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As readers of this blog know, we have consistently opined that at prices exceeding $350 Tesla is significantly overvalued.  Therefore, Cornell Capital has pursued an investment strategy of writing call options with a strike price of 350 when Tesla stock reaches that level.  The strategy has worked well over the years and we continue to pursue it, but last weekend the Los Angeles auto show gave us pause.  We have marveled in previous posts at the lack of exciting, “sexy,” electric car offerings by major traditional manufacturers.  The L.A. show was jarring in that respect.  Teslas small exhibit was packed, as was that of Rivian, an exciting new electric startup.  However, the rest of the show was an electric desert.  Porsche did not even have a Taycan on display.  As we went from BMW, to Toyota, to Daimler, to GM, to Ford and so on the word for electric was 2020, if then.  The sole exception was Jaguar with their iPace.

As we have been driving Teslas for almost six years at Cornell Capital, it is aggravating to not have more real choice in electric cars by now.  But as writers of Tesla options, our concern is graver.  Why is the competition letting Tesla get such a large head start?  It makes sense that they may want to wade into the electric world slowly, given all the complicated political issues including the future of government subsidies.  However, the actual response has been more glacial than just slow.

There is also the issue of “learning by doing.”  Economic theory teaches that way you get better at making electric cars is by making them, not by talking about them, drawing mock-ups, or even producing demos.  There are innumerable little details that Teslas competitors will not get right until they are actually producing, selling and servicing electric cars. Those who wait too long may be unable to keep pace in the next decade.

In short, we fear that Tesla may have more market power than we have modeled.  If consumers begin to think of Tesla as synonymous with electric cars, then the company may be worth more than we have thought.  A price of $350 still appears to us to be rich, but less so than we thought before the show.

Apparently the German Minister of Economic Affairs reads our blog.  In a recent meeting with the leading German automakers, he said (here is the link: https://electrek.co/2018/11/19/electric-car-half-sexy-tesla-german-automakers/)

“I really wonder when you, Mr. Zetsche (Mercedes), or you, Mr. Diess (Volkswagen), or Mr. Krüger of BMW will be able to get an electric car build, which is only half as sexy as one by Tesla. As far as the attractiveness of your e-cars is concerned, you could actually come up with some fresh ideas.”

At Cornell-Capital, we have been saying this for years.  The Model S came out in 2012 and we anticipated the arrival, not too far thereafter, of sexy well designed competitors.  We are still waiting.

Warren Buffett once told me, never fly on an airline that has coffee stains on the seats.  While coffee stains themselves are not a big deal, there existence says somehting about the quality of the airline’s management that could be critical.  The failure of German automakers to have introduced sexy competition to Tesla by now also may say something about management – that they lack the chutzhap to compete with the likes of Elon Musk.  At least that is what the market price of Tesla’s stock suggests.

Related to our recent posts on the role of growth options, we though it would be interesting to rank US equities based on the percentage of market value attributable to growth options as opposed to assets in place.  In the interest of simplicity (and access to necessary data) we use a simple “back of the envelope” method for computing the value of assets in place.  The value of the growth options is then the difference between the market capitalization and the value of the assets in place.

Specifically, we estimate the value of the assets in place as the forecast of earning for the next fiscal year divided by the cost of equity minus the inflation rate.  (We assume that everything grows at rate of inflation.)  Mathematically, we used the equation

Market Value per Share = Forecast earnings per share/(R – inflation) + Value of growth options.

Finally, using data for November 9, 2018, we calculated the percentage of the market value accounted for by growth options.  In doing the calculations, we limited the sample to companies with a market capitalization of at least $5b that are traded on US exchanges and for which EPS estimates were available from Sentieo.

The link below is to a spreadsheet of the results with companies ranked in order of the percentage of their market value due to growth option.

It is interesting to note that there are a number of companies whose portion of growth options exceeds 100% of their market value.  Conversely, there are even more whose growth options have negative value, indicating the market believes their future is bleak.

Not surprisingly, the top of list is heavily populated with bio-tech companies, where the outcome of future treatments or drugs can have a dramatic effect on value. Also, many of our “Top Ten Bubble Stocks” appear near the top as well.

As we wrote in our post on ROKU, companies with a high percentage of value in growth options are likely to be especially sensitive to news suggesting slowing growth. Consequently, investors who hold companies near the top of the list may want to be especially cautious.

Percentage of Value due to Growth Options Spreadsheet

You often hear that as part of a restructuring to improve its financial position, a company plans to sell assets.  GE is a focal point of such discussion currently and the company has sold off some divisions.  But before you accept the view that such actions are beneficial, you must ask yourself where the benefit comes from.  To answer that question, it is necessary to distinguish the operating value of the assets, which equals the present value of the expected future cash flows under current management, and the cash value, which equals the price at which the assets could be sold.

One possibility is that it makes sense to sell the assets because you have found a sucker who is not reasonably assessing the future cash flows.  This is just a version of the greater fool theory.  If a company can find a greater fool, then it is lucky.  However, such rare happenstances cannot serve as the basis for a systematic restructuring program, so let’s assume that all the potential buyers are rational and well informed so that there are no suckers.

In that circumstance, it makes sense to sell the asset only if the cash value exceeds the operating value.  But why would someone else pay more than the seller’s operating value?  It must be the case that the buyer believes he can operate the assets more efficiently.  This would be the case, for instance, if there were synergies or if the current owners lacked the skill to manage the assets effectively.

All this begs the question of why it makes sense for GE to sell assets.  True some of the assets like the power division may be struggling and losing money, but that just means they are not worth very much.  There is no reason to believe that they will be worth more to a potential buyer unless GE is mismanaging the assets, or the buyer can employ synergies that GE lacks.  Given the size and scope of GE’s businesses, the synergies explanation does not seem likely.  If GE is mismanaging the assets, the best solution presumably would be to solve the management problem, not to sell the assets.

Putting GE aside, the situations in which asset sales would be beneficial are likely to be quite rare.  Asset sales should not be thought of as some sort of restructuring panacea, but as a tool to be used only in unique circumstances where the sale value exceeds the operating value.