Tesla is creating a "bubble" much bigger than itself...
Making Chinese EV companies big pandemic winners...
Today, Tesla is officially included into the S&P 500 index. What a year it had – rising +700% in market cap and is now larger than the next five largest global auto companies combined.
If you think that Tesla is a large bubble, then there’s a much larger bubble outside of Tesla – namely the tremendous rise in valuation in EV (electric vehicles) companies in China and beyond. Two Chinese auto companies, BYD and NIO, were nowhere close to being a top 10 auto maker a year ago, but are now ranking no. 5 and 6 respectively with higher valuations than GM (no. 7), BMW (no. 7), Honda (no. 8), Volvo (no. 9), and Ford (no. 13).
Outside of the EV industry, Airbnb and Doordash recently had two high-valuation IPOs that exceeded expectations even though we’re still in a pandemic. Airbnb is now a $75 billion company and Doordash $50 billion. Is there a tech bubble? How justified are these valuations? These are big questions that I cannot answer in one email, but here are some of my quick thoughts.
NIO’s rise is more absurd than Tesla:
Why don’t we use NIO as a case study? NIO is often referred to as “the Tesla of China.” The firm was listed on NYSE in September, 2018 with ~$9.9/share. In the summer of 2019, NIO stock price stumbled to around $2/share and struggled to make ends meet. The private equity fund I worked at two summers ago was an early investor in NIO, and that summer I heard nothing but pessimistic projections for NIO and rumors of its soon-to-happen bankruptcy.
The stock sat around $2/share until this March. Then, Covid hit, and the next thing you know is that the stock price rose to $54/share as of the end of November and now sits at $43.50/share. It went up 27x within the span of ~8 months. What happened?!
You can give all kinds of explanations, but the improvement of fundamentals is certainly not one of them, and certainly not enough to justify a 27x rise in valuation. (The company is only expected to deliver ~14k cars in Q4, and profitability is not high. If you want to learn more about its specific financial metrics please let me know, but I’ll stop here). So why?
Can you fairly value a company like NIO? Yes but not really.
There are two properties of NIO (or similar types of companies) worth noting:
It’s an early-stage, high-growth company. Early stage not in the sense that it only has 10 employees, but that it’s still not consistently turning high profits and not one of these legacy Fortune 500 companies yet. I thus define them as early stage.
It’s in a giant business vertical that is highly popular and essential. These are giant business verticals that investors know will continue to be crucial for the economy in the future, so they know there will be money to be made, but because these startups are so early-stage, you don’t know if this will be the company that does it for you.
A company with these two properties requires a long investment horizon, meaning that you have to value it not based on its revenue/profits this year per se like you do with most normal companies, but based on what you think might happen in 2-3 years or even 3-5 years. Likewise for Airbnb (which promises to disrupt the entire lodging industry but only just started to make money a couple months ago) and Doordash (which promises to be the end-all-be-all delivery service for the future but also struggles to turn positive profits) – these are all grand narratives that won’t happen anytime soon, so do you believe in them today?
If you believe in the narrative – that the company will be profitable in this huge business vertical in 3 years – then the current valuation should be justified since you’re fairly pricing in its future growth, and in that sense there would be no bubble. But if you think its story is BS and it’s still not gonna be profitable in 3 years, then sure it would be a bubble.
But what will happen in 3 years? No one can really tell, so things become much more heavily dependent on market sentiment, and you follow what others do.
The pessimistic side would say: If you only look at market sentiment, it becomes an inherently volatile and highly risky process, and at some point the market optimism will run out and you’ll be left with nothing.
The optimistic side would say: Market sentiments are great measures of where we’re headed next because they show you the consensus. With the Fed not raising interest rates anytime soon, and because the policymakers cannot help but to continue bailing out the markets, what’s there to worry about? The markets will simply go up!
The US is currently in a (possibly still young) bull market, so market sentiment is really high, and everyone’s pricing in these tech companies’ growth for more than 1 year and possibly even for 3-5 years out. So, whether there is a bubble really depends on where you think we end up in 3 years, and if you’re optimistic, then there is no bubble today.
The bottom line is – such a company like Airbnb and NIO seems expensive and overvalued, but based on what benchmark are they overvalued? You feel that there is a tech bubble, but is it really a bubble when these companies seem to lead us towards wonderful innovations and inevitable profitability?
Is Tesla spurring bubbles?
What is fascinating to me is that the US' positive market sentiment has spillover effects beyond the big names we know. Yes, Amazon and Tesla were big pandemic winners, but not just them. When Tesla’s stock rose 10x from $60 billion to $600 billion, some random Chinese EV company called NIO that you’ve never heard of saw a growth of 27x. Two other Chinese EV companies were recently listed in NYSE and NASDAQ: Lixiang Auto (LI) and Xiaopeng Auto (XPEV). You’ve never heard of them, and last summer they were almost going bankrupt, but today, thanks to Tesla’s remarkable rise, their “success” is written by every media outlet in China today.
I don't know how much tech innovations these Chinese EV companies have, but they sure are having a great time in the financial markets thanks to Tesla. Elon Musk hates finance, but is Tesla leading a wave of financialization for EV companies? That might not be Musk's intention, but it will be part of his lasting legacy for sure...
The EV stocks will keep going up:
As for the Chinese EV companies, I can tell you right now that they’re so far away from Tesla from a technological standpoint and they’re certainly overvalued in some way. But I also think they’ll keep going up, because Tesla will keep going up, and we will observe a direct correlation between Tesla’s valuation and the greater EV bubble it’s helping to create.