Opinion: This is the maths for what it takes for Tesla to develop into the Apple of automobile makers
Tesla fans and shareholders argue louder and louder about the future of their favorite company. In it they draw analogies to one of the most successful brands and companies in the history of capitalism. They suggest that automobile manufacturing could take the path of cellphone manufacturing and that – for Tesla TSLA, -0.02% – there is a strong similarity to the Apple AAPL, -3.59% versus Nokia / Blackberry / Ericsson / Motorola dynamic.
For those who don’t know, it was inconceivable in the early 2000s that these old cell phone manufacturers could go away. In 2006, Research in Motion (RIM), the company that makes BlackBerrys, lost a patent lawsuit against NTP and a US district court judge issued an injunction against the sale. The Department of Defense stepped in, claiming a Blackberry restraining order posed a national security threat. Meanwhile, industry leader Nokia held a 40% market share and reached a market capitalization of $ 230 billion by the end of 2007.
But in 2007 something else happened.
Steve Jobs introduced the iPhone.
And that changed the game forever for Nokia, Blackberry and the entire industry.
Coincidentally, Jobs dropped this iPhone seven months after Tesla unveiled the roadster at the San Francisco International Auto Show. Fast forward to 2021, and the cops are suggesting that Apple’s overwhelming success in making mobile phones may be reflected in Elon Musk’s Tesla’s auto manufacturing.
To do this, let’s first assume that within 15 years buyers will require a broadly similar “form factor” for each vehicle. Today it sells 250 brands of cars to suit all tastes and budgets, and perhaps over 1,000 items of equipment. Meanwhile, thanks to the iPhone, the handset’s hardware has basically gone from a variety of styles, sizes, and shapes to one.
Similarly, imagine that the production and value of automobiles and light commercial vehicles will depend less on the style or performance required than on the software inside the vehicle.
Finally (and this is a huge debate, but) we assume that Tesla will have better software – especially better autonomous driving ability – than any other vendor or manufacturer, be it in Silicon Valley, Detroit, Wolfsburg or elsewhere .
In other words, let’s say Tesla becomes the Apple of automakers.
To do this, we have to ignore that Apple is not just a cell phone manufacturer. For the first three quarters of this year, the company had iPhone sales of over $ 150 billion, representing 55% of total sales. In addition, revenues were reported from the “Services” segment, which comprised revenues from advertising, digital content, AppleCare and other divisions. If we assume that all sales were driven by the iPhone (even if not all were), we get that the iPhone accounts for about 65-70% of Apple sales.
This means that Apple has a sizable business (about $ 110 billion this year) that also sells Macs, iPads, wearables, and accessories. In our “Tesla is Apple” analogy, we have to assume that Tesla will make similar enhancements to new products.
We also have to ignore that most of Apple’s profit in cell phones comes from mobile advertising and app sales, much of which Apple reports in the above services segment. To stay within our framework, we also have to believe that Tesla would generate something similar through its over-the-air updates or its own app store.
With all these assumptions, the future margins in “car manufacturing” – for at least one manufacturer – could theoretically tend to the margins that are generated by Apple today.
In terms of cell phone market share, people around the world will buy approximately 1.4 billion cell phones this year, and the average retail price will be around $ 320. Apple holds about 16% of the world market and will sell about 225 million iPhones.
Just a guess, but if these iPhones sell at an average price of $ 890, the average price of all other phones sold worldwide has to be around $ 125 for the math to make sense. And because Apple can sell its iPhone at such a high price and generate remarkable income from advertising and app store sales, it generates a whopping 24% profit margin.
In comparison Volkswagen VOW3, -0.97% VWAPY, -2.67%,
which went into operation in 1938 has worked its way up to a world market share of 12.0% and generates net profit margins of 5.0%.
Toyota 7203, + 0.33% TM, -0.15%,
which was also put into operation in 1938, also has a world market share of 12.0% and generates even better net profit margins of around 7.0%.
Nokia got what it’s worth, 14% net margin before the iPhone changed the game. In other words, even before Apple emerged, making cell phones was more than twice as profitable as making cars for market leaders.
Anyway, people around the world are going to buy roughly 75 million new cars this year, and at an average price of $ 30,000 (home fleet), that’s over $ 2.2 trillion in sales. This is about five times the size of the cell phone market, which will reach about $ 450 million. Toyota and Volkswagen are the largest – and best-in-class – scale automakers in the world. Other groups, including Ford F, -0.14%,
Stellantis (FCA / Peugeot) STLA, -0.55%,
Daimler DAI, +1.48%,
General Motors GM, + 0.37%,
Honda 7267, -0.53% HMC, -0.64%,
BMW BMW, -0.22% and many others also have a significant stake.
This year Tesla will sell about a million cars, which equates to a world market share of 1.3%.
And I dare say that any of Tesla’s competitors will be reluctant to give up more market share, hence the huge investments in research and development, as well as investments they will be making in the upcoming transition to electric vehicles (EVs). From the CAPEX metric alone, we can see that these competitors will actually spend more than Tesla in the next year.
A lot more.
Not in the credits
But let’s assume that all the old automakers can’t keep their stake. Also, let’s imagine that most of the profits in the industry go to Tesla at some point (like they do to Apple for phones).
As a starting point, analysts assume that Tesla will generate sales of over 50 billion US dollars this year. The automotive business accounts for more than 85% of these sales.
In 2035, when EVs account for 95% of all new cars sold and Tesla has the same 16% market share as Apple today (which clearly dwarfs VW or Toyota), it will produce 22 million cars and light trucks and generate sales of over $ 1 trillion.
This year, analysts expect Tesla to generate over $ 10 billion in net income (including approximately $ 1.2 billion in profit driven by regulatory credit.
If Tesla were able to achieve the same 24% net profit margin as Apple does today (remember VW is at 5% and Toyota is 7%), it would be making about $ 250 billion in profit in 2035 .
As Tesla has grown from zero to a million cars, it has built manufacturing facilities in Freemont, Shanghai, and soon Austin; battery-producing giant factories in Nevada, Buffalo, Germany and Austin again; and additional manufacturing and tooling facilities in Michigan, Ontario, Shanghai, two more in California and three more in Germany.
To fund that expansion, Tesla rose from 35 million diluted shares in 2009 to 641 million in 2015 to over 1.1 billion today. Of course, some of these went to key company executives as compensation, but for the most part, this stock offering helped fund the company’s impressive growth to date.
And if Tesla plans to build over 20 million units annually (up from about 1 million this year), it will require a lot more capital. But given the strong share price and internal cash flow generation, we assume that Tesla’s new issue rate will slow dramatically, to just 1.5% new shares per year. At this rate, they would have “only” 1.4 billion shares in 2035.
And this year, with production of 22 million vehicles at an average selling price of $ 46,000 (again, our estimate) and a net profit margin of 24%, those $ 250 billion profit would be about $ 178 per share .
Given Tesla’s dominance in this scenario of exhausting its market share, the only downside is that it is no longer a secular story, but rather one more dependent on the cyclical nature of automotive engineering. So, of course, its enormous revenue and revenue would grow much more slowly by then. But even for this exercise, we assume that Tesla will still find a way to continue to achieve steady EPS growth of 10% to that $ 250 billion figure.
And despite this slowdown, we also expect investors to want to pay a P / E ratio of over 20 for what is now a huge and cyclical business.
With a P / E ratio of 22.5, that would result in a market cap of $ 5.6 trillion and a stock price of $ 4,000.
Those are big numbers. And despite what we hear from the more upbeat Tesla bulls, we also assume that today’s shareholders only want to hit 10% a year by 2035.
If we roll back that $ 4,000 10% to today, the stocks are worth $ 1,050.
That’s pretty close to where we are right now.
So all of the above is what needs to happen in order for $ 1,050 to be a fair share price today.
Doubters, admittedly like us, will point out that the execution risk is enormous and that market shares (and especially margins) may be impossible.
Despite the fact that we actually cannot ignore the aforementioned differences between the cellphone and automotive industries, the believers – who are indeed right – must literally see the Apple-like industry dynamics, market share, and profit margins all making sense in their own right.
It’s also important to keep in mind that Tesla will actually have to outperform anything Apple has achieved in order for the stock to climb even more from current levels.
Bull or bear, there is no doubt that what Musk has achieved so far has been simply incredible. Five years ago hardly anyone would have thought it possible that Hertz would order 100,000 Tesla at once for its rental car fleet or that Tesla would produce and sell a million cars in a single year.
He will keep doing amazing things. He changed the world and the mindset of his competitors. None of this is in question. The future that will discount its stock price is the question we ask today.
Andrew Dickson is the Chief Investment Officer of Albert Bridge Capital, a concentrated equity portfolio manager for institutional investors. He has no position in Tesla, neither long nor short. Follow him on Twitter @albertbridgecap.