The Seattle Seahawks stood moments from victory or defeat against the New England Patriots during Super Bowl XLIX.
With 26 seconds left, Seattle is down by four points, second down, goal to go, and one timeout remaining.
The next step was undeniably clear to everyone watching, from the most seasoned analysts to casual observers. Put the ball in the hands of ‘Beast Mode’ Marshawn Lynch and let him bulldoze through the middle. There was no question about it.
People around me started to shout, “give the beast (Marshawn Lynch) the ball!”
Yet, as the play clock dwindled to its final five seconds, the center hurled the ball to Seahawks quarterback Russell Wilson, and in a twist, Lynch veered left—ball-less! Wilson, defying all expectations, launched a pass, only to be intercepted by Patriots defender Malcolm Butler.
Game over.
And so the grilling of Seattle coach Pete Carroll commenced.
At the time, I was in Seattle watching the game with a group of investing nerds. While I’m not a football fan by any stretch, there I was, engrossed in the match, absorbing the collective shock.
In true nerd fashion, we dissected Carroll’s decision post-mortem. We pondered an alternate reality where that game ended with a triumphant touchdown pass—a Seattle victory. It was a highly probable outcome, given that no one anticipated a pass. Had that been the case, the narrative would’ve been dramatically different, lauding Pete Carroll as a Albert Einstein level genius.
It’s a common fallacy to conflate great outcomes with great decisions. That couldn’t be further from the truth. It is possible for poor decisions to lead to fortuitous outcomes, just as it is possible for wise decisions to lead to disappointing outcomes.
The majority assess outcomes with the clarity of hindsight, but those in the driver’s seat must navigate the murky waters of foresight. This is where probabilistic and second-order thinking becomes paramount: understanding not just the immediate effects but the ripple of subsequent impacts that follow.
Just as the infamous Super Bowl XLIX left fans questioning the Seahawks’ strategy, Tesla’s latest earnings report has stirred similar debates about the automaker’s current trajectory. The scrutiny is centered around three main concerns:
1) Declining profitability, and
2) “Recalls” of its cars
3) US$56 billion lawsuit
Let’s tackle them.
Declining Profitability
Tesla’s gross profit margins have seen a notable decline, falling 620 basis points from the previous year to 17.6%, with operating margins slipping even further, from 16% to 8.2%. This drop in profitability can be attributed to two primary factors:
1) Tesla’s substantial reinvestment in its operations, described by Elon Musk as “record capex, expenses, and R&D,” particularly towards the Cybertruck production ramp. R&D expenses, for instance, have increased from 3.3% to 4.3% as a percentage of revenue.
2) A strategic decision to aggressively reduce vehicle prices.
First, my thoughts on the former, I have no issues with businesses ramping up on investments, especially for a company that’s able to do so profitably while having the genius of our generation running it. I would rather businesses do what it takes to fuel innovation, expand its moat, and explore new avenues for growth than attempt to smooth out its expenses and capital expenditures in order to please Wall Street with a consistent profitability profile.
And it’s not every day you have a billionaire CEO who’s still burning the midnight oil and sleeping in the factories, doing what it takes to see that the company hits its goals. Here was what Elon said on the timeline of the next-generation platform vehicles, “The reason I want to put this new, revolutionary manufacturing line at Giga Texas was because we really need the engineers to be living on the line… That will be a challenging production ramp. Like, I will be sleeping on the line practically. In fact, not practically; we will be.”
Second, on price reductions of its vehicles, the bears and bulls can argue until the cows come home on whether they’re reducing prices because of competitive pressures or because they’re trying to destroy the competition to seize market share.
One thing is for certain, and that is the competition can’t keep up with Tesla’s cost structure. Tesla is able to cut prices aggressively and continue to reinvest heavily while remaining profitable while its competition struggles and are handicapped by the debt on their balance sheet. In my earlier Tesla’s deep-dive:
“However, most of Tesla’s competitors are currently saddled with debt which would make it difficult for their transition into EVs. The three leading German automakers Volkswagen Group (VW), Daimler Benz and BMW have over US$450 billion in debt combined. Likewise, US automakers Ford and General Motors (GM) are also drowning with debt of over US$200 billion collectively.”
Recently, the CEO of Stellantis said this about the situation, “If you go and cut pricing disregarding the reality of your costs, you will have a bloodbath. I am trying to avoid a race to the bottom.”
The thing about Elon is that he has been clear since day one what his goal is, as shared in Tesla’s grand master plan back in 2006:
Step 1: Build sports car
Step 2: Use that money to build an affordable car
Step 3: Use that money to build an even more affordable car
Step 4: While doing above, also provide zero emission electric power generation options
His goal is to make it affordable so that the world can increase EV adoption. Even though they already have the best cost structure in the industry, they continue to focus relentlessly on cutting costs, and in this earnings call, they shared a lot about how they watch costs like a hawk:
“…we’re focused on reducing the cost of our vehicles. This is a very extensive and involved exercise where we — whereby we look at not just the component cost down to the packaging used to get the materials to the production floor. Each element of the cost is scrutinized to optimize further. A few pennies saved at the subcomponent level, whether through engineering redesign or for many other things which I mentioned, leads to cost reduction. This is a constant exercise, and we just have to chase down every penny possible.”
Furthermore, in the earnings call management further highlighted that 90% of their vehicle sales in 2023 come from first time Tesla buyers. Tesla has an insanely loyal customer base and are very unlikely to churn, from my earlier deep-dive:
“It has one of the highest Net Promoter Score (NPS) of 97 (out of 100). In a survey of 5,000 Tesla owners, 99% said that they would recommend the Model 3 to their family or friends, and 98% said they would buy the vehicle again.”
The benefits of making it affordable now doesn’t just drive sales in a higher interest rate environment, it brings in new customers who’re likely to become repeat customers and Tesla’s evangelists who’ll strengthen Tesla’s ecosystem.
More cars sold means more data and more potential for monetizing FSD one day. It’s a bold strategy but I think it will pay off long-term. These are the sort of decisions that Wall Street hates but with a long-enough view, they make a lot of business sense.
Furthermore, they are slowing down competitors and pushing them out of the market as we see Detroit manufacturers pulling back their ambitious EV plans.
Now, for the second problem.
“Recalls” of its cars
The news has been plastered with Tesla having multiple recalls recently but we must understand that Tesla’s “recalls” are very different from traditional vehicle recalls where there are costs incurred with the car being sent back to the manufacturer.
The media and more specifically the National Highway Traffic Safety Administration (NHTSA) don’t have a term for software update, so everything is called a “recall” even if it didn’t cost Tesla anything.
“Never incorporate your company in the state of Delaware”
A shareholder who owned 9 shares filed a lawsuit that stopped Elon from getting his US$56 billion compensation from the huge incentive plan. The crux of the lawsuit was that Elon came up with the incentive plan rather than the board of directors. The judge ruled that there were conflicts of interest and board members are required to remain independent for a compensation plan to be considered legal.
From a shareholder’s perspective, that’s a whole chunk of shares that wouldn’t be vested out of the fully diluted share count.
I am not certain whether Elon will do anything radical to advance his interests given that he wants a 25% voting control stake.
When asked about his statement about not being comfortable with expanding AI and robotics at Tesla if he does not have 25% of the vote, Elon responded:
“My concern is here, which is that, you know, I see a path to creating an artificial intelligence and robotics juggernaut of truly immense capability and power. And my concern would be I don’t want to control it, but if I have so little influence over the company at that stage that I could sort of be voted out by some sort of random shareholder advisory firm…I want to have enough to be influential. Like, if we could do a dual-class stock, that would be ideal. I’m not looking for additional economics; I just want to be an effective steward of very powerful technology. And the reason I just sort of roughly picked approximately 25% was that that — that’s not so much that I can control the company even if I go bonkers. And if I’m, like, mad, they can throw me out, but it’s enough that I have a strong influence. That’s what I’m aiming for is a strong influence but not control.”
My guess is that Elon is scarred by his PayPal experience where he was ousted from the board and replaced by Peter Thiel. By getting the board to grant him more shares, he isn’t looking for monetary advantages, but more control.
This means that Elon’s request will not result in further diluting of shareholder ownership.
Elon seems to be lashing out at the state of Delaware for the ruling, not the board, not the company, and not even the individual shareholder with nine shares. It doesn’t seem to affect his commitment to Tesla in any way.
We’ll see how his request for the 25% voting plays out and I’ll share more of my thoughts as the facts unravel.
Conclusion
Like the controversial play by coach Pete Carroll at the Super Bowl, we have no absolute control over the future nor the outcomes, but we’ll have to evaluate the quality of the strategy using probabilistic and second-order thinking.
At a cursory glance, Tesla’s profitability appears to be under pressure. However, considering the second-order effects, Tesla’s strategy is clear: maintain a cost structure that suffocates competition and continue to prioritize cost reduction. While the short-term optics may not impress, Tesla’s long-term outlook remains robust. The company is not just maintaining profitability but also positioning itself as a dominant force with multiple engines for growth, independent of capital market whims.
Disclaimer: This research reports constitute the author’s personal views only and are for educational purposes only. It is not to be construed as financial advice in any shape or form. From time to time, the author may hold positions in the below-mentioned stocks consistent with the views and opinions expressed in this article. Disclosure – I hold a position in Tesla at the time of publishing this article (this is a disclosure and NOT A RECOMMENDATION).