Enough About Tesla's Market Cap
Sometime after they announced their big merger in 2000, AOL’s Steve Case and Time Warner’s Gerry Levin flew to London to, among other things, address the assembled local employees of their two companies. I was one of those employees, and remember trooping into a West End theater to hear the two men gush about the bounteous future that awaited us.
That’s about all I remember from the event, apart from one thing that Case said. AOL-Time Warner, which at the time had a combined market capitalization in the low hundreds of billions, was going to be “the world’s first trillion-dollar company,” he told us.
I think I remember this so well because it bothered me even then (and I’m not one of those geniuses who already knew the merger was a disaster). Couching the company’s ambitions in terms of market cap felt all wrong. It isn't just that, if you fail to achieve it, lots of people will be sure to point out how much you missed by ($928 billion, going by today’s combined market cap of the unmerged AOL and Time Warner). It’s that market cap is, for a bunch of reasons, a flawed target for a chief executive officer.
So a bunch of alarm bells went off last night when I heard that Tesla’s Elon Musk had talked in the company’s earnings conference call of someday having a market value “basically the same as Apple’s is today.” Apple’s current market cap is almost $740 billion, the biggest any company has ever had unless you count the brief, weird moment when PetroChina sold shares in an initial public offering in 2007. Tesla’s is about $25 billion.
In context, the quote isn’t quite so bad. Analyst Brian Johnson of Barclays had asked Musk to “explore a bit where you see the trajectory of cap ex and op ex.” As part of an extended answer that began with the wonderful sentence, “We're going to spend staggering amounts of money on cap ex,” Musk offered these “back-of-the-envelope” numbers:
If you take this year's revenue, around $6 billion or thereabout, and if we're able to maintain a 50 percent growth rate for 10 years and achieve a 10 percent profitability number and have a 20 P/E, our market cap would be basically the same as Apple's is today.
He’s not exactly saying, “we’re aiming for a $700 billion market cap.” Close enough, though. It’s certainly what the headline writers picked up on. That’s a problem for Musk or any other CEO because:
- You can’t control your stock price. That’s true of most business metrics, obviously -- Musk cannot unilaterally insure that Tesla will have sales growth of 50 percent a year. But he can have a much more direct impact on that over time than on the company’s stock price. Witness what Tesla stock has done since his bold pronouncement about its future: it fell as much as 9 percent today.
- Your stock price is often wrong. That was in retrospect the case with AOL in December 1999, when its market cap peaked at $222 billion even as its core business of dialup Internet service had begun to decline. Case’s decision to trade his company’s inflated stock for Time Warner was thus to some extent a genius move, but he subsequently acted as if he really believed his going-to-a-trillion talk and blew a lot of his potential gains.
- Stock prices are about expectations, not performance. Roger Martin of the Rotman School of Management argues that paying corporate executives with stock is a little like rewarding National Football League quarterbacks for beating the betting spread. The key becomes not how well you manage your company, but how well you manage the expectations of investors about your company.
- Focusing on market cap, or on maximizing shareholder value -- which is basically the same thing -- can lead you to do all sorts of things that end up reducing shareholder value, like scrimping on investment and overpaying top executives. James Montier of the money management firm GMO made this argument in a widely distributed white paper in December, concluding that Peter Drucker was right when he wrote in 1973 that “the only valid purpose of a firm is to create a customer.”
- Market cap targets don’t motivate employees. I’m willing to imagine that stock price targets sometimes do -- “if we make it to $100 a share, my restricted stock will be worth…” But nobody other than a CEO with delusions of grandeur cares what the overall market value of the company is.
Tesla has been pretty successful at creating customers so far. But the best way to keep doing that, as Apple’s Tim Cook put it this week at the Goldman Sachs Technology & Internet Conference, is to focus not on the numbers but “on the things that produce the numbers.” That may sound sanctimonious and even a little disingenuous. But it’s a much better way to communicate your goals within and outside of your company than talking about your market cap.
In light of recent events, I was a little concerned that this might be a case of invented memory, but Alec Klein quotes Case saying something similar in his book “Stealing Time,” as does Steve Kessler in this report from the AOL Time Warner Investor Day in 2001.
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