Legendary investor and observer of human nature Charlie Munger has said of Tesla and Elon Musk: “Tesla has already created more significance than anybody had predicted. Its founder is bold and brilliant, and he swings for the fences. People like that get some remarkable results. Sometimes they get some quick failures. I haven’t the faintest idea how Elon Musk will turn out, but he has a considerable chance of success and considerable chance of failure. He seems to like it that way.”

We could not have put it any better. Indeed, few entrepreneurs can boast having successfully built significant companies in three different very challenging, established, and staid industries – payments (PayPal), space travel (SpaceX), and automobiles (Tesla). On top of it all, Musk risked nearly everything for each venture.

Bold and Brilliant indeed!

But that does not preclude him from following the rule of law if not conventional norms — with the SEC filing suit last Thursday to bar Elon Musk from running any public company, Tesla had the real danger of failing just as the electric vehicle market it popularized reaches a tipping point towards real volumes.

Source: IEA, Bloomberg

Musk did end up settling with the SEC since then (not without his usual antics), but given his history of erratic behavior, flouting the conventional norms and rules governing public company executives, the significant risk still exists that he may not be able to lead the company to see its ultimate potential on his own.

While ignoring convention is very much in the DNA of every disruptive entrepreneur, Musk generally goes further than most in ignoring rules that don’t necessarily help his stated objectives, and in fact may be detrimental to some of them. Additionally, Tesla’s continuing dependence on raising capital as it scales production from the capital markets also presents risk if the market’s generally optimistic view of Tesla’s future were to reverse and close off funding.

Rather than get caught up in the day to day soap opera of Elon and his detractors, we think it is important to step back and think about the bigger picture. Tesla has already transformed the auto industry. Every major automaker is now launching electric vehicles with many pledging all electric fleets within the next decade. Despite the uncertainty around Musk and Tesla’s ability to deliver on their promises, there is tremendous potential value in the company. If Elon lost his ability to lead the company, it seems very likely to us that Tesla will be forced to sell, with rather dramatic implications.

One of the higher probability outcomes may well be that Google buys Tesla, combines it with their Waymo autonomous vehicle (AV) business and becomes the dominant player in the future of transportation with effectively unlimited cash and organizational resources to accelerate the transformation of the auto industry.

Match made in heaven

Combining today’s leading luxury EV producer (>200K annual production run rate) with the leading AV provider would serve to bring rapidly growing scale to both with a cost advantage of 10x relative to ICE based transportation, would enable Waymo to stretch its lead by a margin so wide that it would be the clear leader. Just as network effects help Google deliver better search results (reinforcing algorithms – more searches, more feedback, better searches, driving more searches), more trips make Waymo’s vehicles better “drivers” (more trips, more safe, higher quality rides, broader coverage area, more trips).

 

Source: @martinengwicht, insideevs.com 

Source: cleantechnica.com

Waymo is already the leader in the technology with the longest project tenure, lowest disengagement rate of any competitors, and most miles driven autonomously. It plans to rapidly scale its commercial AV taxi service beyond trials in the Bay Area and Phoenix, “targeting 1 million trips per day in the next few years” in conjunction with its partnership with Jaguar.

Source: Economist

While there is no doubt that Elon Musk and Tesla have demonstrated the feasibility and desirability of EVs complemented by the timing of government regulations around emissions (a tipping point enabled by Tesla’s success), the company has certainly had a haphazard record of scaling effectively with a lot of drama around every required capital raise in doing so. If Musk had a complementary partner with a more effective execution capability running production, many of Tesla’s woes and detractors would be extinguished.

As a buyer, partner, and incubator, Google could be the ideal partner for Musk/Tesla, leaving him to focus on what he does best – vision, design, and engineering – while installing an effective equally ranked executive to partner with Musk to manufacture and scale with a more robust process than that used to design the “machine to build the machine” hypotheticals that resulted in Tesla’s ongoing “production hell” saga.

Google also brings unlimited capital, a long-term investment horizon, and a fellow believer and friend in Larry Page, who has not only invested for a decade in Waymo’s AV technology but has also been willing to rescue Tesla in a previous distressed episode. We don’t believe Page’s buyout offer was just a charity offer for a friend but rather a belief in the potential that Tesla would have in transforming the overall transportation market, as it’s become clearer today.

Making it work

While some would argue that “firefly” like pods are what AV will eventually look like (despite being discontinued by Google), no one would argue that having a Tesla drive you around instead of your Ford Taurus at 1/2-1/5 the price wouldn’t be more appealing if you could get comfortable with an AV driver.

Source: Techcrunch

Of course, the most prolific early adopters will be the young and the carless, uber-loving inhabitants of large cities globally. In the meantime, those users choosing to own an EV could join the fleet of Tesla owners who actually drive billions of miles, while delivering real time imaging data to use in AV simulations, reinforcing behavioral learnings of the AV engines from real world human decisions.

We believe Google has realized that forgoing hardware in the smartphone market led to Apple dominating the profits in the market (~90% of the profits of the most lucrative consumer product ever created), the majority of the most valuable users (top 20% globally), and a trillion dollars of value. Most of Google’s hardware partners have produced sub-par hardware as a result of competing for small slivers of profits striving for market share with undifferentiated hardware powered by Google’s Android service.

Google used this strategy to get Android and its accompanying services to ubiquity. However, that ubiquity in services ended up being less lucrative than selling a premium integrated experience. Now Google has redoubled efforts to deliver a premium Android experience by building and selling its own smartphones with its Pixel phone line of products in order to win back some of these high-end customers but doing so is difficult from an entrenched competitor offering a great experience.

The secret of the iPhone’s success has been its integrated software/hardware/apps experience, great design (an identity feature), high utility, low cost (~$1/day), and high profit/ROIC. And now it is basically sold as a service with monthly financing plans allowing for the effective exercise of pricing power.

Riding in style

We think a similar analogy is likely with AV/EV — the most economically well-off people will still care about comfort, features, and identity that the AV/EV they ride and arrive in imparts on them. If Waymo can deliver a premium experience at a better price and higher utility than their current solution (i.e. driving themselves in their own cars or Ubers/taxis) with cost economics that yield a strong profit margin/ROIC at scale (1/2-1/3 the pricing of Uber at 1/10 the cost), it will have built an offering that will be set to be the leading AV service and create tremendous value for shareholders despite the early capital intensity. Estimates of the value of this Transportation as a Service (TaaS) or Mobility as a Service (MaaS) go from hundreds of billions on up based on Morgan Stanley’s estimate of 11 billion miles (3B in the US) driven globally and forecasted to double over the next decade.

Source: Electrek

Eventually, if Waymo is successful at taking the strong lead via network effects in AV and converting enough consumers to use its premium service (achieving a cultural and regulatory tipping point), it could decide to open up its service’s usage across other auto “hardware” partners as they demonstrate their ability to deliver a certain level of quality experience and scale globally, enabling a broader application of its service to lower tiers of the market with lower capital intensity (akin to Apple’s 2nd hand iPhone market, which broadens its user base for services offerings).

Having articulated the value, we think a reasonable price for Google to pay for Tesla in the event it were distressed would be $30-40B. This is 35%-50% below Tesla’s current enterprise value and could only occur in the event Musk is unable to execute on his vision, a possibility that we believe is very real. However, this is also well above the near zero value that many of Tesla’s detractors believe the company is worth as they expect bankruptcy to arrive before too long and fail to appreciate the very real value inherent in Tesla. A buyout at this price would be less than 5% of Google’s $800B+ market cap – coincidentally the change in the market cap just last week – a reasonably sized bet for Google to make in light of its own scale and ambition in the AV market, while also allowing it to clearly win any competition that could emerge from a traditional auto OEM or other likely suitor.

Bottom line

While the settlement with the SEC pushes out any sort of forced sale of Tesla in the near term and perpetuates the drama surrounding the company, we do believe that the value it has created is real and significant, but also still very much in doubt. Partnering the vision of its brilliant CEO Musk with a reliable long-term oriented execution partner and capital provider in Google would be a great outcome for both companies, their shareholders, and consumers globally.

As of the date of this blog post, clients invested in Ensemble Capital Management’s core equity strategy own shares of Alphabet (GOOGL). The company represents only a percentage of the full strategy. As a result of client-specific circumstances, individual clients may hold positions that are not part of Ensemble Capital’s core equity strategy. Ensemble is a fully discretionary advisor and may exit a portfolio position at any time without notice, in its own discretion.

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