Tesla and the fallacy of Amazon


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In Monday’s initial trading, Tesla’s market capitalization hit a staggering $ 320 billion. It has been a race for the electric vehicle company since March, when its shares fell briefly below $ 400 at the height of the coronavirus panic. At the time of writing, they were $ 1,744. Those who had the courage to buy the dive were duly rewarded.

Tesla’s valuation is even more uplifting than it was when we last reviewed the company in late April, and although there has been some positive news, including second quarter deliveries, it’s difficult to see how that justifies an additional $ 180 billion in market capitalization.

Although his temperament to bring the price down turns into day traders, algos or delta-hedging, it is difficult to really know what pushed the valuation of the company to 13 times that of Ford.

But price action, in itself, has a way of creating its own justifications for a business. And so it was with Tesla.

One popular tale we have seen ex ante of recent bulls, such as CNBC’s Jim Cramer or Harvard Business Review, is what we like to call “the fallacy of Amazon.”

You know the argument. Amazon, for the most part, suffered losses early in its life by focusing on the scale and market share of online retail. Thanks to this, Bezos was able to build a corporate leviathan with a grip on the voice-activated speakers, cloud infrastructure and cardboard waste generation. Tesla, or any other loss-making company with a vague technological angle that is a cherished investor, is therefore potentially the same.

There are several problems with this argument. Former Alphavillian Kadhim Shubber chose one in 2017, when a few UK-based venture capitalists tried to defend the delivery of cremating cash incinerator Deliveroo.

For Tesla, however, the real point of difference with Amazon comes down to the cash flow.

“Income is vanity, profit is healthy but money is reality” is a popular axiom in the business world, and for good reason: cash flows allow business operations to be supported without the kindness of foreigners or without diluting existing investors.

Bezos, when he founded Amazon, knew this. In his famous 1997 letter to shareholders, the first published after the company’s publication, he said that when he was offered the choice, he would give up profitability to “maximize the present value of future cash flows”:

Later in its 2004 letter to shareholders, perhaps in response to concerns about Amazon’s profitability, Bezos developed on this point:

Our ultimate financial measure, and the one we want most in 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 profits don’t translate directly into cash flow, and stocks are only worth the present value of their future cash flows, not the present value of their future profits. Future earnings are a component – but not the only significant component – of future cash flows per share. Working capital and capital expenditures are also important, as is the future dilution of stocks.

And it is delivered. Here’s what Amazon’s cumulative free cash flow looks like (calculated as operating cash flow minus capital expenses) relative to profitability since its IPO in 1997:

During this 23-year period, Amazon generated 2.6 times more free cash flow than profit.

This allowed him to finance his new activities – successes like Amazon Web Services to chess like Fire Phone – without constantly returning to the market with a cap in hand. At this point, add up the Amazon cash flows from the financing over the years, and you will find that the balance is negative – that is, it returned more money to the investors than it is not extracted from the market (mainly in the form of debt repayments).

Tesla couldn’t be more different. The simplest way to demonstrate this is to compare the two companies over historical periods since their initial public offerings in 1997 (Amazon) and 2010 (Tesla) respectively.

Both have experienced rapid revenue growth as their operations grow, but when it comes to free cash flow, it’s chalk and cheese:

There are several reasons for this, but the most obvious is that Tesla, basically, is an automotive company. To both maintain and expand their business, automakers require constant reinvestment in the form of capital spending.

And that’s what makes Amazon incomparable, because even though its warehousing and logistics also required additional capital, it was able to leverage its supplier relationships to generate cash, paying them more slowly than necessary to receive money from customers.

If Tesla manages to challenge the skeptics and maintain its dominance in electric vehicles – which is far from clear – it will be nothing like Amazon’s path to the conquering business it is today.

However, there is also another point to emphasize here, and it applies to the wider investor enthusiasm that we have seen for companies with large total addressable markets – whether in software as a service , the electric vehicle or quasi-transport – in the last few months.

During the dotcom boom, Amazon’s prospects as the leader in e-commerce made investors salivate, and they rewarded the company with its valuation at $ 25 billion in late 1999 – about 25 times revenue.

They were right. Amazon has become the market leader, not just in e-commerce. However, in the short term, being directional has not been rewarded by the market.

Between December 1999 and September 2001, Amazon’s shares fell 94% as the dotcom boom turned into an explosion.

Tech investors hoping that a company could become the next Amazon – whether the comparison is valid or not – should take note.

Related links:
Is Deliveroo an “Amazon”? – FT Alphaville

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