Been There, Done That

To Unravel Tesla, GM and Einhorn, Look To Oil

Both industries have struggled to respond to cash-burning disruptors.
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Those trying to make sense of what's happening to auto stocks -- and that includes hedge-fund manager David Einhorn -- might want to take a look at an industry intimately connected with the business of driving: oil.

As fellow Gadfly Chris Bryant wrote on Tuesday, "car companies can’t catch a break" -- unless they happen to be Tesla Inc. Even as shares of Ford Motor Co. and General Motors Co. were tumbling on Monday after reporting disappointing March sales figures, Tesla was hitting a new all-time high. It took five months for Tesla's market cap to hit $3.3 billion after it debuted less than seven years ago; it added that much in a single session on Monday:

Ludicrous Speed

Tesla's valuation is closing in on $50 billion

Source: Bloomberg

The conundrum here, as you probably know, is that Tesla is valued more highly than both Ford and GM (adjusted for net debt/cash on the balance sheet) despite the fact that its car sales -- the proximate reason for Monday's exuberance -- are a rounding error on those of Detroit's behemoths.

Despite Tesla burning cash at a ferocious rate and sporting more red flags than a Chinese embassy, investors are happy to bid up its stock (and buy more of it) even as they steer clear of steady earners with pristine balance sheets such as GM. Indeed, Einhorn's scheme for GM to issue a preferred-stock-like dividend share reflected a resort to financial engineering to achieve what the regular, automotive kind apparently cannot.

Well, guess what: The oil industry has seen it all before.

Tesla's identity, as both a disruptor and a stranger to positive free cash flow, gives it more than a passing resemblance to the U.S. exploration and production companies that pioneered the shale boom. Like Tesla, they are valued for growth above all else and have had few problems tapping investors and bondholders for more money, despite accounts awash in red ink. E&P stock prices are typically compared to their net asset values -- essentially discounted cash flows of their producing fields, adjusted for expectations about reinvesting in developing more reserves, energy prices and other assumptions. It's all pretty back-end-loaded in terms of when the positive free cash flow is supposed to arrive.

Similarly, no one's buying Tesla today on its historical results -- as CEO Elon Musk was quick to point out on Twitter on Monday -- or indeed the expectation of it spitting out cash anytime soon. Take a relatively bullish analyst such as Morgan Stanley's Adam Jonas. He values the core automotive business at $229 a share, implying a value of about $38 billion. Yet the modeled free cash flow through 2030, discounted back at his assumed cost of capital of 13 percent, adds up to just $14 billion. There's a lot riding on Tesla's terminal value there.

Like Tesla, the shale minnows are besting their bigger brethren in the stock market, especially those minnows in the most disrupt-y bit of the disruption, the Permian basin:

We Shale Overcome

Permian-focused stocks have trounced Exxon's over the past year and are now even higher when looked at across the whole period of the oil crash

Source: Bloomberg

Note: 'Permian E&P stocks' is a market cap-weighted index of Approach Resources, Callon Petroleum, Clayton Williams Energy, Concho Resources, Energen, EP Energy, Diamondback Energy, Laredo Petroleum, Matador Resources, Parsley Energy, Pioneer Natural Resources, Ring Energy, RSP Permian and Cimarex Energy.

Bear in mind that U.S. shale output represents all of 5 percent of the global oil market. Also bear in mind that Exxon Mobil Corp. is forecast this year to invest north of $20 billion and still have more than enough cash flow enough left over to pay out roughly $13 billion in dividends, according to data compiled by Bloomberg.

Simply throwing your arms in the air and bemoaning the market's irrationality is, however, not a good survival strategy. There is madness -- and a lot of it -- in the relative valuations of Tesla and GM and the frackers and the majors. But there is also some method.

A big reason why Einhorn's plan for GM to issue a dividend share wouldn't work is that no one in their right mind would value a stock backed by GM's dividend like some sort of perpetual preferred. Why? Because GM operates in a business that is not only cyclical but, now roughly 100 years old, faces fundamental questions about its longevity under its current paradigm, due to things like electrification, autonomous driving and ride-sharing. It is also worth remembering that GM only exited bankruptcy in November 2010 (around the same time Tesla first hit that $3.3 billion valuation, coincidentally), so it carries some baggage.

The same holds true for the oil majors. Dividend yields for the majors have jumped during the oil crash, with even Exxon's breaching 4 percent at one point, the first time it has done that since the merger that formed the modern company in 1999. Others such as Royal Dutch Shell Plc have approached 10 percent.

The reason is that their business models were built for a market where oil prices and demand were expected to keep rising ad infinitum. The return of the inevitable down-cycle in oil -- helped along by those frackers -- and portents of mortality, ranging from efforts to address climate change to the mooted IPO of Saudi Arabian Oil Co. have forced a rethink. And similar to GM, while the majors didn't go bankrupt, they did lose their heads in the prior boom and trashed their returns. They aren't getting a free pass on investing capital wisely, either.

Big Oil and Big Auto aren't necessarily doomed, just as Tesla and the shale gang are by no means necessarily going to support your pension. Both GM and Ford are pivoting to meet the challenges of this brave new world, just as majors are into natural gas and shale. But there are no guarantees that, for example, GM's Bolt will be a Tesla-killer or that Exxon will tame the Permian to its own ends.

And they face the thorny issue of keeping an established investor base onside even as they redirect spending into less-familiar, and cash hungry, new ventures. In short, they must prove themselves again despite having spent a century or more doing exactly that.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Liam Denning in New York at

    To contact the editor responsible for this story:
    Mark Gongloff at

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