The “Tesla Top”

Submitted by Nick Colas of DataTrek research

Would a Tesla go-private deal be a sign of a market top, like AOL-Time Warner or the RJR Nabisco LBO? It certainly checks a lot of the boxes, and also highlights several fundamental shortcomings to public equity markets. For investors that latter point is critical, since they end up long “the disrupted” with no/little chance to own “the disruptors”.

In April 1995, billionaire investor Kirk Kerkorian made a surprise bid to buy Chrysler Corporation for $21 billion. The offer came after a private conversation with then Chair/CEO Bob Eaton where Kerkorian had said “You ought to consider going private… I already own 10% of the company. It would be easy!” Eaton simply replied “Interesting idea”, not wanting to alienate a key investor. On the strength of that discussion – and nothing else – Kerkorian made his very high profile move.

I know that sounds hard to believe, but I heard it from Bob Eaton himself when working on Chrysler’s defense against the bid. Every other senior manager concurred; Kerkorian, the consummate dealmaker, had simply heard what he wanted to hear.

So when Elon Musk announced yesterday that he had “Funding secured” for a buyout of Tesla, I flashed back to Kerkorian’s ill-fated assumption. Did Musk raise the topic of going private with a few high profile venture capitalists and hear “Interesting idea” in reply? Or perhaps he has a few anchor investors and assumes they will work to find more capital. No matter which (or none of the above), we will hear soon enough.

The real question from a market perspective is different: “How is a go-private of a $64 billion unprofitable car company even possible or an attractive idea?” A few thoughts on this:

#1. Every investment cycle has a “high water mark transaction” that signals underlying market trends have reached their apex. For example:

  • RJR Nabisco went private in 1988 in a leveraged buyout led by KKR, using $1.5 billion of investor capital to underpin a $25 billion deal. The transaction ended up working well enough, but it became a hallmark of 1980s greed and excess nonetheless.
  • In 2000, AOL effectively purchased Time Warner with its dot-com bubble inflated stock for $164 billion. The combined company’s stock declined by 90% in the years after the transaction.
  • In May 2007 Goldman Sachs assembled and sold Abacus 2007-AC1, a collateralized debt obligation chock full of risky mortgages. That’s the one where hedge fund manager John Paulson helped pick the paper he wanted to short and these were packaged and sold to other investors, who eventually lost close to $1 billion.

For better or worse, Tesla’s move to tap venture capital (debt is not an option here) to exit public markets captures every dominant narrative of the current cycle to a “T”. Venture capital fundraising is booming as VC firms struggle to compete with SoftBank’s $100 billion Vision Fund. And while public equity markets still award disruptive Tech giants outsized multiples, they usually cannot match private valuations or the convenience/flexibility of private ownership.

Bottom line: VCs are so flush with cash that they desperately need companies like Tesla – large, scalable, and levered to mega-trends like autonomous driving and clean energy – as much as Tesla needs them. Musk understands that dynamic better than most.

#2. Tesla has never been a “Typical” public company, and that highlights some of the structural shortcomings of equity markets. Forget the quirky CEO – the problem here is that disruptive technologies in capital-intensive industries take a long time to generate profits. In the interim, their stocks live and die on investor confidence alone. That makes for a volatile ride, which can hurt employee morale and motivation since they are often shareholders.

Equity investors face an even larger problem, however: consider that GM and Ford are in the S&P 500 but Tesla is not. And if TSLA is no longer a public company, there will be once less way for investors to hedge technological disruption in this industry. Blow that concept out to public equities as a whole and the issue becomes clear. Stock markets will consistently be long “The disrupted” and short “disruption”.

Not a comforting thought but that is exactly what is happening as VC-backed companies take longer to come public, and now one high profile example wants to go private again.

So what should investors make of all this? Two final thoughts:

#1. While we are not superstitious by nature, we do fear this transaction looks an awful lot like other deals done at the peak of prior cycles. If TSLA really can go private with VC capital (a $57 billion ticket), it may show that venture capital has gotten too large relative to its opportunity set. Or, perhaps, that investor enthusiasm over disruptive companies is simply too high in both public and private markets. Or both. Is all that a sign to sell everything? Obviously not, but it bears watching especially if this deal actually goes through.

#2. Venture capital investing is hugely risky and success depends heavily on access to the right deal flow, but for long-term investors there seems little choice but to play as best they can regardless of the prior point. For those who don’t check the “high net worth” category, the only choice is to own large public Tech companies that can at least buy assets from venture capitalists and fold them into their operations.

Put another way, public equity markets are packed with successful and highly profitable old-line companies. That used to be a feature. Now, with tech-based disruption, it is a very serious bug and the work-arounds are difficult and risky.

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