Incumbent Automakers: Throw a dart, hit a loser
Many of the big, incumbent automakers are going to be big losers in the next decade. Disruptive and existential threats have been coming for big, incumbent automakers for a while, but they are now playing out faster and in more dramatic fashion than originally predicted. So much so that many of the incumbents will vanish over the next two decades. Those who survive won't be anything close to their current form and will be miles behind Tesla and other new entrants such as NIO. The closest analogy to the fate of the automakers is what happened to mobile phone manufacturers (remember Ericsson, Nokia, Sony etc.).
The auto giants have not been sitting idle. Since 2017 - when Tesla's stock started its ascent - many have done massive overhauls of their structure to become more nimble and efficient. They have also been reducing their costs. Despite all these efforts, they find themselves in a more precarious situation than in 2017. What has really changed that they didn't foresee - at least not to this extent - is the view of capital markets of their industry. Let me explain.
To be around for the next two decades, the automakers need to have valuation levels that are in line with Apple, Amazon and Google. Unfortunately for the auto giants, the gap has only grown massively since 2017. Tesla has beaten them by fetching a market cap of over $800B, making the company worth more than the next 12 most-valuable carmakers combined. So why are valuations important?
Valuations are more than just a matter of bragging rights. The current old auto valuations are shackling the incumbents and depriving them from the ability to access resources needed to better fit themselves for an electric future. Last month, Tesla, NIO and other Chinese automakers raised ~$10 billion worth of capital by selling stock, all in one week. The $5 billion that Tesla raised was about half of VW’s annual net cash flow. Tesla has done this twice in 2020.
Many analysts keep saying that the trends with Tesla's and NIO's valuations are overdone. They are always quick to point out that the number of vehicles sold annually by the auto giants dwarfs Tesla's full year deliveries. They also argue that the combined ~ $1T market cap of the incumbents has remained largely unchanged over the past 12 months, while Tesla's and NIO's have gone through the roof. This is not a valid argument. Stock prices and growth mainly reflect future growth. Sadly for the incumbents, the sentiment towards them continues to be far too pessimistic - they have high cost structure, they are not nimble and their sales growth is going to be modest and consistent with what they deliver today. This has the effect of depressing their valuations and limiting their access to critical funding needed to grow.
Investments in EVs, software operations, and autonomous technology are enormous. While Tesla and other new EV entrants are able to sell stocks to raise the money for such investment, pay debt, strengthen their balance sheet, the incumbents can't afford to do that. If they were to do it, their investors would face much higher dilution and their stocks would further lose value.
Their only option to raise the money needed is to become lean and massively cut costs while avoiding a drop in their earnings. If the R&D costs were to affect the earnings, their stock would take a hit. Just ask Walmart, who in 2017, dropped 1/3rd of its value after it alerted investors that its costs will increase because of investments in e-commerce and faster delivery for online orders. It's a vicious and ugly cycle. Contrast that with Tesla. Elon Musk and Tesla had a great vision (story) that they were able to sell investors and deliver on. They positioned Tesla as far beyond an automaker (e.g. robo-taxi, large batteries etc.). Tesla's stock's value has inflated due to Tesla's technological developments, improvements in battery capabilities, production efficiencies, and delivery figures that have managed to outperform Wall Street's estimations. That surge in the stock value provides the company with access to enormous amounts of cheap money (selling stocks) that fuels the flywheel of growth, investments etc. The auto giants are doomed.
The incumbents should have spun off their EV business a few years back or invested in some of the new entrants. VW invested ~$300M in battery start-up QS that became over $10B when QS stock soared. Only that would have given the incumbents access to the same financial resources available to Tesla and the new entrants and given them an opportunity to compete.
The auto giants have not been sitting idle. Since 2017 - when Tesla's stock started its ascent - many have done massive overhauls of their structure to become more nimble and efficient. They have also been reducing their costs. Despite all these efforts, they find themselves in a more precarious situation than in 2017. What has really changed that they didn't foresee - at least not to this extent - is the view of capital markets of their industry. Let me explain.
To be around for the next two decades, the automakers need to have valuation levels that are in line with Apple, Amazon and Google. Unfortunately for the auto giants, the gap has only grown massively since 2017. Tesla has beaten them by fetching a market cap of over $800B, making the company worth more than the next 12 most-valuable carmakers combined. So why are valuations important?
Valuations are more than just a matter of bragging rights. The current old auto valuations are shackling the incumbents and depriving them from the ability to access resources needed to better fit themselves for an electric future. Last month, Tesla, NIO and other Chinese automakers raised ~$10 billion worth of capital by selling stock, all in one week. The $5 billion that Tesla raised was about half of VW’s annual net cash flow. Tesla has done this twice in 2020.
Many analysts keep saying that the trends with Tesla's and NIO's valuations are overdone. They are always quick to point out that the number of vehicles sold annually by the auto giants dwarfs Tesla's full year deliveries. They also argue that the combined ~ $1T market cap of the incumbents has remained largely unchanged over the past 12 months, while Tesla's and NIO's have gone through the roof. This is not a valid argument. Stock prices and growth mainly reflect future growth. Sadly for the incumbents, the sentiment towards them continues to be far too pessimistic - they have high cost structure, they are not nimble and their sales growth is going to be modest and consistent with what they deliver today. This has the effect of depressing their valuations and limiting their access to critical funding needed to grow.
Investments in EVs, software operations, and autonomous technology are enormous. While Tesla and other new EV entrants are able to sell stocks to raise the money for such investment, pay debt, strengthen their balance sheet, the incumbents can't afford to do that. If they were to do it, their investors would face much higher dilution and their stocks would further lose value.
Their only option to raise the money needed is to become lean and massively cut costs while avoiding a drop in their earnings. If the R&D costs were to affect the earnings, their stock would take a hit. Just ask Walmart, who in 2017, dropped 1/3rd of its value after it alerted investors that its costs will increase because of investments in e-commerce and faster delivery for online orders. It's a vicious and ugly cycle. Contrast that with Tesla. Elon Musk and Tesla had a great vision (story) that they were able to sell investors and deliver on. They positioned Tesla as far beyond an automaker (e.g. robo-taxi, large batteries etc.). Tesla's stock's value has inflated due to Tesla's technological developments, improvements in battery capabilities, production efficiencies, and delivery figures that have managed to outperform Wall Street's estimations. That surge in the stock value provides the company with access to enormous amounts of cheap money (selling stocks) that fuels the flywheel of growth, investments etc. The auto giants are doomed.
The incumbents should have spun off their EV business a few years back or invested in some of the new entrants. VW invested ~$300M in battery start-up QS that became over $10B when QS stock soared. Only that would have given the incumbents access to the same financial resources available to Tesla and the new entrants and given them an opportunity to compete.
Disclaimer: This post is merely my own assessment and is not an investment recommendation. For professional advice, seek input from a licensed investment advisor.
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