Social Capital CEO Chamath Palihapitiya was one of the show-stoppers at the recent Sohn Investment Conference in New York, pitching a Tesla Inc (NASDAQ:TSLA) play that he believed had little downside risk and huge upside potential. Chamath’s fund, which is focused on investing in companies which could play a positive role in the development of humanity, believes Tesla is such a company and that the stock has huge growth potential.
However, Chamath also stressed the capital intensive nature of Tesla Inc (NASDAQ:TSLA)’s business model and the risks that go along with that. As such, he admitted trepidation at being naked long stocks such as Tesla and instead sought another course of investment in the company. What he found was 2022 convertible Tesla bonds, which he pitched to great effect at the Sohn Conference. We’ll take a look at his comments on Tesla and the bonds in question below, before breaking down the specifics of the play. Also, don’t miss the full transcript of Chamath’s presentation, which is well worth a read.
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Let’s first take a look at some of the comments from Chamath Palihapitiya regarding Tesla Inc (NASDAQ:TSLA), beginning with his thoughts on the company’s growth potential.
“…what we see is a business that very reasonably in a decade, can get to about 5% of the global car market. Now to put 5% share of the car market in perspective, it is about half or less than half of the leading incumbents. And what’s great for Tesla is their cost basis and their operational balance sheet is completely different from these companies. They spend dramatically less on R&D. They don’t have pension obligations. They don’t spend anything on a dealer network. They spend nothing on advertising. They sell software at premium service, so their economic model at selling cars is really meaningful and when we do the waterfall of those economics and think about this business in the context of a Porsche or even for a BMW, and you look at that multiple, what you see is a business that could be worth hundreds of billions of dollars in a decade.”
Let’s next take a look at what Chamath had to say about Tesla’s 2022 convertible bonds and why they may be the safest play to score from the potential hundreds of billions of dollars in Tesla growth.
“Why do we love the convertible bonds? It pays a reasonable coupon, it has a reasonable conversion price, which is only about 4% or 5%. So what does that mean? To the average investor in the room, what that means is for all of us, we can buy these converts and we’re guaranteed not to lose money as long as Tesla’s worth at least $15 billion. Now let’s put that in context. Today, it’s a $50 billion market cap. Even if the equity goes entirely to zero, we’re protected. Because as long as somebody is going to pay $15 billion, which is about less than one-times 2018 sales, or a little bit more than two-times what Google tried to buy this company for in 2013, we get all of our money back. But more importantly, while our downside is protected, on the off chance that this guy (Elon Musk) pulls it off, we get 95-plus percent of the upside.”
Sounds pretty impressive right? But is it really that easy to find a play in the market with such lopsided risk/reward potential? To answer that question we contacted Ankur Daga, one of Insider Monkey’s contributors, who broke down the odds of Tesla’s success and failure and concurred with Chamath’s thesis that the bonds were a worthy investment. Check out his thoughts and projections on the next page.
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Let’s start with Ankur Daga’s thoughts on Tesla Inc (NASDAQ:TSLA), including the joy of driving one, what kind of potential technological advantage it has over its rivals, and whether it’s destined to take a huge share of the global EV market (or whether that’s even the right question to be asking).
“As a Tesla Model S owner, I believe that the shorts are overestimating the ability of other car manufacturers to create a superior or even at par experience with their electric cars – the head start is simply too great and is comparable to the one Amazon had with AWS. The feeling of driving a Tesla is very similar to holding the iPhone for the first time – the technological leap is profound and one will find it hard to switch to competing products even if Tesla sells its cars at an iPhone-like premium. Further, with Tesla’s experience during manufacturing the Model S and Model X, they have more than the substantial expertise needed to create the much simpler Model 3. Given that the Tesla battery led setup has roughly two orders of magnitude less moving parts than the standard ICE engine setup, I believe that applying the traditional logic on car manufacturing ramp up time and capital investment to Tesla’s situation is a non-starter. I believe that on the automotive side, Tesla will be able to pick up the type of market share in EVs that the Model S has in the luxury car market (the more relevant question perhaps is what % of the total automotive market will EVs be in 10 years). I am, however, unconvinced that Tesla’s margins will be anywhere close to Apple’s iPhone margins given the price point,” Ankur said.
Like Chamath, Ankur also believes that in a worst-case scenario where Tesla is bleeding money and simply can’t stay afloat long enough to achieve its targets, that the company should easily be able to find a buyer to pay at least $15 billion for it so that the note owners don’t lose anything.
“In the event that Tesla has grossly underestimated its cash requirements and overestimated its production speed, I believe that there are plenty of buyers for the company at the right price – Apple, Google and others would easily pay upwards of $15 billion for the company, thus convertible bond holders will not lose money.”
Let’s now look at what Ankur believes are some of the things that investors must believe Tesla will achieve if it’s to dominate transportation (and possibly energy) in the same way that Apple Inc. (NASDAQ:AAPL) is dominating the mobile phone industry:
– Tesla can achieve iPhone-like penetration (30%+ of U.S sales) in the EV US auto industry
– Tesla can produce superior margins with economies of scale (current gross margins are ~20% and need to roughly double)
– Automobile sales will be driven by software rather than hardware in the future and Tesla has a substantial lead in software that will be hard to catch up with
– The ecosystem will create virtuous sales effects where one would buy Tesla cars, Tesla Powerwalls and Tesla Solar for Home
– Tesla can take on Uber through its self-driving technology
– Further option value is created through new businesses that Tesla will be entering into that are hard to predict today – e.g., Tesla Energy becomes a massive business
– Tesla battery technology knowhow and scale is a sustainable competitive advantage
On the other hand, let’s look at some of the factors that Ankur believes would have to arise for Tesla to lose 70% of its market cap and the bearers of the notes to lose money.
– Tesla will be substantially delayed in producing its Model 3 and will bleed cash in the interim
– Management is underestimating the capital investment requirements by at least a factor of 2 – adding an additional $10+ billion in investment required
– Other car manufacturers will catch up very quickly and will reduce Tesla’s ability to gain Apple-like marketshare and/or Apple-like margins
– Something goes wrong with Autopilot or other Tesla technologies that significantly hurt the brand and cause very substantial legal problems
– Projects such as the Solar City acquisition and Tesla’s Model 3 will yield very low or negative gross margins and thus will cause the company to bleed cash
– Tesla battery technology is a commodity and others will quickly be able to replicate it
– Electric cars are still only ~1% of the market and will not likely increase market share exponentially in the near future
We’ll check out Ankur’s final breakdown of the various Tesla probabilities and the Expected Value of the 2022 convertible notes on the final page of this article.
With the array of possibilities mentioned on the previous page in mind, let’s see how Ankur breaks down the likelihood of each scenario playing out:
#1 Probability that this becomes a 10x and Tesla is the next Apple and dominates multiple industries: 25% (if Tesla gets 5% of global market share, Chamath believes Tesla’s market cap jumps to 7x current levels just on the automotive side)
#2 Probability that Tesla becomes the most valuable car company in the world, but does not become a 10x: 15% (~3x upside in this case)
#3 Probability that Tesla remains a niche player and has 1-2% of global market share: 20% (assume no upside in this case)
#4 Probability that Tesla remains under 1% of the market and also needs substantially more cash to stay afloat: 20% (in this case, we can assume it will be worth more than $15 billion and thus the convertible notes do not lose value)
#5 Probability that Tesla suffers a catastrophic loss: 20% (for example #3 in the downside scenario happens and the company value goes to 0)
As Ankur noted, even if the odds were adjusted to the point that #1 was only given 10% odds and #5 was given 90% odds, the expected value of the 2022 Tesla convertible notes would STILL be slightly positive. However, given his actual projections above, Ankur rates the investment as having an Expected Value of 2.8-times, making it a very attractive play, and one in which he also plans to invest heavily in once the note goes back to par.
