Tesla, Inc. (NASDAQ:TSLA) certainly has had a rough start to the year businesswise as well as on the stock market. Sales cratered, as did Q1 profits. Moreover, the Delaware Court of Chancery voided CEO Elon Musk's 2018 compensation package, which would have seen him being granted stock options with a combined value of up to $56 billion (considerably less at the current share price). The board is putting the same compensation package to a vote at the June 13th general meeting (cf. item 4 of the agenda). The company even launched a dedicated website to advocate shareholder approval of the measure.
If approved, the downside for shareholders would be a significant measure of dilution if and once the options would be exercised. All this comes at a time, when at least anecdotally, Elon Musk's behavior outside his role at Tesla is increasingly alienating (potential) Tesla customers.
Yet despite all this, I see some positives for the company. Specifically, I believe that it is not unlikely that we will see Tesla beginning to distribute a dividend in the foreseeable future. Below, I will explain my reasoning behind that thesis and why I believe Tesla to be overvalued regardless.
Sustainable Profitability
Q1 net income amounted to $1.1 billion. While that figure is less than half what it was in the corresponding quarter of 2023 and represents a staggering decline of 86 percent QoQ, it still speaks for Tesla's sustainable profitability. After all, a quarterly profit of $1.1 billion, in absolute terms, is not all that bad. Also, keep in mind that Q1 of 2024 was certainly an awful quarter both on a macro level (the car market, EVs in particular, took a steep downturn; trade disruptions in the Red Sea and elsewhere) as well as for Tesla in particular (sabotage at the Grünheide factory, quality control issues with the Cybertruck). If even under circ*mstances as adverse as these, there is still a sizeable net profit, I am quite confident that profitability will remain the norm. Furthermore, Tesla also has a rather strong balance sheet compared to industry peers.
There are some voices who suggest that the current wave of rather abrupt layoffs on short notice may hurt the company going forward in terms of recruiting. But I somewhat disagree with that sentiment. You have to keep in mind that Tesla is not the only business in its industry that is experiencing challenges. I assume that many of the laid-off employees will be back if they are wanted back. Despite my notoriously bearish stance on the Tesla stock, I am quite optimistic about the underlying business in the long run.
No Better Way To Spend The Money
Do profits necessarily mean a dividend? Certainly not. But absent distributions, the question of what to do with the money presents itself. Let's face it: the time of explosive growth is over for Tesla. Debt levels are entirely moderate. So, there is no pressing need to retain profits. This is especially true in a possible scenario where the development of the likes of AI solutions may increasingly be undertaken outside of Tesla at some of Elon Musk's other companies. At the same time, share buybacks do not make any sense at the current valuation.
With a payout ratio of around 40 percent, that would amount to a cumulative dividend per share of around 50 to 60 cents in a bad year, but might easily top $2 in a strong year. Relative to the share price, that is not overly impressive. But if you consider absolute figures, a few hundred million dollars may find their way to Elon Musk's personal coffers with any given distribution, while any other shareholders would also receive their share pro rata to their respective stakes.
Elon Musk Needs Money
Now, the most likely catalyst for instituting a dividend is, in my opinion, that Elon Musk needs money, while at the same time being keen, as per his own statement, to not reduce, but in fact, increase his stake in Tesla. And if a person who exercises effective control of a profitable company needs money, a dividend is a reasonably likely thing to happen.
Technically, Mr. Musk is not in a position to decide this alone, as it is up to the board of directors to propose a dividend. But in practice, I have little doubt that the other members of Tesla's board (most of whom, on a side note, have been found to be so close to Mr. Musk to a point where the body lacked independence from him by an impartial Delaware Chancellor) would favorably consider such a proposal. At the end of the day, directors serve the company's shareholders. And I have yet to encounter the shareholder base that opposes being paid a dividend.
The elephant in the room is, obviously, that it appears counterintuitive at first glance that one of the richest individuals on the planet should be in need of funds. Let me explain. Elon Musk is what could be described as asset rich, but cash poor. Now, admittedly, Mr. Musk seems to be leading a relatively modest personal life for a man of his wealth. That being said, he has a plethora of business interests which - despite huge potential - are net cash consuming for now.
X Corp., the social media business formerly known as Twitter, in particular, generates massive losses. I doubt that Mr. Musk is too keen to let the company go bankrupt. Also, I think it should be considered that control of X appears to be some kind of hobby (and a costly one, in more than one way, at that) for him. Given recent negative experience with public shareholders, I imagine he might also be reluctant to take the likes of SpaceX public and/or dilute his stake. That entails, of course, that he will have to participate in upcoming equity rounds to end up with the same relative share of economic ownership - which in turn requires liquid funds.
At the same time, Mr. Musk's go-to source of liquidity has somewhat dried up: Under the amended share pledge policy (cf. p. 9 of the 2023 proxy statement), the maximum amount of permitted pledging of Tesla shares by its CEO is now capped at the lower of $3.5 billion or 25 percent of the value of pledged shares. Even being granted stock options under a reinstated compensation package will not change that limit. Effectively, that means that Mr. Musk can no longer monetize his shareholdings without (a) selling shares or (b) receiving a dividend. That very amendment furthermore demonstrates that, to some degree, the Tesla board is likely to keep closer tabs on executives, including Elon Musk, going forward.
In theory, Mr. Musk could step down as CEO of Tesla, thereby freeing all his shares up to borrow against as he pleases. I believe that this, despite his shortcomings, would be bad news for Tesla investors. Naturally, any potential negative fallout of such an exit would be disproportionately felt by the largest individual shareholder. If anything, I would see a risk of him leaving office due to his compensation package not receiving shareholder approval (which I would not treat as a foregone conclusion) or subsequently being voided in court yet again (which is not entirely impossible).
At the current share price, Tesla only accounts for a minority of his personal portfolio. Actually, his most valuable individual holding - albeit by a rather slim margin - is his 42 percent equity stake in SpaceX (SPACE), which at the latest private market valuation of $180 billion for the company should be worth about $75 billion, a few million dollars more than his last reported Tesla stake (keep in mind that the beneficial ownership includes unexercised stock options subsequently voided by court; the actual ownership figure are the 411 million shares owned outright). But that notwithstanding, the absolute value of the position is still very significant. These absolute figures are also, why I believe he is reluctant to simply sell more shares (arguably the most straightforward way to monetize an asset). Such a move might be understood by the market as a sign of waning confidence, thereby triggering further sells and thus destroying value.
Be that as it may, I believe that the likelihood of him staying on as CEO is considerably higher than that of an exit. Consequently, a dividend would be the most straightforward option to generate liquidity without selling further shares.
Valuation
So much for the good news. Time to face the elephant in the room: valuation. Readers of my previous work probably already know that I do not view Tesla as more than a car company. In fact, I believe that its nature as "just" a car company is underlined by recent developments. In particular, the cuts to the Supercharger unit make it highly unlikely that this will be a business that moves the needle any time soon. Nor is the energy generation and storage (revenue +7 percent YoY) looking like much of a game changer.
For a car company, Tesla appears quite highly valued. Even using peak earnings, the company trades at a P/E multiple of around 40. A dividend, while generally positive, would not justify this kind of premium to the likes of Toyota Motor Corporation (TM, OTCPK:TOYOF), Mercedes-Benz Group AG (OTCPK:MBGAF) or General Motors Company (GM) to name but a few. The Cybertruck, even with the current quality control issues resolved, is unlikely to lead to significantly higher overall margins due to relatively low volumes. The new "small car" platform code-named Redwood appears to have been postponed or canceled in favor of a new low-cost model based on existing architecture. While this may reinvigorate unit growth to a degree, margin expansion is unlikely, as customers in this segment are particularly price sensitive and competition is fierce. These new models are part of how I believe that Tesla could get to eventual revenue in the range of $200 billion with a profit margin of around 10 percent eventually.
Much of Tesla's valuation is based on more or less vague fantasies of some "next big thing" materializing at some point in the future. The current flavor of the day seems to be Robotaxis, as demonstrated by the positive market reaction following the announcement of an announcement on August 8th. I reckon that a disappointing Robotaxi reveal may be a downside catalyst, leading to substantial dips in the immediate aftermath.
Meanwhile, as I have stated before, I would not assign significant value to the "Optimus" robot project. My approach is to view it as a venture investment on the side, not as a real business (yet). Recent developments, if anything, seem to have somewhat dampened optimism about Optimus.
Thesis Risk
There are of course some risks to my thesis that should be noted. First, a short-term profitability boost is not unlikely as a result of massive cost-cutting. Excellent QoQ developments are to be expected as a matter of base effect applying following a weak Q1. That could spark some serious short-term exuberance in terms of stock prices following the July Q2 earnings release.
Furthermore, the Robotaxi announcement/reveal could lead to even more (not necessarily warranted) optimism, if it is impressive and/or inspiring enough to fuel investor fantasies. And of course, there is always the possibility of some very impressive dance moves being performed on video by some Optimus robot.
As relates to a potential future dividend in particular, it should also be noted that Elon Musk could come up with alternative sources of liquidity. For once, he might borrow against his SpaceX stake (especially if an IPO were to happen eventually). Also, the pledging restrictions at Tesla are not set in stone and may be reversed or amended.
Conclusion
All in all, I believe that Tesla by now has established itself as a profitable carmaker - not just an electric carmaker - that is here to stay. Then again, I am more than ever convinced that it is not more than just that: a very good, sustainably profitable carmaker. As such, I see a reasonable likelihood of the company beginning to return profits to its shareholders in the short to medium-term future.
At the same time, the fact remains that Tesla is richly valued, to say the least, compared to industry peers. As I have stated before, my bull case valuation target for Tesla is $60 per share on an undiluted basis. Recent developments, if anything, make that target price more, not less, ambitious, in my opinion. Consequently, I do not see any reason to adjust that price target upwards. In fact, the probability of significant dilution by way of the compensation package alone would probably merit a downward revision. For now, I will stick to $60 as the upper end of what I believe to be a reasonably justifiable share price. At the time of writing, that makes Tesla overvalued by close to 70 percent. Unsurprisingly, I am therefore maintaining my sell rating on Tesla, Inc. the stock.
Christoph Liu
I am and have been for some time interested in various investment-related topics. Therefore I started investing a few years ago. At this moment I do exclusively invest using own money. My focus is primarily on stock market investments with a long term investing perspective. Particularly, I invest in companies with a strong and fortified market position and stable profits.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of MBGAF either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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