November 22, 2014

Peter Thiel analyzes Tesla Motors

While Peter Thiel was born in 1967 in Germany, his family moved to California when he was young. Stanford was the school of his choice before he began trading derivatives at the Credit Suisse Group. In 1996, he founded the hedge-fund Thiel Capital Management, and he's also famous for being the first outside investor in Facebook. 

Peter Thiel has also donated $3.5 million to the Methuselah Foundation, which is a life-extension-research organization that believes humans will one day live to be 1 000 years old. One of the founders argued that the first human to live a 1 000 years is already born.

In 2005, Peter Thiel created Founders Fund, a San Francisco based venture capital fund. In the fund, you can find companies like SpaceX and Spotify. He has also written a book called Zero to One where he talks about his strategies. 

Peter Thiel is a venture capitalist (VC), who invests in new technology companies. It's generally difficult to follow the rules a VC has if you are investing in the public stock market, but I still believe you can learn something from some of the rules.

Venture capitalists aim to identify, fund, and profit from promising early-stage companies. But most of these companies will fail, and so will the fund. According to Peter Thiel, the biggest secret in venture capital is that the best investment equals or outperforms the entire rest of the fund combined. If you don't want to fail, then only invest in companies that have the potential to return the value of the entire fund. However, even if you find a successful company, you may still fail. For example, Andreessen Horowitz made a 312 times return on their investment in Instagram, but that wasn't enough to cover the rest of the fund because their investment was too small. 

Peter Thiel has two main rules
The value of a business today is the discounted sum of all money it will make in the future. That's why it may seem that new technology companies are extremely overvalued compared with older companies. For example, when Twitter went public in 2013, it was valued more than 12 times the Time's market capitalization – even though each employs a few thousand people, each gives millions of people a way to get news, and the Times earned $133 million while Twitter lost money. While investors expect Twitter to generate cash flows in the future, they don't believe in more traditional ways to read news.

Monopoly is the condition of every successful business. Under perfect competition, no company makes an economic profit. On the other hand, a monopoly owns its market, so it can set its own prices. Each monopoly is unique, but they usually share the following characteristics:
  1. Proprietary technology. It's impossible to replicate the product – like Google’s search engine. 
  2. Network effects. You have a network effect if a product is more useful as more people use it – like Facebook. 
  3. Economies of scale. The company gets stronger as it gets bigger. 
  4. Branding. Creating a strong brand is a powerful way to claim a monopoly.

Peter Thiel has seven questions he asks before he's investing in a company
  1. Can you create breakthrough technology instead of incremental improvements? As a rule of thumb, the technology must be at least 10 times better than its closest competitor. PayPal was 10 times better because it took 10 days faster to let buyers pay. Companies must strive for 10 times because smaller improvements end up meaning no improvement at all for the end user. 
  2. Is now the right time to start your particular business?
  3. Are you starting with a big share of a small market? Huge trillion-dollar markets mean ruthless, bloody competition. Facebook began with a big share of the small market "Social networks for Harvard University." The initial markets are often so small that they often don't even appear to be business opportunities at all. 
  4. Do you have the right team? One of the single clearest patterns Peter Thiel has noticed from investing in hundreds of startups is that a company does better the less it pays the CEO ($150,000 per year is enough). Real technologists wear T-shirts and jeans, so never invest in a tech CEO that wears a suit. 
  5. Do you have a way to not just create but deliver your product? Selling and delivering a product is at least as important as the product itself. 
  6. Will your market position be defensible 10 and 20 years into the future? For a company to be valuable it must grow and endure – even though many entrepreneurs focus only on short-term growth because growth is easier to measure. The most important lesson learned from Steve Jobs has nothing to do with design. The greatest thing Steve Jobs designed was a long-term vision. Many companies have failed because they didn't answer the question "What will stop China from wiping out my business?"
  7. Have you identified a unique opportunity that others don't see? Great companies have secrets: specific reasons for success that other people don't see. 

Let's apply it on Tesla Motors
The value of a business today is the discounted sum of all money it will make in the future.
Tesla's stock market value is high compared with other car manufacturers like General Motors. But that's because the investors believe more in Tesla's future profits than what they believe in the future of General Motors.

Monopoly is the condition of every successful business.
  1. Proprietary technology. It's not yet as difficult to replicate a Model S compared with what it takes to replicate Google. 
  2. Network effects. If more people drive cars from Tesla, the infrastructure around the cars (like charging stations) will improve, so more people will drive cars from Tesla because of the infrastructure. 
  3. Economies of scale. It's easier to lower the price per car if the factory is bigger, and Tesla is also building their own battery factory. 
  4. Branding.


1. Can you create breakthrough technology instead of incremental improvements?
Tesla's technology is so good that other car companies rely on it. Daimler, Mercedes-Benz, and Toyota are all using technology from Tesla. Moreover, the Model S was rated higher than any other car by Consumer Reports and the Model S became the car of the year by several magazines.

2. Is now the right time to start your particular business?
The original founders of Tesla founded the company because they saw that people were driving the hybrid Toyota Prius only because they cared about the environment and they couldn't find a true electric car. The world will also begin to run out of oil in a few years, so now is the time to sell cars not dependent on oil 

3. Are you starting with a big share of a small market?
Tesla started with the small market "high-end electric sports cars" when they designed the Tesla Roadster. They now had a little more money and a brand they could use when they designed the Model S.

4. Do you have the right team?
The current CEO of Tesla Motors, Elon Musk, described his team: "If you're at Tesla, you're choosing to be at the equivalent of Special Forces. There's the regular army, and that's fine, but if you are working at Tesla, you're choosing to step up your game." Elon Musk is also a big believer in electric cars. 

5. Do you have a way to not just create but deliver your product?
Tesla want to own the entire distribution chain where they sell and service the cars themselves without any traditional car dealer. 

6. Will your market position be defensible 10 and 20 years into the future? 
As the world is running out of oil, and Tesla believes electricity is the weapon of choice when there's no oil, there will be a big demand for electric cars in 10 and 20 years. But what about China? It's true that the Chinese are building several electric cars, but the question is how good future models are compared with a future Tesla?

7. Have you identified a unique opportunity that others don't see?
Tesla has identified that 100 percent electric cars belongs to the future. Other car companies tend to believe in hybrid cars or cars powered by fuel-cells, but Tesla will not sell any of those cars.

This article is a part of the article series Tesla Motors Stock Analysis