The Musk of a Dynamic Business Model – Part 1

Elon Musk does not think small. Neither does he think narrow. The South African born entrepreneur has managed to dip his fingers into a number of industrial sectors to varying degrees of success. With SpaceX (Industry Sector: Space Exploration), Tesla Motors (Industry Sector: Automotive) and SolarCity[1] (Industry Sector: Renewable Energy) remaining going concerns, Musk has etched his way into the global consciousness as someone who can achieve whatever he puts his energy into.

Does an investor invest in the person or the idea? It is probably both, but when Musk approached potential financial backers for SpaceX and Tesla, their decision was swayed by his success in setting up PayPal. The ideas for these new companies were, at first glance, too off the wall. Space exploration is a capital intense industry; electric cars are hindered by scale, performance, infrastructure and the durability of the gasoline car. Both industries are at the service of a select few.

Nevertheless, Musk has managed to get financial backing for his projects. As Daniel Gross points out in 2012, Musk has an ingenious knack of raising money. First, there is his own, considerable wealth generated from the success of PayPal. Second, venture capital funds come in handy, and when one is sitting in California, many a green fingered individual or fund is looking to invest in the next big idea. Third, there is the IPO. Tesla Motors and SolarCity are on the exchange, with Tesla raising $226 million in 2010 and SolarCity raising $92 million in 2012. Fourth, the financial market is an arena in which an astute individual can be innovative in their fund raising. SolarCity has securitized the rent on solar panels, created long term bonds, and sold onto the market. Fifth, obligating consumers to pay a percentage of the price before the goods are put onto the market. To purchase Tesla cars, you are required put a deposit of between $2500 and $5000 depending on the model of the car. Sixth, exploit or rely on the government. A convenient loophole in legislation forced large automakers to buy credits from Tesla. Tesla has also benefited from $465 million loan from the Department of Energy. NASA has paid over $300 million for SpaceX cargo missions. SolarCity receives a number of tax incentives thereby cheapening production.

Musk does not like the idea of taking subsidiaries. Indeed, free market proponents such as Musk are critical of government support as they can distort the market. But for the grandiose vision of his ideas, it is difficult to keep a distance with the government especially when it comes products that are not completely economically viable. The government has the greatest access to liquid cash, and decides legislation which can help or derail businesses. Government support is consequently necessary in some form. This is especially true when it comes to Research and Development. With Tesla Motors and SpaceX R&D is particularly important in order to ensure continuing, viable companies, and hence they have to rely on some form of government assistance to enable – either through tax rebates, credits, loans – investment. The existence of SolarCity, a company that installs solar panels rather than develop new ways of harnessing solar power, owes itself to the decades of government funded R&D in the US, Japan and Germany.

Looking at Tesla Motors recent quarterly report, the company reported an adjusted net loss of $45 million, or 36 cents a share, which compared with adjusted earnings of 12 cents a share a year ago. Tesla’s adjusted revenues hit $1.1 billion. For the average reader, the word ‘loss’ would ring bells, but analysts were pleasantly surprised by the results expecting a greater loss. Breaking down the revenues further, we see that $66 million was gained from regulatory credits and a further $51 million from the sale of zero emissions vehicle (ZEV) credits to other automakers. Overall, most of the revenue will be going into R&D. Indeed, in 2014, Tesla Motors spent $464 million on R&D.

Tesla Motors does not regularly post profits, and yet its share price has on the whole shown an upward trend since IPO in June 2010. Finishing at a share price of $23.89 on the day of the IPO, it is currently at $226.03. Musk does not think Tesla will turn into profit until 2020. But, arguably, there is a sense in the market, that Tesla, as well as SolarCity and SpaceX (SpaceX however is not on the exchange) are on the brink of a new dawn, a revolution if you will, creating a world in which our driving or the way we consume energy will be significantly different to the current juncture in the world that we find ourselves in. By buying Tesla shares, investors are investing in both a product and a cause.

Buying into a cause is an idea alien to most investors whose main concern is a sound profit. The complex art of investing is underpinned by a range of concerns: the state of the market, the price-earnings ratio, the decisions of the company, but at its most fundamental is whether there is sufficient demand for the company’s product to justify short or long term investment. One can never be certain as to how successful a company will become; the best they can do is predict reactions of customers. Yet at the same time, supply can create demand, especially if there is a principled interest in a greater objective. Most people are interested in renewable energy, if not for its potential to reduce pollution, then certainly for its potential to move away from scarce resources such as fossil fuels and to more enduring sources. Indeed, once sunk costs are paid to set up the infrastructure, the cost of producing thereafter will be low with distribution being the key concern.

Investors are turning onto this idea and are willing to give Elon Musk’s schemes a shot. But this is not pure investor activism. Rather, Musk has to create a kind of smoke and mirrors strategy in which he tempts investors with profit, while reinvesting and locating other forms of investment, including government assistance to build up the companies as well as the proposition. We explore this in the next article.

[1] Musk is the Chairman of SolarCity and not it’s CEO although he has been pivotal in its startup and continuance.

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