’t, because I was an owner-operator. As a manager, you can quit much more easily. It’s a different situation.

That’s why in my investing today, I gravitate towards owner-operators. I’ve been one, and I understand them much better than hired managers. 

Lesson 4: Strong sales organization

Number 4 on Phil Fishers 15 point checklist is: “Does the company have an above average sales organization?“

I had to learn this the hard way. For the first two years, I was the only sales person in our company. It wasn’t working well. I had no prior sales experience, and I wasn’t enjoying the job. I realized that we need to build a sales team.

So I took a deep dive: I read sales books, went to sales seminars and hired our first sales manager. We ended up hiring 4 sales managers in one year, and quadrupled our revenues.

So today, I have a much better sense for what Fisher means by „above average sales organization“.

Lesson 5: Strong marketing & lead generation

A sales organization cannot be effective without a strong lead generation. If all you do is cold sales, you likely won’t get very far. You need qualified prospects and hot leads. 

Here we had an advantage. Because it was one of the areas we were above average.

Our core product was sponsored postings on blogs, what today is called influencer marketing. To not be misleading, we required every blogger to label their sponsored posts. And not only label them with something like „This is an ad“. Instead, we branded the label with our company name, and most importantly, included a link to our website. So each campaign for our clients, be it NIKE or RedBull or Disney, turned out to be a free campaign for ourselves. It was a marketing flywheel. And it was our #1 lead generation source.

So, in order to assess the sales capabilities, you need to be able to understand the whole marketing & sales funnel.

Lesson 6: The Flywheel Effect

Ever since reading Good to Great by Jim Collins, I keep thinking about flywheels.

I’ve learned that great companies have a strong, self-perpetuating and ever-increasing engines. Our viral marketing tactic was a one example. Network effects are another example.

So my lesson is: look for strong flywheels.

Lesson 7: Innovator’s Dilemma

The Innovator’s Dilemma describes why established companies have great difficulties to cannibalize and re-invent themselves, and why startups can be so disruptive.

It was one of the favorite business books of Steve Jobs, and he was a master of solving the dilemma. 

In times of ever faster technological change, it’s important to keep this concept in mind, and seek companies that have demonstrated that they have the courage and stamina to solve this dilemma.

Lesson 8: Certain things don’t show up in the accounting statements

I’ve learned that certain things don’t show up in accounting statements.
Hiring procedures, HR practices, company culture, early R&D experimentation all don’t show up at all, or only much later. 

As a startup, we had a strong company culture. It was a matter of necessity. We couldn’t afford to pay market salaries, and the job required every team member to put their heart & soul into the company.

Startups not for everybody, but if done right, they create a strong culture and a high level of productivity. If a company can preserve this startup ethos, it can be a huge asset. 

So the lesson is: don’t forget the soft factors.

Lesson 9: All eggs in one basket / Take something off the table

As a founder, especially a young founder who has no meaningful assets outside his company, you are not only concentrated, you are hyper-concentrated. All your eggs are in one basket, and as this would‘t be enough, the odds are stacked against you. 8 out of 10 startups fail.

It’s not a healthy situation, because you are over-exposed. That’s why it can be good to take a portion, say 10 or 20 percent of your stake, off the table, if you have the opportunity, to reduce the psychological pressure. Not right away of course, but maybe after 2 or 3 years, depending on how your startup develops.

So while insider buying is usually a good sign, insider selling doesn’t need to be bad. It could be prudent from a personal capital allocation perspective, and also a risk-taking perspective. If essentially your whole net-worth is tied up in your company, it might be hard to take the necessary risks to maximize long-term potential. So you need to understand the motive of insider selling before drawing conclusions too fast.

Lesson 10: Be a Learning Machine

Books have been super important for me. Whenever I faced a problem, I ordered the best books on a the topic, and tried to apply the best practices. That’s how I learned how to organize myself, how to build a sales team, how to build a positive company culture, and much more.


Posted on by Remo Uherek

How to Identify Great Capital Allocators?

This was the topic at the recent MOI Global Zurich chapter dinner I attended. Here I summarize my notes and thoughts on this topic.

I understand capital allocation as follows:

How do companies spend their limited resources, be it capital, time, or mental resources, so that they create the maximum amount of value per invested unit of capital?

So it’s all about value creation, efficiency and high returns on invested capital, however you want to define it.

So how to identify a great capital allocator? First, try to find people with a solid record of value creation. Growth in earnings per share or free cash flow per share could be useful metrics. Exceptional customer loyalty, products that solve real problems, or a full R&D pipeline with promising improvements could be qualitative factors to look for.

One shortcut is to look for owner-operators. People who own a large stake of their company and are the driving force. Especially if those people already have a strong track record.

A case study by Phil Ordway of good capital allocators was mentioned.

Then we discussed a number of topics and companies.

Amazon
Jeff Bezos was mentioned as a great capital allocator. Because he is obsessed with creating customer value, and takes a very long-term view. He has a deep understanding of capital allocation from his 8 years working on Wall Street (including working at a hedge fund). Plus, he is the owner-operator.

Disruption / Innovator’s Dilemma
Disruption is a real challenge. Many companies are faced with the Innovator’s Dilemma, being stuck with path-dependancy and an inability to cannibalize their still profitable, but increasingly obsolete, business units. Steve Jobs was a master of breaking this dilemma. Mark Zuckerberg seems to be pretty good at it as well.

BMW vs. Tesla
So what should a company like BWM do, faced with the disruption created by electrification and autonomy, or more generally speaking, by software and data? Should they compete with the Google’s and Tesla’s of the world on software, and potentially lose a lot of money, or would it be better to milk the current cow and slowly decline?

Warren Buffett and his textile business
Warren Buffett was faced with the same situation in his early textile business. He did a very sensible thing. He did not try to save the business at all cost. He took the profits, and reinvested them more productively. In his case, buying great and profitable companies like banks and insurance companies. And when his textile business started to lose money, he shut it down completely. He faced the facts and acted accordingly. He wasn’t romantic about it.

Mergers & Acquisitions
Acquisitions only make sense when done sensibly. Buy great assets, and don’t overpay. A lot of times, mediocre acquisitions are made, for way too much money.

Stock buybacks & Dividends
If its own stock is undervalued, it creates value for a company to buy back shares. If buybacks don’t make sense, paying a divided is better than acquiring a mediocre business, or starting a mediocre project.

Apple
What should a company like Apple do? So far they have been heavily buying back shares and paying out dividends. So it seems that the current management can’t find better opportunities internally or externally to deploy the cash.

To summarize, there seems not to be a single way to identify great capital allocators. It all depends on the specific circumstances. Personally, I like the owner-operator approach. This might be a great shortcut to find, and then partner with, great allocators. In fact, when I look at my personal portfolio, this is exactly what I ended up doing in a lot of cases.

(Image by 401(K) 2012)

Posted on by Remo Uherek