In Monday’s early trading, Tesla’s market capitalisation is touching a mammoth $320bn. It’s been quite a run for the electric vehicle company since March, when its shares briefly fell under $400 at the height of the coronavirus panic. At the time of writing, they’re $1,744. Those brave enough to buy the dip have been duly rewarded.
Tesla’s valuation is even more eye-watering than it was when we last looked at the company back at the end of April, and although there’s been positive news, not least from second-quarter deliveries, it’s hard to see how it justifies an extra $180bn in market capitalisation.
Although its temping to put the price moves down to day traders, algos or delta-hedging, it’s difficult to really know what’s pushed the company’s valuation to 13 times Ford’s.
But price action, in and of itself, has a way of creating its own justifications for a company. And so it’s been with Tesla.
You know the argument. Amazon, for the most part, sustained losses in its early life as it focused on scale and market share in online retail. Thanks to this, Bezos was able to build a corporate leviathan with a stranglehold across voice-activated speakers, cloud infrastructure and cardboard waste generation. Tesla, or any other lossmaking company with a vague tech angle that’s an investor darling, is therefore the potentially same.
There are multiple issues with this argument. Ex-Alphavillain Kadhim Shubber picked over one back in 2017, when a few UK-based venture capitalists tried to defend cash-incinerating food delivery business Deliveroo’s negative gross margins.
For Tesla, however, the real point of difference with Amazon boils down to cash flow.
“Revenues are vanity, profit are sanity but cash is reality” is a popular axiom in the business world, and for good reason: cash flow allows business operations to be sustained without the kindness of strangers, or diluting existing investors.
Bezos, when he founded Amazon, knew this. In his famous 1997 letter to shareholders, the first published after the company went public, he stated that when presented with the choice, he would eschew profitability for “maximising the present value of future cash flows”:
Later in his 2004 letter to shareholders, perhaps in response to worries over Amazon’s profitability, Bezos expanded on this point:
Our ultimate financial measure, and the one we most want to drive over the long-term, is free cash flow per share.
Why not focus first and foremost, as many do, on earnings, earnings per share or earnings growth? The simple answer is that earnings don’t directly translate into cash flows, and shares are worth only the present value of their future cash flows, not the present value of their future earnings. Future earnings are a component — but not the only important component — of future cash flow per share. Working capital and capital expenditures are also important, as is future share dilution.
And he’s delivered. Here’s how Amazon’s cumulative free cash flow (calculated as operating cash flow minus capital expenditure) looks versus its profitability since it IPO’d back in 1997:
Over this 23-year period, Amazon has generated 2.6 times as much free cash flow as profits.
This has meant it’s been able to fund its new business lines — from successes like Amazon Web Services to failures like the Fire Phone — without constantly returning to the market with cap in hand. To that point, add up Amazon’s cash flow from financing over the years, and you’ll find the balance is negative — ie, it’s returned more cash to investors than it’s extracted from the market (mainly in the form of debt repayments).
Tesla could not be more different. The easiest way to demonstrate this is to compare the two companies over the historical periods since their initial public offerings in 1997 (Amazon) and 2010 (Tesla) respectively.
Both experienced rapid revenue growth as their operations expanded but when it comes to free cash flow, it’s chalk and cheese:
There are various reasons for this, but the most obvious one is that Tesla, fundamentally, is a car company. To both maintain and expand operations, automakers require constant reinvestment in the form of capital expenditure.
And that’s what makes Amazon incomparable, because even though its warehousing and logistics also required additional capital, it was able to leverage its relationships with suppliers to generate cash, by paying them slower than the time taken to receive cash from its customers.
If Tesla does manage to defy the sceptics and maintain its dominant position in electric vehicles — which is far from clear — it won’t look anything like Amazon’s path to the all-conquering company it is today.
However, there’s also another point to be made here, and it applies to the wider investor enthusiasm we’ve seen for companies with large total addressable markets — whether it be in the software-as-a-service, electric vehicle or quasi-transportation sector — over the past few months.
During the dotcom boom, Amazon’s prospects as the leader in ecommerce had investors salivating and they rewarded the company by bidding its valuation up to a $25bn by the end of 1999 — around 25 times revenues.
They were right. Amazon did become the market leader, and not just in e-commerce. But, in the short term, being directionally right was not rewarded by the market.
Between December 1999 and September 2001, Amazon’s shares fell 94 per cent, as the dotcom boom turned to bust.
Tech investors hoping a company might become the next Amazon — regardless of whether the comparison is valid or not — should take note.
Is Deliveroo an ‘Amazon’? — FT Alphaville
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