Info Launch and Inventory Worth Actions: Tesla’s Earnings Announcement and the Musk Tweet
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Q2 hedge fund letters, convention, scoops and so on
On uncommon events particular person observations of inventory worth actions are sufficiently informative that fascinating perception may be gained even from single observations. The response of the market to Tesla’s earnings announcement on August 1, 2018 and the Elon Musk tweet on August 7 are prime examples.
After the market closed on August 1, Tesla reported monetary outcomes for the second quarter of 2018 adopted by a convention name with analysts. Earlier than the announcement, Tesla closed at $300.84. By the top of buying and selling on August 2, Tesla had jumped to $349.54 – a rise of $48.70 or 16.2%. This was the most important day by day proportion improve in Tesla’s inventory worth since December 2013. The market capitalization of the corporate rose by $eight.16 billion dollars. The dramatic worth improve raises the apparent query of what info was conveyed to justify the leap.
Subsequent, on August 7 at 12:48 Japanese time, Elon Musk tweeted, Am contemplating taking Tesla personal at $420. Funding secured. Previous to the tweet, the inventory had closed at 341.99 August 6. Following the tweet, it rose 11.zero% to shut at 379.57 on August 7. Because of the chaos brought on by the tweet buying and selling was halted in Tesla between 2:08 and three:45.
Earlier than turning to the small print of these occasions, nevertheless, it’s useful to offer perspective by beginning with a elementary valuation mannequin that relates the market worth to the current worth of future money flows. For this train, we depend on the work of Prof. Aswath Damodaran who posts on his web site detailed, and absolutely clear, discounted money stream valuation fashions for quite a lot of corporations together with Tesla.
As of August 1, 2018, Prof. Damodaran’s most up-to-date valuation of Tesla was posted on June 28, 2018. Prof. Damodaran is also known as a “Tesla bear” as a result of at the moment his estimated worth was $165.96 per share, barely half the worth of the inventory on August 1. Nevertheless, examination of the mannequin particulars reproduced in Exhibit 1 reveals that Prof. Damodaran was hardly pessimistic. In his mannequin, Tesla’s revenues develop from $12.47 billion to $97.53 billion over the ten-year forecasting interval – a compound progress price of 22.eight%. On the similar time, working margins enhance from -11.four% to 10.zero%. By comparability, among the many ten largest auto producers on the planet, none had an working margin of 10.zero%. The highest was BMW at 9.9%. Thus, Prof. Damodaran was projecting each speedy income progress and dramatic enchancment in margins to business main ranges, hardly pessimistic evaluation of the corporate.
Along with his base mannequin, Prof. Damodaran additionally posted what he referred to as his “royal flush” state of affairs. This state of affairs employed what he believed have been probably the most optimistic attainable assumptions. His royal flush valuation got here to $395.52. By combining the 2 units of projections, it’s potential to reverse engineer the market worth of $300.84 on August 1, 2018. The results of that train is proven in Exhibit 2. Exhibit 2 makes three main modifications to Exhibit 1. First, the income progress charges are elevated in order that the compound fee is now 25.1%. Second, the working margins turn out to be constructive extra shortly and rise to 11.6%, properly above that of Tesla’s rivals. Third, the chance of failure is lowered from 5% to zero%. With these modifications to Damodaran’s baseline assumptions, the estimated share worth involves $300.91, seven cents larger than the market worth.
Following Prof. Damodaran, in each Reveals 1 and a couple of the idea is made that Tesla will keep a sales-to-capital ratio roughly equal to that of its main rivals. This assumption is essential as a result of it determines the quantity of reinvestment. It implies, opposite to statements by Mr. Musk, that as gross sales ramp up whereas working money movement stays meager, further capital raises shall be required.
It’s useful to pause for a minute to digest these projections. Elon Musk has been in an ongoing verbal battle with “Tesla shorts.” Mr. Musk’s feedback typically suggest that he has concluded that the shorts view Tesla as a distressed firm. Whereas this can be true of some brief sellers, it hardly must be the case. Look again, for instance, at Damodaran’s baseline projections in Exhibit 1. They mirror a extremely profitable future for Tesla that’s fairly exceptional given the aggressive and capital-intensive nature of the car business. Damodaran tasks a mixture of each speedy progress in income and pronounced enhancements in working margins to business main ranges, hardly the earmarks of a failing firm. Nonetheless, his valuation of $165.96 implies that a rational investor ought to brief the inventory as a result of his projections, optimistic as they could be, are considerably much less optimistic than these impounded within the pre-announcement market worth of $300.84.
The elementary level is that the rationality of the market’s response to Tesla’s earnings announcement or Mr. Musk’s tweet can’t be analyzed within the summary. They will solely be assessed correctly just about the projections already impounded out there worth previous to the bulletins. With that in thoughts, we first flip to the earnings announcement.
2. Tesla’s Earnings Announcement and the Inventory Worth Response
In analyzing the response of Tesla’s inventory worth to the earnings announcement, we dispense with the excellence between uncooked and residual returns. It’s because compared to the 16.2% improve within the worth of Tesla actions within the common market and the automotive business have been immaterial. On August 2, the S&P 500 rose zero.49% and the NASDQ elevated by 1.23%. Then again, inventory costs of auto makers have been usually decrease. Toyota and GM, fell by zero.5% and 1.four%, respectively, whereas Ford was flat.
Throughout buying and selling on August 1, 2018, Tesla’s inventory worth fluctuated round $300 because the market awaited the earnings announcement and investor name earlier than closing at $300.84. The investor letter was launched by Tesla at four:05 Japanese time on August 1. The firm reported income of $four.00 billion, in comparison with $three.41 billion the prior quarter and $2.79 billion for a similar quarter one yr earlier. The year-over-year income progress was a powerful 42.eight%, however there’s a caveat. In 2018, Tesla adopted a brand new income recognition rule, ASC 606, which modified the best way it accounts for vehicle gross sales with a resale worth assure and automobiles leased by means of leasing companions. The impact of the change was to extend reported income. Had the identical conference been used within the earlier yr, income would have been $2.93 billion and the year-over-year progress fee would have been 36.5%.
Earnings are extra ambiguous as a result of Tesla reviews outcomes on each a GAAP and a non-GAAP foundation. Right here we give attention to the GAAP outcomes, however notice that the non-GAAP outcomes present the identical image. On a GAAP foundation, the corporate reported earnings of -$743 million (-$four.22 per share) in comparison with -$785 million (-$four.19 pers share) the quarter earlier than and -$401 million (-$2.04 pers share) the identical quarter the earlier yr.
Tesla additionally reviews free money circulate in a non-standard style. The firm consists of money flows from non-recourse financing actions, which is usually a supply of financing, not free money movement. The firm additionally excludes photo voltaic panels from its definition of free money move. We use the corporate’s definition with regard to the reported outcomes, however not within the valuation mannequin. Finance concept makes it clear that worth depends upon free money circulate as conventionally outlined. Based mostly on its definition, Tesla reported free money movement -$739 million in comparison with -$1,054 million the quarter earlier than and -$1,159 million in the identical quarter the earlier yr.
Exhibit four plots the worth of Tesla on a minute-by-minute foundation from the shut of the market on August 1 to the shut on August 2, together with after-market buying and selling on August 1. In response to the discharge of the monetary info, the inventory worth initially bounced up and down in after-market buying and selling. Nevertheless, by four:20, as the knowledge was digested, the inventory worth rose to $315.00 and held that degree till the start of the investor name at 5:37. Through the name the inventory worth ran-up twice. The first run-up, to about $325, adopted Mr. Musk’s feedback about potential enhancements in autopilot and the position of synthetic intelligence beginning at 5:47. The second run-up, starting at 6:03, to a worth of $335, occurred following Mr. Musk’s statements that he hoped to realize manufacturing of seven,000 Mannequin 3s per week by the top of the yr and that he anticipated the corporate to show worthwhile within the third quarter. He additionally apologized for his conduct in the course of the earlier quarter’s earnings name. The inventory worth remained at round $335 till the decision ended at 6:08 and after-market buying and selling largely ceased.
The subsequent day, on August 2, 2018, Tesla opened at $328.44 and remained across the $330 degree till midday when it turned a bumpy improve to shut at $349.54. Although there was widespread media protection and analyst dialogue throughout buying and selling hours on August 2, the corporate didn’t launch any additional monetary knowledge that would clarify the late day improve.
three. Interpretation and Implications
As a result of inventory costs in a comparatively environment friendly market ought to reply solely to new info, the start line for analyzing the response of inventory costs to monetary bulletins are the forecast errors or “surprises”. Exhibit three presents the surprises for Tesla’s income, earnings (each GAAP and non-GAAP), and free money movement (as outlined by the corporate). The general takeaway is that the surprises have been combined and never very giant in any occasion. Revenues have been barely larger than anticipated and earnings, by both measure, have been barely much less. The largest constructive shock was at no cost money move which got here in 17.6% above the consensus estimate, however that outcome is just not as constructive because it seems. The enchancment was because of the firm’s lively determination to chop capital expenditures. Though such a reduce improves short-term free money move by definition, the long-term influence is inconsistent with the corporate’s plans for dramatic progress alongside the strains forecast in Exhibit 2. Clearly a ten-fold improve in income would require new factories, new supply factors, and new service facilities at a minimal.
Taken as an entire, it’s exhausting to see how the surprises related to the Tesla’s earnings announcement might account for a lot motion within the inventory worth. Wanting on the outcomes with out information of the inventory worth response it will be troublesome to foretell the path of motion. There’s nothing to recommend a 16.2% improve. The rational reply, to the extent that there’s one, should lie within the convention name.
As famous above, the convention name was related to two run-ups within the inventory worth. The first occurred at 5:47 when Mr. Musk mentioned improvements in Tesla autopilot and the attainable incorporation of synthetic intelligence. The second occurred when he stated that weekly manufacturing might attain 7,000 automobiles and he anticipated the corporate to be “profitable” within the third quarter and money move constructive by the top of the yr. He additionally apologized for his impolite remedy of a number of analysts through the prior quarter’s earnings name.
The added info within the convention name was interpreted in a lot of the media as “good news.” The firm was forecasting future progress and technological innovation and believed it was on the street to profitability. However this begs the important thing query, excellent news relative to what? The information shouldn’t be interpreted relative to a state of affairs by which Tesla stays static, however relative to the projections impounded out there worth previous to the announcement. Particularly, was the information adequate to require a big upward adjustment within the projections proven in Exhibit 2 to justify a 16.2% leap in worth?
Whereas it’s true that the announcement revealed spectacular income progress, with the right accounting adjustment, the expansion price is nearly similar to the projected progress in Exhibit 2. The announcement and the decision additionally pointed to improved working margins, however the enchancment in margins in Exhibit 2 is dramatic. It’s arduous to see how the announcement would warrant an upward revision. The largest discrepancy between Exhibit 2 and the announcement is with regard to capital expenditures. The exhibit exhibits capital expenditures rising with gross sales, whereas Tesla was truly slicing investments. As famous beforehand, nevertheless, it’s onerous to interpret this as a bullish sign. The cutback seems to be a part of a short-run effort to maneuver towards constructive free money move. As such, it might properly undermine the expansion assumptions that drive the excessive valuation reported in Exhibit 2. For these causes, we can’t reconcile the worth 16.2% improve with a rational evaluation of data contained within the Tesla’s earnings announcement and follow-up convention name.
Although we’re admittedly shifting into the realm of hypothesis, there’s one speculation we discover intriguing. In reacting so strongly, it’s as if the market is deciphering the knowledge in Tesla’s earnings announcement within the summary irrespective of the projections already impounded within the inventory worth. Whereas the general information conveyed by the announcement was “positive,” in that it implied enchancment within the firm’s operations, such constructive developments, certainly one might say much more constructive developments, have been all prepared included within the inventory worth previous to the announcement. This underscores our major level, modifications in inventory costs in response to the discharge of data have to be analyzed within the context of a reversed engineered DCF mannequin whose output equal the worth of the inventory previous to the discharge.
four. The Musk “Going Private” Tweet on August 7, 2018
Exhibit 5 plots the minute-to-minute worth of Tesla on August 7, 2018. It was at 12:48 pm when Elon Musk tweeted, Am contemplating taking Tesla personal at $420. Funding secured. Previous to that point the inventory had already elevated about 5% to round $355 on information that the Saudi sovereign wealth fund had bought between three and 5 % of Tesla’s inventory. Following the tweet, the inventory jumped once more to about $370 and buying and selling volatility spiked. In response to the chaos, buying and selling was halted at 2:08 pm and didn’t resume till three:45. Within the final 15 minutes, Tesla traded round $380 earlier than closing up 11.zero% at $379.57.
As soon as once more, the right approach to consider the impression of the tweet is to start with a reverse engineered DCF mannequin. On this case, we concentrate on the worth of $420 talked about by Mr. Musk in his tweet. Exhibit 6 begins from the mannequin in Exhibit 2 and makes additional constructive changes. The interval of speedy progress is prolonged in comparison with Exhibit 2 and the working margins are adjusted upward barely. The primary change is a discount within the reinvestment required to realize the income progress. Put bluntly, Exhibit 6 assumes Tesla will carry out a trifecta of speedy income progress, working margins rising to heretofore unheard-of ranges for main auto manufactures, whereas sustaining an business main sales-to-capital ratio. With the modifications, the truthful worth estimate proven in Exhibit 6 is $420.09
However there’s one other drawback. Even when Tesla have been capable of stay as much as the monetary mannequin proven in Exhibit 6, buyers within the buyout would solely earn the mannequin’s public market value of capital – a mean of considerably lower than eight%. That hardly looks like a return that a personal fairness fund or sovereign wealth fund would discover adequate for taking Tesla personal, partially due to the decreased liquidity. To the extent that buyers require a better return, the projections must be adjusted upward additional to justify a buyout worth of $420. Moreover, the mannequin in Exhibit 6 assumes that Tesla stays public in order that not one of the authorized, accounting and regulatory prices related to going personal have been deducted. All of this means that a buyout of Tesla at $420 is just not economically rational and is unlikely to happen. The market apparently had some doubts as properly. The closing worth of $379.57 was properly under $420.
However our level is to not argue over the truthful worth of Tesla. There’ll all the time be projections sufficiently optimistic to justify a buyout at $420 or much more. The first step in analyzing a potential buyout, like the start line for evaluation of the market response to the earnings, have to be a reversed engineered low cost money circulate mannequin whose output equals the worth in query. It is just close to the monetary projections that end result from reverse engineering of market costs that the rationality of the market’s response to new info or the rationality of a possible transaction could be assessed correctly.
Article by Bradford Cornell
California Institute of Know-how and Cornell Capital Group
Pasadena, Ca 91125
Cornell Capital Group
Cornell Capital Group