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Leading the charge

Tesla has drawn more attention than any other company Ballie Gifford has ever invested in on behalf of their clients and is a top ten holding in the Long Term Global Growth Fund. In this article, the Baillie Gifford team reveals the research behind one of the highest-profile investments in their 113-year history. Learn how the team got to know the company, how they stayed the course and what they’re thinking about next. 

In Little Fockers, the lazy but enjoyable third movie in the Meet the Parents franchise, the perfect ex-boyfriend and spiritual tree-hugger played by Owen Wilson rocks up to the family house in a silent orange sports car and jumps out. On seeing the open-mouthed wonder of the Focker family, he shrugs and says: “Yeah … I guess it’s a Tesla Roadster or something? Supposedly eco-friendly, like that 2003 Prius.”

When we think about seminal automobile moments in Hollywood, what comes to mind? Probably Steve McQueen’s green Mustang in Bullitt, bouncing sonorously down the streets of San Fran, or James Bond’s silver-birch DB5 with innovative weaponry in Goldfinger. Maybe it’s time to add a third icon, in terms of entry into collective consciousness: the orange Tesla Roadster in Little Fockers.

But when did Long Term Global Growth’s consciousness about electric cars awaken?

The answer predates the 2010 release of that film and, like many successes, it stemmed from initial failure.

2007 to 2010

Our investments in the 2007–2010 period in alternative energy stocks (Vestas, First Solar, Q Cells) did not pan out well, as we have recounted before. But in 2008 one offshoot of the alternative energy investments was a look at electric vehicles, which we did through one of our inquisitive researchers, Daniel Simpson. We sent him off to try out whatever electric vehicles he could find. A few of you may remember the children’s toy dimensions of the G-Wiz, and at the time that’s exactly how the public thought of electric vehicles.

2012

But then Daniel tried the Tesla Roadster – like a sleek Lotus Elise but with even faster acceleration. He reported back that electric cars had suddenly become cool and exhilarating. This provoked our interest, as did our global small-cap team investing in Tesla in January 2013 (at a market cap of $4bn) on the basis that it had a tiny chance of being the next big thing (it made a mere 3,000 cars in the year before we bought it).

The rotation of analysts around teams at Baillie Gifford has always been an important part of our investment culture, promoting collaboration and idea sharing. When Peter Singlehurst, now head of our Private Companies Team, moved from our global small-cap team to LTGG at the end of 2012, we asked him: “Which of the 100 small-cap holdings should LTGG own?” Peter said: “Tesla.” So, at that point, we did our own LTGG 10Q on the company, whose blueprint is now famous:

Blueprint
The blueprint (Source: Baillie Gifford)

2013

January: 10Q on Tesla

When we look at our best investments, it’s striking how much we got wrong. With Tesla, the share price was $8 when we wrote the 10Q in January 2013, versus $800 eight years later. After a few months of deliberation, we started buying it well north of $8, kicking ourselves for not getting on with it earlier. As we were doing so the share price seemed to get away from us further. We paused. The share price continued up. And we resumed our purchases at an even more annoying $20 – more than twice the price a few months earlier! Imagine if we’d stopped altogether, on ‘valuation grounds’?

Deliberations over Tesla in 2013 serve as a hugely important lesson on valuation, though not one that clients tend to like to hear, namely that the valuation we buy in at early on, for a great growth stock, does not matter. It really doesn’t – not if you latch on to a company that then grows revenues at 25 per cent or 35 per cent or 50 per cent per annum for the next decade. If the company delivers on that sort of growth, our investment will go up many times in value. Imagination is the key, not discipline.

Much like our early attempts at imagining how big Amazon could be, our blue-sky case on Tesla fell a long way short of future reality. Remember, we pride ourselves on being the optimists, but the lesson here is the same: if you buy the right company, then even the wildest optimists (i.e. us) will be miles short of imagining the scale of future achievement. Our brains cannot compute the astounding results of high-growth compounding (we’ve cited the Sissa and the chessboard grain-of-rice story before). But at least we were trying, and with years of practice we may even be getting better.

So, for Tesla in 2013 our medium-term upside was $15–$18bn of market cap in five years’ time (from $4bn) and $45bn in 15 years’ time. As you know, the market cap today, eight years on, is over $600bn, so more than 10 times our 10 times upside. But the prescient author of the first note, humbly sensing inadequacy, did finish with a plea to colleagues: help me be more imaginative with the upside.

Nevertheless, what we got right was far more important than what we did not. We believed Tesla had a huge lead in electric vehicle technology and a huge competitive advantage over the conflicted (non) competition, that the auto industry was blind and asleep to what would happen over the next few years, that Elon Musk was the visionary to lead this transformation in transportation, that electric would go mainstream, that the Tesla was simply a superior product to internal combustion engine (ICE) cars regardless of your environmental views, and many other contentions.

The unfolding Tesla story therefore also brought another lesson home: about the blindness that comes from over-specialisation. We have long eschewed sector specialists at Baillie Gifford, and Tesla is a great example of why. The worst people for predicting the future of the automobile, the most blinkered observers – we did ask around – were without doubt the automotive analysts and industry insiders themselves. They all trotted out the same knee-jerk “GM/Toyota/Ford will just squish Tesla when they take it seriously” line.

The analysts were useful – as contrary indicators of the future. They fell into the pattern we also saw with Amazon and the retail analysts: “Amazon must be overvalued because its market cap is bigger than Borders and Barnes & Noble’s combined” (2006). The auto analysts? “Tesla is hugely overvalued because its market cap is bigger than GM”. At a time of impending industry transformation, sector specialists will be the last to see the wood for the trees.

That’s not to say we weren’t frequent visitors to BMW, Porsche and Toyota ourselves, but each time we came away with the same conclusion: their giant existing ICE businesses were continuing to hold them back. Tesla was gaining a bigger lead by the week.

We had another go at the Tesla upside in 2017, but in the intervening period we were reminded why being optimistic and supportive shareholders is often tough – “hell is other people”, as Jean-Paul Sartre put it.

Hold discipline vs distractions

Clients and consultants often ask about ‘sell discipline’. This may be the wrong question. What they should really ask managers who claim to be long-term investors is: “Tell us about your hold discipline.”

It’s quite hard to convey now how difficult it was to remain focused on the fundamentals of the Tesla story for the years after 2013. We have owned companies that have gone up and down and in and out of favour, but nothing like Tesla. The turbulent backdrop was reflected in many meetings with clients, the majority of whom would have had us sell Tesla on several occasions.

We’ve never fully understood the waves of vitriol that Tesla has met. It has probably been the most shorted stock of all time. We are a long-only equity firm and don’t seek to profit from such a practice, but others do (such a shame to see so many of them lose their cuff-initialled shirts on Tesla). Nonetheless, the ‘shorts’ did have a point – there were several years where Tesla still had a substantial, if declining, chance of failure. What was hard to understand was the tone of mainstream media, and some US pension funds, which made you think Tesla must be a Russian manufacturer of land mines, not an innovative West Coast tech company transforming the transport industry for a better future.

We saw numerous drawdowns of 30–50 per cent in the stock, which meant that in June 2019 it was trading for less than in December 2016. Some of this was due to the way Tesla refused to play the game: rather than set a target that was doable, but that it could then surpass, Tesla took to promising the impossible, then delivering the near impossible, which would then be called a ‘miss’. So myopic was Wall Street’s perspective on this that the fact Tesla was scaling production faster than Ford in the glory years of the Model T went unnoticed.

Whatever was behind the disproportionate vitriol, the company did also bring some troubles and distractions upon itself: the SolarCity acquisition (we expressed dissatisfaction at the time), a couple of surprising volte-face capital raises, Elon Musk’s weed smoking and Twitter tirades, and the infamous “private funding secured” tweet which led to us spending several weeks helping the SEC with its investigation. The reasonable “they’ll never make a profit” refrain rumbled throughout, but the distraction we were most concerned with was SpaceX – an exciting story, one in which we ended up investing in the private markets, but which threatened to divert too much of Musk’s attention. This was the reason we supported the contentious incentive package, as we wanted Tesla to be Musk’s one way of financing life on Mars.

Weathering all these storms suggests we managed to show a decent amount of hold discipline with Tesla.

Tesla
Source: Tesla; Model T Ford Club of America, www.mtfca.com/encyclo/fdprod.htm

2017

Blue sky 2

In 2017 we had a better go at a blue-sky scenario. Crucial elements included factoring in the huge potential of the battery businesses (stationary and auto), Tesla’s autonomous driving software becoming a reality, a higher probability of making 25 per cent gross margins and 10 per cent operating margins on the cars and a lower discount rate (why were we using 10 per cent for so long?). The 2017 work got us from $70 to a blue sky of $400, on a five to eight-year view. Not bad.

Nothing happened for a couple of years, but the share price ascent in 2020 surpassed any near-term expectations of operational progress recognition, and then started gobbling up some of our longer runway too. We were technical sellers on a number of occasions in 2020 as Tesla blasted through our limit of 10 per cent of the portfolio in one stock. By the end of the year we had recycled around 10 per cent of the portfolio out of Tesla and into new holdings, yet Tesla was still a 9 per cent holding. But we were only trimming from the maximum holding size perspective, and as little as possible each time.

2021

March

Finally valuation has become a factor, even for us – but about eight years later and 30 times higher than when other analysts first felt vertigo. We said that the entry valuation to a great growth stock early on is usually irrelevant. It’s only at some point much later that valuation comes in, and for us this moment was around Tesla’s market cap of $500bn in early 2021.

This all means that, as of February 2021, we remain bulls of Tesla, but with an evolved perspective. A perspective that accepts a bit more competition is finally arriving, and a bit less upside from here is likely than in the past. Our blended upside gives a $1,650 share price or $1.6trn market cap. At the time of writing, in March 2021, the market cap is $650bn, so we see a respectable upside from here for Tesla. This is enough for it to remain in the LTGG portfolio, but at a reduced weighting.

What would our concluding thought (for now) be on Tesla? The company went from a high chance of disappearing altogether when we first bought it to a good chance of being one of the world’s biggest ever companies. Yet the salient Tesla reflection probably echoes one from 17 years of owning Amazon: in LTGG, we are set up to identify and hold a small number of great growth companies during a decade or more of their most transformational growth. When we get these companies even vaguely right, our most optimistic scenarios will fall ludicrously short of the feats these companies achieve.

In other words, we can make many mistakes analysing a company such as Tesla along the way – as we did – and it will not matter. Applying our imagination to great growth companies, and holding on to them for many years, is a formula that stacks the investment odds massively in your favour. It remains a mystery, to us at least, why so few fund managers really let their imaginations free. If there is ever a Meet the Parents IV, expect Owen Wilson to arrive in a flying electric car – and know that we’ve already invested.

About Baillie Gifford

An active global equity growth manager with an expressly long-term approach, Baillie Gifford has a reputation for spotting opportunities before anyone else – they were early investors in Amazon, Google, Facebook and Tesla, among others.

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