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Size the business before the company _ Tesla Inc. example


#entrepreneurship #valuation #consulting #business #management



 

While managing or evaluating corporations and new ventures, it is easy to get lost in the financials of the company losing sight of the numbers of the business. This post may help entrepreneurs and investors make strategic decisions by gaining a first high-level understanding of the opportunity, before getting involved with the specifics of the implementation. The discussion will be applied to Tesla Inc; if simple and direct math can be applied to public companies, it can be applied to much smaller ones too.


For this discussion it can be useful to distinguish three different concepts and they can be called: the business, the company and the investment:


1. The business is about sizing the company and its underlying potential at maturity. The analysis of the business tells us the obtainable revenues, implied costs and obtainable cash.

2. The company is a concept involving the execution – “how to get there” -- therefore the process allowing us to get to the point of realizing the value of the underlying business. The company involves the entrepreneur, the management and the decisions in time.

3. The investment is the idea of whether the value (from the cash-flows) of a specific company is coherent with our existing portfolio, required return, investment size and investment domain. It is a mix of the purchasing price, cash-flows in time and existing portfolio.


This post deals with the more generic concept of the business, without considering immediately how the management can get there or whether it would be a good investment of capital. A first rough calculation makes it easier to understand which aspects of the underlying business are more critical; that knowledge can help during the subsequent analysis of the company and the implementation.


Let’s now go through an example, Tesla Inc.

This is not meant in any ways as a discussion of Tesla’s stock and valuation. This is meant to be a way to show that even situations that are hard to forecast and evaluate, can be simplified in order to size the opportunity.

In the analysis of the business presented below, possible revenues as a mature company in 5 – 10 yrs are calculated together with margins and final cash-flows. Automotive revenues are based on Tesla's current public material and margins are based on possible targets currently implemented. Energy related numbers are obtained as per the calculation in the blue cells starting from current results. After the cash-flows per each product-line or business-unit are calculated, a common level of Depreciation & Amortization is added back and Capital Expenditures are subtracted; that is in order to figure out the total cash-flows at a steady-state of the business. Finally, the annual cash-flow is discounted at perpetuity of 5% (average current public-market discounting rate, Price over Earnings ratio of 20). Despite the possibility that the reader has different idea on the size of obtainable revenues, margins and the discounting rate, the analysis should not involve at this point any considerations on management, ramp-up, cash-management etc ... That is also why the calculation below uses a low and average discounting rate as per a steady company – that would be a long discussion anyway.


Possible size of the business in few years:


Just as reference, what Tesla currently may already have of the possible steady plan above, is revenues from Model S and X totaling about $10Bil (as per numbers above), plus maybe something less than 50k Model 3 in the last twelve months totaling about $2Bil in revenues and a combined annualized $1.55Bil revenues from energy storage (batteries) and production (solar panels) – single components may be $250MM + $1.3Bil. That gives Tesla something close to about $13.5Bil in current Trailing-Twelve-Months revenues.


However, the objective of the analysis above is to build a simple and quantitative snapshot of the business able to “size” the opportunity; therefore at a more mature state – it reaches almost $53Bil revenues in the picture above. It could be enriched with a breakeven analysis able to study the profitability of the business considering the operating leverage (variable vs fix costs) and different levels of sales. At the end, it is possible to obtain a fair rough valuation assuming an optimistic and successful implementation. The assumptions above result in about $83Bil value that is about $490 per share considering current diluted shares. The obtained value can be a first useful reference for further refinements including ramp-up investments etc ...


To conclude, if a small entrepreneur is asked a certain amount to start, buy or sell a business, a similar rough and direct calculation could be an effective starting point for further thoughts. The analysis could expose critical levels to reach for a specific valuation to be considered fair. The calculation could also expose flaws of an excessive price and opportunities of a low one. This is completely opposite of valuing a business at a certain price just because a similar one was sold for x-time the sales or other comparable numbers; opportunities will seldom be caught in that way. Only after understanding what has to happen, it is possible to design how to get there and whether it makes sense to the investor and entrepreneur.



 

This post does not constitute in any ways investment advise


 

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