The Saudis should buy Tesla, but not at $420 per share

 Crown Prince Mohammed bin Salman at a meeting of deputy princes.

Crown Prince Mohammed bin Salman at a meeting of deputy princes.

On Tuesday, Elon Musk tweeted that he was considering taking Tesla Motors (NASDAQ: TSLA) private at $420 per share, an overall valuation of $82B, which would make the electric car maker the most valuable private company in the world. In a subsequent post on Tesla’s blog, Musk clarified his thinking: “As a public company, we are subject to wild swings in our stock price that can be a major distraction for everyone working at Tesla, all of whom are shareholders.”

Earlier that day, the Financial Times reported that Saudi Arabia’s sovereign wealth fund has been buying up TSLA stock under the radar; the Saudis now have a 3-5% stake in Tesla worth between $1.7B and $2.9B. 

The two revelations—about Tesla’s board exploring a private sale, and Saudi Arabia’s substantial investments in the company—are interesting because a private sale of Tesla would be very unusual. First, it would be an extraordinarily large sale, with about $66B necessary to complete the transaction (excluding Musk’s 20% ownership). Secondly, it would be very difficult to finance such a large leveraged buy out of a cash flow negative company. 

“What we have some doubts about is maybe the sources of that funding—I don’t think traditional lenders would really sign up to support the deal given the financials. So in our view, there has to be some significant  outside funding lined up,” said Joseph Spak, capital markets analyst at RBC, on Bloomberg TV. Spak was the analyst who was famously cut off by Musk during Tesla’s Q1 earnings call for asking ‘dry’ questions. 

If traditional lenders won’t finance a leveraged buyout of Tesla, then Musk and his board might be thinking of sovereign wealth funds like Saudi Arabia’s Public Investment Fund, which put $3.5B into Uber in 2016 and about $1B into Virgin Group’s space companies in late 2017. 

We think it actually makes sense for the Saudis to buy Tesla, but $420 per share is too rich; even extremely efficient automakers—and we don’t count Tesla in that category—cannot deliver the return on invested capital that would justify such a high valuation. A 2017 note from Vilas Capital Management makes this case very clearly by comparing Tesla to Ford. To put it simply, Tesla would need hundreds of billions of dollars of additional capital invested in order to generate the revenue that would justify its valuation, because even top-performing auto companies, on an enterprise value to revenue basis, sell at a ratio of roughly 0.2 (Ford, the only American car company to avoid bankruptcy, had a 2016 revenue of $152B and an enterprise value of $29.2B). 

But why should the Saudis of all people buy Tesla? There are two good reasons. The first reason for a petro-economy to buy an electric car company is to hedge against a secular decline in global oil demand. Right now, Saudi Arabia’s economy is the least diverse of any OPEC member. Assuming they bought Tesla, if oil demand falls and the price of Brent crude craters, the Saudis would own a massive asset perfectly poised to electrify transportation. The value of Tesla would multiply.

Secondly, we think that Saudi Arabia’s other primary natural resources, underutilized to this point, could cross-sell with Tesla. What resources? Empty space and sunshine. In other words, Saudi Arabia could cover a vast swath of the empty quarter with solar panels and huge batteries, leveraging Tesla’s other energy technology businesses, to supply parts of Africa, India, and Europe with cheap electricity. High-voltage transmission lines lose about 3% of their electricity for every 1,000 km. A 4,000 km radius drawn around Riyadh includes all of Egypt, Ethiopia, Kenya, Greece, Italy, Ukraine, most of Poland and Kazakhstan, Pakistan, and almost all of India.

Saudi Arabia is therefore well-positioned to sell generate the cheap electricity to meet the power demands of an electrified transportation sector. At first, the Tesla purchase would be a hedge and a way to diversify their economy with a large asset negatively correlated to oil demand. Then, if—and it’s a big if—-oil demand flatlines or declines, the Saudis could put photovoltaic installations over a large area and double-down on clean energy.