Gasoline in the blood or vibrato at the power outlet: Daimler versus Tesla
I. Macro Hypothesis
The economic cycle is far advanced. Due to the concurrently positive economic development worldwide we assume that European consumers will have more money in their pockets this year and next year.
The favorite child of the Germans, the automobile, should benefit from this. When business goes well, companies treat their employees to extra benefits. Individuals, too, concern themselves with longer lasting consumer goods, which, of course, include cars whose purchase is put on hold in economically more challenging times.
II. Diesel or Electric
As to cars, during the summer slump there was no topic hotter than diesel or electric. Our assessment is differentiated. On the one hand it’s clear that China is putting enormous pressure on the automotive industry to improve the climatic situation in the big cities. Motorcycles already are electric, for cars this is being spurred on emphatically as well.
However, we don’t share the belief popular especially in Berlin that “the German electric spirit shall heal the world.” The construction of subways has changed mobility in many cities, and in New York already thirty years ago it was barely possibly even for a banker who made good money to afford a private parking space in Manhattan.
It may very well be that cities like Paris or Shanghai are flirting with the idea to change the cityscape with self-parking, emission-free cars that help to free space in cities from parking cars.
But by no means is it certain that the prevailing technology in the long term will actually be the electric car.
The way we fuel is changing.
III. Elon’s Electric Euphoria
Until late August 2017 there was barely a stock that had risen as much as Tesla’s:
Performance since early 2017 through late August: + 63%
In the past five years +1,000%. The S&P 500 rose by +75% in this timeframe, automotive stocks by +58%.
This development is intrinsically tied to the charismatic serial entrepreneur Elon Musk. To gain an understanding of how far investors are willing to go in order to be a part of it, here’s a brief calculation (as of late August 2017):
On average, analysts estimated in late August that the company will manage to increase its result by 250% per year in the next three years. With this assumption, the price-earnings ratio came out to “only” 23. Not that pricey, right?
Private equity investors calculate a bit differently:
Market Value Tesla $ 58 billion
Liabilities (net) $ 5 billion
EV (Enterprise Value) $ 63 billion
EBITDA $ .7 billion
Currently, an EV/EBITDA multiple of 12 is paid for private equity transactions in Europe—and this is considered rather expensive by historical comparison. The valuation of Tesla is eight times higher.
Let’s assume Tesla will manage to increase not only its result but also EBITDA by 250% p.a. over three years:
The result would be an EBITDA of $11 billion in 2020. Then, the EV/EBITDA multiple is only a low 5.8. However, this calculation also assumes that Tesla has to increase its result fifteenfold within three years. Racy. Tesla is a classic case of venture capital.
Nothing for private equity investors. That doesn’t mean that there’s no money to be made with Tesla, but it does mean: the risk of making money is extremely high—including total loss.
IV. Daimler’s Diesel Blues
There’s no comparing Daimler’s price gains in late August 2017 to those of Tesla:
Performance since early 2017 through the end of August: -13%!
In the past five years +67%—as much as Tesla just since the beginning of the year!
On average, analysts estimated in late August that Daimler would be able to increase its result by 4% per year in the next three years. With this assumption, a long-term price-earnings ratio came out to seven.
Private equity investors calculate a bit differently:
Market Value Daimler $ 79 billion
Liabilities (net) $ 100 billion
EV (Enterprise Value) $ 179 billion
EBITDA $ 18 billion
A complete takeover of Daimler by private equity seems illusive—but it doesn’t have to stay that way. The number of private equity companies managing more than $100 billion has increased dramatically. The biggest deal so far—TXU in 2007—was at $45 billion and was carried out by a consortium of three private equity companies.
The current valuation of Daimler—not taking its sheer size and political implication into account—wouldn’t prevent a takeover, on the opposite. If the corporation was taken over for $200 billion including its debt, investors would have to come up with debt capital of around $100 billion and equity capital of a similar amount. If the hunt for returns at the bond markets continues the way it has in the past years, it might be possible to constitute more than 50% of the overall financing through bonds. Given the earning power of Daimler, servicing its debt wouldn’t be a problem. The debt amounts to $100 billion already today, and the dividend yield is over 5%. Debt could be paid off, for example, by splitting off the truck business and taking it to the stock exchange separately. There surely are many possibilities to raise values. One of the other measures is certainly implemented without the pressure of a takeover and should contribute to raising values for the stockholders. Wearing private equity glasses is helpful when identifying and evaluating these selling points.
When valuating automotive corporations, their degree of flexibility in the production needs to be taken into account when different engines are to be offered cost-effectively. If Volvo declares it’ll only build electric cars, that sounds good initially. However, one of the resons for this announcement is probably that Volvo‘s sales figures don’t suffice to offer the entire line-up of possible engines cost-effectively. Should things turn out differently for the electric car than Volvo thought, then “Volvo good night.”
The large-quantity manufacturers are capable of offering electric engines in addition to gas, diesel, hybrid, hydrogen, and whatever else may be added to the mix. The number of corporations that are in this position will probably decrease rather than increase given the enormous cost pressure of the automotive industry. A narrowing oligopoly isn’t a scenario in which company valuations drop. Just take a look at what is currently happening with airlines. It’s certainly not bad for the stockholders of the surviving airlines. If passengers still enjoy flying under those circumstances is an entirely different question, of course.
Should it, however, come to the creation of large overcapacities for electric cars especially in China, then there’s the risk that in a combination with do-gooders from Berlin the same will happen that has already happened in the solar industry. Political euphoria with huge subsidies and the resulting withering ability to compete for entire industries isn’t a recipe for economic success—neither in China nor in Germany.
V. Private Equity Focus on Management
A key difference between Daimler and Tesla is their management. When Friedrich Karl Flick dissolved the corporation in the ‘80s that his father had built by selling it, Daimler also lost its principal stockholder. The family Flick was controlling the car manufacturer during the entire post-war era. There were no scandals due to lacking business success. The Flick scandal “the acquired republic“ was about illegal political party funding, tax evasion, and a large network of slush funds. But no one ever claimed that Flick wasn’t successful as an entrepreneur.
The Flick family had barely vanished into thin air in the mid-‘80s when the managing board’s visions and, as a result, the problems for the stockholders started.
For private equity, the management aspect has special significance: who manages the company and leads like an owner and who doesn’t.
Warren Buffet always says that he doesn’t invest in companies in which the management board picks the supervisory board (it should actually be the other way around) because there is no stockholder who monitors effectively. This statement is from a long time ago, and even mega caps like Nestlé are confronted today with individual stockholders building packages and exerting pressure.
But that doesn’t change the fact that Daimler was, over many years, a deterring example from a stockholder perspective in which the owners’ representatives (i.e., the managing board members) were taking care of all kinds of things, just not the wellbeing of the organization.
Elon Musk is an entrepreneur through and through—I can’t say for certain if this is true for Dieter Zetsche. But the development of Daimler in the past years has shown that Zetsche at least managed to not continue the excesses of his predecessors, and the corporation is currently giving the impression that it’s accomplishing more than it did in the past.
But regardless it’s clear that the difference in valuation can be attributed to the acting persons. Whether Elon magic makes for 10 billion of 40 doesn’t make a difference—the increase in valuation is high for the American “Rocketman.”
Elon Musk’s SpaceX Falcon 9 Rocket Launch in Cape Canaveral
© JMarro / Shutterstock
VI. Electric, Summer Slump, and what may come
Significant for the question of valuation is whether or not the change to electric will come as quickly as some believe.
We believe that enthusiasm will be dampened quite a bit. A major technological problem is the low energy density of batteries compared to diesel and regular gasoline. The differences with multiples of 50 are much bigger than politicians want to admit. But even here it’s true that parliaments can’t deny, in addition to gravity, other laws of nature.
There are many problems in connection with electric. Imagine, for example, you live in a multi-family apartment building, and in the parking garage six or eight electric cars need to be charged at the same time overnight. One thing is clear: this won’t work with today’s power lines.
You certainly know from the area of glass fiber and the Internet how long the upgrades to the lines take and what they cost. Whether or not this is economic is questionable. Apart from that, we may manage to obtain enough raw materials for the batteries. But that doesn’t change the fact that not only cell phone batteries can catch on fire, and the question of waste disposal is open. Regards from Gorleben. [Note: The German village Gorleben is the site of a radioactive waste disposal facility. It has been used as temporary storage facility with plans to possibly use it as final repository. Attracting many protests from citizens and environmentalists, Gorleben has been a very controversial topic.] Maybe the electric batteries can be stored together with the nuclear fuel rods—should there be a final repository at some point.
Because electricity comes, as we know, from power outlets, it should be clear that further problems delaying the victory of the electric car are to be expected. During the next economic crisis at the latest the question of costs will gain in importance especially in the field of energy when sites are competing in attracting companies and mobile people.
German energy policy is similarly visionary as Daimler managing board members Reuter and Schrempp were with mobility—crash included.
In all, we’re noting from our perspective:
Electric will come for cars, too, but whether or not its significance will go beyond that of electric bicycles remains to be seen.
Why the future isn’t in electric cars
WOLFGANG BOK April 27, 2017
Because we anticipate that electric will happen at least in China, we invest with a focus on companies such as Glencore, which hold key positions in all raw materials related to batteries. Another stock that holds the potential to benefit from increasing prices for electricity is Uniper.
“The price of Uniper has not yet reached its end”
Jürgen Flauger interviews Georg Oehm, Mellinckrodt
We have started building a position with Daimler in early September to profit from the in our opinion significant undervaluation.
We believe that Tesla is totally overvalued. We still don’t short Tesla as this would seem too risky to us. Tesla has the potential to be the EMTV of this stock exchange cycle. The stock is moving mostly independently of valuation aspects—the price, of course, may multiply again—with the respective risks if one shorts.