Tesla's Valuation: From Ridiculous to Gary Busey in 5.8 Seconds

Last month I did my best to describe why I felt that electric vehicle maker Tesla Motors' (TSLA 0.44%) valuation appeared ridiculous. To do this, I conjured up my own metrics which I felt demonstrated beyond a shadow of a doubt that on a fundamental basis Tesla was overcooked and ready to be sent back to the kitchen.

And then Tesla reported its second-quarter earnings results last night and things quickly bypassed ridiculous and went to a new level of crazy that I now refer to as Gary Busey.

Why Gary Busey? Because Tesla Motors, like Gary Busey the actor, has managed to rise to the big show from obscurity. No one believed Tesla would be successful at mass producing an electric vehicle; succeeding where other automakers, such as General Motors (GM +2.56%) with the EV1 and Toyota (TM +1.93%) with the RAV-4 EV, had failed. But it has been successful on a large scale: Tesla's Model S is selling so well it can't produce the car quickly enough to meet demand.

But the reason I also equate Tesla to Gary Busey is that on a scale of sane to crazy, Gary Busey is often viewed by the media as being in his own world, which is exactly where Tesla's valuation traveled today.

Source: Steve Jurvetson, Flickr.

The nitty-gritty of Tesla's second-quarter results is that things are improving. You heard me right: Elon Musk's company is looking better than it did one quarter ago. On an adjusted profit basis Tesla earned $0.20 per share and delivered $405.1 million in revenue which is more than 15 times what it produced at this time last year. Comparatively, the Street expected just $386.9 million in revenue and a loss of $0.19 per share. Furthermore, Tesla delivered 5,150 cars which topped its own quarterly guidance of 4,500 vehicles. 

Those were the good aspects of this report. I'm not going to deny that Tesla produced those figures or topped its delivery expectations, but I also want to point out some of the figures that Wall Street seems intent on ignoring that help prove just how insane the valuation on Tesla has become.

Tesla unmasked
For starters, let's begin with Tesla's bottom-line profit of $0.20. This figure represents Tesla's adjusted profit, including the benefit of zero-emission tax credits, and excludes one-time fees. Ultimately, Tesla reported a narrower, but still hefty, GAAP quarterly loss of $0.26, or $31 million. Don't be too surprised about Tesla'a GAAP loss as the very first sentence of its quarterly shareholder letter notes that profits are "not our primary mission"!

Even revenue figures were masked by a GAAP/non-GAAP bias. Because of a reduction in price of $10,000 per car that Tesla honored for orders of discontinued 40-kWh battery packs, revenue was actually flat compared to the first-quarter... but investors seemed to ignore that fact.

Let me not also fail to mention that it recorded a cash outflow of $38 million during the quarter. Instead, the big boost in cash on Tesla's balance sheet comes from what will wind up being a 4.5 million share dilutive offering and not from cash generated from the sale of its automobiles.

How about margins you say? For the quarter we certainly saw gross margin improve to 22% from 17%, but these are non-GAAP margins. In layman's terms it just means that this figure includes those one-time benefits like ZEV credits. If you strip those out of the equation, the real production margin on Tesla's operations is a meager 13%. Sure, that's a nice improvement from the 5% it produced in the first quarter, but it's a long way to go to a target of 25% with just two quarters to go before its ZEV credits are gone for good.

Let's also examine Tesla's quarterly production. There isn't much negative I can take away from Tesla yet again outrunning its own guidance on the production front with 5,150 Model S sedans produced during the quarter. Yet, oddly enough, Tesla didn't boost production guidance for the remainder of the year, choosing to keep it at 21,000 units. The reasoning is that many of the cars produced toward the end of the second quarter are now on their way to Europe and won't get there until well into the third quarter. So despite producing more cars than expected this quarter, Tesla's production capacity really didn't improve, at least from Musk's forecasting standpoint.

The price of insanity
Now that you have a better understanding of what's really hidden beneath Tesla's one-time costs and benefits, let's have a look at the meat and potatoes of just how expensive this company has become.

Basing my calculations on Tesla's last after-hours trade at $153.20, Tesla now commands a market value of $17.7 billion, which is higher than robotic surgical device maker Intuitive Surgical, confectioner Hershey, and handbag and accessories maker Coach. Though in different sectors, what these three companies have in common is that they produced $672 million, $817 million, and $1.04 billion, respectively, in free cash flow last year. By contrast, Tesla Motors has struggled to even deliver breakeven cash flow from its operations.

On a forward basis, Tesla is valued at roughly 150 times forward earnings. For those of you who like to trump Tesla's revolutionary new product as a reason for its frothy valuation, I'd like to point out that the company's projected growth rate next year is going to slow dramatically to just 25%. Running the math on Tesla's price earnings to growth ratio leaves us with a ridiculously high PEG of six! Normally anything over three should sound the alarm in your head.

But, let's also revisit my price per car tabulation that I examined last month and see how this valuation has become even more distorted.

Source: Yahoo! Finance and author's calculations. * Based on after hours price; ** based on 2013 projections. 

In general, the figures for the other carmakers haven't changed much since last month, with each company offering its own unique selling points. GM is in the process of introducing its new line-up of redesigned trucks (the Sierra and the Silverado) in the U.S. for 2014; Ford is focused on pushing its fuel-efficient small cars and EcoBoost-powered vehicles in China and domestically; and Toyota and Honda are both targeting a push that'll help them reclaim lost market share in the U.S. by focusing on fuel-efficiency and value.

Then there's Tesla, which I thought was grossly overpriced at $600,000 per car three weeks ago. Based on last night's after-hours price, Tesla is commanding close to $843,000 per car – in other words, about 12 times the actual cost of the vehicle with the assumption that it's free to produce! With real operating gross margins of 13% on its $70,000 Model S, Tesla is reaping about a $9,000 gross profit from each car produced, yet we're willing to place a valuation of $842,857 on each car! Based on the above calculations, Tesla would have to boost its production by a factor of 20 just to be twice as expensive on a value-to-car basis as the next highest big automaker in the table above, Honda. By this context Tesla's valuation could be up to 10 years ahead of itself.

Is this the craziest valuation ever?
Given Tesla's numerous production gaffes leading up to the debut of the Model S, I have a strong suspicion that its Model X SUV will suffer numerous delays next year. Let's face it, production was already pushed back a full year to 2014. Tack on the fact that the infrastructure to support EV battery replacement and recharging isn't there for a good chunk of the public, and pricing on the Model S is well beyond the scope of most budgets, and you have even more reasons to avoid this stock.

I remember seeing some pretty frothy valuations in the heyday of the tech bubble, but I can't recall any company in recent history that has commanded as lofty a bounty as Tesla. I very recently initiated a short position in Tesla and, when the Fool's disclosure policy allows, I will almost assuredly be adding to that position.