Will hype beat history?
Two weeks ago, I wrote about Apple and Tesla and their respective involvement in the car industry. Apple is obviously a tech stock by virtue of its current product offer, and Tesla is treated as one, rather than part of the traditional auto industry. We have become familiar with the high valuations achieved on the stock markets by companies like Tesla and newer start-ups such as Nio and Rivian. Tesla is now worth not only more than Toyota or Ford, but the next thirteen most valuable non-Chinese car companies combined, which is quite an eye-watering thought. Rivian – which has not sold one car – is valued at $28 billion, close to the $39 billion valuation of Ford (who ironically are investors).
However, in an interview earlier this month with Bloomberg, Herbert Diess, the Volkswagen Group CEO, highlighted another aspect of the froth that surrounds these companies. For the most part, the growth of the share price in any stock benefits the shareholders rather than the company directly. Managers may be more motivated if they can see the value of their own shareholdings and any stock options they have been awarded grow, but any profit goes to the seller of the shares, not the company. However, when a company issues more shares or issues bonds, then these funds do come to the company, and for established players it is a relatively rare event, as there are downsides in terms of diluting the earnings of existing shareholders – the dividend pot needs to be spread across more shares or the interest in the bonds needs to be paid from profits. Normally there has to be a clear upside for the issuance of new shares or bonds to be successful – often the acquisition of another major player.
Car companies therefore fund their normal investment needs – new products, even on the scale of the electrification we now see, or expansion into growth markets – from their cash flow. In the case of a company like Volkswagen, this is huge – they generated over €5 billion in free cash flow in the last quarter of last year, and over €10 billion for the full year, despite Covid. However, this huge achievement needs to be considered in the context of Tesla, Nio and XPeng, another Chinese BEV start-up, who raised almost that same amount in a single week in December through issuing new shares. Tesla’s much-acclaimed annual production in 2020 of almost half a million cars is equivalent to less than three weeks’ sales of VW in a Covid-affected year. Nio delivered under 44,000 cars and Xpeng 27,000, the latter two combined representing two or three days for VW Group production.
The effect of this difference between ‘old world’ players and the ‘tech’ players is that for an old world player to fund a billion euro investment, they need to operate a large and complex global business effectively for a few months. For the new tech players they need a good Powerpoint slide deck that shows substantial growth from a small base, and throws in a few buzz words that investors are attracted to, like autonomy and connectivity. I’m exaggerating to some extent, because some of the emerging Chinese players are launching good product, and we will see it in increasing numbers in the coming year or two. However, as long as there is relatively easy capital available, they have an advantage over the old world players who understand how difficult it is to deliver autonomous cars safely, and have been struggling to monetise the investments that they have made in providing connectivity in an era where the smartphone has become ubiquitous.
Where the rubber may hit the road (or should that now be the electron hits the silicon?) is in the marketplace, where the hard work of the old world manufacturers is delivering a torrent of electrified product, sold through dealer networks (regardless of any future contractual changes) who understand customers and are becoming increasingly capable. They can take a few knocks and come back fighting. The tech players depend on a continuing good news story for the investor community. It would be extraordinary for them not to come across some bumps in the road, at which point they will quite likely find that the money quickly goes to the next good news provider. They need to start putting down some roots, so that they can also take a few knocks and demonstrate more than good year-on-year sales growth and shiny tech in their latest product. Of the various tech players, only Tesla seems close to that point, and that has taken almost a decade from the launch of the Model S.