We published an article this morning providing a detailed breakdown of the Sohn Investment Conference presentation made by Social Capital CEO Chamath Palihapitiya earlier this month, during which he pitched Tesla Inc (NASDAQ:TSLA) 2022 convertible bonds as an investment opportunity with limited downside risk and huge upside potential. What were the results of our analysis? Well, you’ll just have to read that article to find out.
As we didn’t have room to analyze the bulk of Chamath’s presentation, we wanted to share a full transcript of it with our readers as supplemental material to that article, so they can better understand his own motivations for betting on Tesla Inc (NASDAQ:TSLA). The presentation was transcribed by Insider Monkey using an audio recording of the event. It should be noted that the audio quality was not the best and that several sections of the transcript are missing words which were either drowned out by other noises or were otherwise muffled.
The transcript of the presentation, which was viewed by many as one of the highlights of this year’s Sohn Investment Conference, is a must-read for anyone interested in Tesla Inc (NASDAQ:TSLA) as an investment and particularly for those curious about these 2022 convertible bonds. Check it out below.
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Social Capital CEO Chamath Palihapitiya: Before I begin, obviously let me just thank the Sohn Foundation for allowing me to be here. I don’t know with all of you, but for me, as a father with young children, just seeing that family just touches a nerve about how important it is that when people get sick that there are other people around who are doing the right thing to support you.
So let me begin the same way that I started last year at Sohn, with a talk about how we think. At Social Capital, we invest billions of dollars and make investments at very early stages all the way through the public markets, in companies and entrepreneurs that we believe are solving some of the most interesting and important issues at the time. Whether that’s building the next generation’s silicone machine learning or using software to cure diseases like diabetes and cancer, or inventing rocketry. And the reason we come to that strategy is through the people that work at our organization. The partnership [indecipherable] pride have some of the most well-known and talented technologists and entrepreneurs who spent their lifetime before they’ve come to work with us, building many of the great products that all of you have used and grown to love. As [unintelligible name] said, it was from that land that we presented to you last year, a company that we believe is a multi-trillion dollar monopoly, hiding in plain sight. The business set was fundamentally misunderstood because it started from a model [unknown] perspective. It’s like what he said, was when you start from a broad technology perspective, what you see is a monolithic organization being built. A multi-trillion dollar business in retail, a multi-trillion dollar business in opportunity with infrastructure, and probably one of the single best jobs of capital allocation that we’re seeing being done in anything. What’s great is it’s working, we still continue to believe that this is one of the most interesting companies in the world, and it’s something that we think that we made one of our most fundamental high-conviction [garbled].
Now, let’s talk about something else. Amazon I think at this point is non-controversial. It is a business that all of us would believe basically has the best days ahead of it. But there’s another company that’s equally vulnerable, which half of you in this room probably believe is one of the most interesting companies in the world, and the other half would believe would be something that is probably something close to either a fraud or a bank. What’s interesting about controversy is that controversy really comprises of three really important things. There’s always good, there’s generally some bad, and then in this case, there’s also some ugly. The company we’re talking about today is Tesla.
Now let’s start with the good. The good is unbelievably good. Because at the end of the day, no prepped business can ever be built in the absence of fundamental consumer demand, and the intent in Tesla is undeniable. In four years from launching a luxury sedan business, they’ve now captured a third of the entire market. In four quarters of launching the luxury SUV business, they’ve captured 10% of that market. And just by simply announcing the long-term availability of a mid-priced sedan, they’ve generated 400,000 deposits, which on a look-through basis is equivalent to 16 billion dollars of sales. And what has been incredible for Tesla has been equally horrible for their competitors. BMW 3 Series demand literally fell off the cliff in the face of their model, and a 25% reduction in unit sales.
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So despite all that ego, there’s some bad. While most of us would say the selling part of the entire business, “let’s just stick to selling cars,” Tesla says don’t. That’s just how we start. We’re going to sell pickups and semis. We’re also going to actually launch level 5 autonomy and actually cannibalize our existing business to launch [unintelligible]. In fact, for those of you that own Teslas, you’ve actually already agreed to never allow that Tesla to be used in Uber and Lyft. You may not have realized it, but this is a screenshot from the agreement we got from [unintelligible]. They also bought SolarCity, a business that many people in this room would say defies any shred of industrial logic. They’re building a factory 5 and a half million square feet, the largest building in the entire world visible from space, where raw materials come in one end; cars and machines and batteries come out the other. In fact, it’s not just one; they intend to build multiple of these. In fact, it’s not actually a factory, they describe it as a machine that’s going to build the machines that they are going to sell. And they also want to see sustainable energy independence for power generation and power storage.
Now all of that was roughly announced or tweeted for Q1 of 2017. So the point is, there’s a lot of other things that are in the offing here that we don’t even know about. And the one thing that we can all agree on, whether we agree with the strategy or not, is that these things are extremely capital intensive. In fact, when we do our bottoms up assessment of how much money it’s going to take, this is an incredibly capital [unintelligible]. In fact, everything that we look at says, that it’s at least twice the amount of capital in the management business. The management thinks it’s about 10 million of investment capital we can use [unintelligible].
So we took the good, we took the bad, we took the ugly, and we tried to model the business. We’ve talked to the company, we’ve talked to analysts, and what we found is unbelievably insightful, which is that it’s absolutely unmodelable. So anybody who is telling you that some [unintelligible] is telling you to be long or short this company is completely making it up. So what we did was we went back to our superpower and we said, “Let’s start thinking about this company from a product and technology orientation.” Build a logical framework bottoms up to describe what this business could be. Could it be 10x in 10 years like Amazon? As we did it, this amazing thing came to light, which was a historical analog. Another company very similar to Tesla, we had already run the exact same play that we believed [unintelligible]. That’s why I want to explain to you our view on Tesla in the context of another company that you all know, Apple.
In 2007, Apple did something that most companies are never able to do, which is to launch something revolutionary. The iPhone was an unbelievable feat of technology, of engineering, it was magical. And what this product did was capture consumer imagination, and then created the tailwind of the game. And what they were able to do was take that demand and start to consolidate an extremely fragmented and highly undifferentiated market. Just remember that a decade ago, that was what was in your pocket. And now look at the phone today, and ask yourself, who did that; it’s Apple. And the most important thing is that when you consolidate share and you consolidate a fragmented market, you have the ability to expand product scope. What does that mean? That means hiring unbelievably talented engineers to work on the next incremental [unintelligible]. When you do that, you start to create a virtual cycle. And when you do that, you can do something that’s equally important, which is to vertically integrate your critical components of your system that drive long-term profitability. Software in iOS, a retail infrastructure, a development platform that’s hired millions of supporters, and what did they do, they vertically integrated from that expanded product skill. They built their own semiconductors including that idea. They started [unintelligible] operating system, and they started to move up the staff, to build value-added services and extremely [unintelligible]. Then from there, they expanded. They launched the tablet business, they reinvented their laptop business, and they launched the smartwatch business.
So what happened? They redefined the market. They redefined what it meant to be in the markets [unintelligible]. Massive consolidated share, unbelievable pricing power in the face of [garbled] of pricing power for their competitors, and the most important thing of all, all the profits, 104% to be exact. Which means that they rendered their competitors in a situation where they are raising billions of dollars just to be in the same market as Apple.
Now why we think that’s interesting is that what it resulted in was in 10x in 10 years. From a $73 billion market cap to three-quarters of a trillion dollars, they did it. What we think Amazon is in the midst of doing, they did it in the last [muffled]. And now let’s ask ourselves: Is Tesla running the same playbook? Step 1, check. If you have a Model S, or if you have a Model X you will agree, it is impossible to go back to traditional combustion engine cars. Those cars are for rent. This car is beautiful. They equally have opportunity to consolidate a lion’s share in what is an even more fragmented and fundamentally undifferentiated market. What this shows you is that nobody has point of view, and nobody really understands how to engineer a product for mass consumer adoption. They’re also extending the product store and vertically integrating. They’re building batteries and manufacturing them in. The core genesis that the brain of the car is no longer mechanical, it’s software. They’re building the Gigafactory, they’re building a billion-dollar retail and charging infrastructure. And what I think is probably the single most impressive enhancement in software, autopilot, which by the way, they sell for thousands of dollars and basically 100% gross margin. And now, they’re expanding into adjacent markets as well. They’re moving down the market. They’re building power generation and power storage to scale and they’re building these bigger factories.
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So all of that is good, except we all know that what they haven’t been able to do yet is redefine the market. In fact, it’s not clear with any of us what market are we really talking about. Is it engine, is it cars, is it [unintelligible] service, it’s a really complicated story. What we do know though is that the early traction of Tesla is tracking very closely to Apple, and this is what is really key. iPhone 1 and iPhone 2 were about [unintelligible] dollars, and iPhone 3 was their breakthrough. That model 3, the third generation was what consolidated and broke down the walls of consumer demand. And what you can see is that [unintelligible] has set the stage for the 3. And when we do the model of forecasting them, which is something we can be quite accurate about, 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 (enter Toyota as an incumbent). And what’s great for Tesla is their cost basis and their operational balance sheet is completely different from these companies. [muffled]. 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.
OK, great, so selling cars theoretically upwards of a [muffled]. And again all of these things that we’ve talked about before, [unintelligible] cars, transportation services, energy generation, energy storage, let’s get in front of them and say that they can do these things half as well as cars. So now, all of a sudden, we’re in this mythical territory of potential 10x in 10 years. But again, we have this issue of the capital intensity. What if the credit markets seize up? What if the equity markets seize up? What if we c just can’t execute? Where’s that extra $20 billion going to come from? So it’s very difficult from our perspective to be naked long or naked short the stock. Instead, what we’ve been asking ourselves is how do we share in this potential upside, but frankly protect our downside. And so it comes now to what we believe is our pick for an incredible opportunity, and our 2017 pick itself, which is in 2022 Tesla convertible bonds. 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.
So let me end by talking about the man for a second. Look, we’ve all been faced with decisions where we try to use a model to figure out innovation. We tried to do that with Jeff Bezos, but we were wrong for many, many years until we were right. There’s a [unintelligible] for Google. We thought Google was in one business until we realized it was probably the most integral monopoly ever built, we were all there. We thought that Mark Zuckerberg could not make the transition to mobile, the stock got hammered, the models were wrong, he was right. And yet again, he had an interesting character. One of these unbelievably iconic entrepreneurs. While we’re trying to figure out how to get an Uber to come to Lincoln Center, he’s figuring out how to send a rocket back from space and land it on a [unintelligible] in the middle of the ocean. While we’re driving our kids around Chuck E. Cheese on the weekends, he’s built a machine that can tunnel under the city of Los Angeles to completely alleviate traffic. And while we’re still trying to figure out how to get Netflix to work on our Apple TV, this guy has built a human brain interface so that his thoughts are translated to machines. I mean the point is, that the 2022 converts for us are an incredible way to make a bet on the right side of history, on the right side of the change, to participate in what theoretically could be another massive 10x in 10 years, in a way that has been complete downside protection and the most important thing of all is to stand shoulder to shoulder with a guy what we think is our generation’s Thomas Edison.
Thanks everybody.
Disclosure: None
