Rivian shares have been under pressure, but at a market capitalization of over $100 billion, bigger than GM and Ford, it would be hard to say the electric vehicle upstart isn't a major success. The buying and selling action in EV stocks lately has been intense, from all the fuss over Elon Musk's selling of Tesla shares to former Tesla executive Peter Rawlinson's Lucid Group, which went public earlier this year and is now at a valuation over $80 billion, just about as big as the Detroit stalwarts.
As the stock market faces a new test after President Joe Biden reappointed Jerome Powell to lead the Federal Reserve, leading to market calls that investors are about to cycle back into value stocks and away from the hottest growth names ahead of interest rate hike pressures, Tesla's competitors have been giving back some gains. Are EV stocks in a bubble?
CNBC recently spoke with Nick Colas, co-founder of DataTrek Research and a former Wall Street auto industry analyst, about what's going on in the EV space.
Rivian and what makes market bubbles
Rivian's valuation is extremely high, according to Colas. "There is no getting around that. Any time you are talking about a company that hasn't sold any product yet and has a $100 billion valuation it is a huge valuation, but it is not necessarily a bubble," he said.
Tesla itself did not have an $80 billion-plus market cap until early 2020, Colas noted in a recent research note, and by then, it was producing 100,000 vehicles a quarter. Rivian is just starting to ship its first customer vehicles now.
The recent investor interest in EV stocks and their valuation gains reflects one element of what makes a bubble: an imbalance between the supply of a particular investment desire and demand. Market bubbles can form when too much money is put to work in a particular area that is short on supply. Overall, Colas isn't worried about the stock market being in a bubble that pops any time soon because the liquidity in the market remains high, as do household savings which will continue to pursue market gains. But within the longer-term EV story, there is the fact that investors are chasing the few names available to them.
"Investors are looking for any possible play in autonomous vehicles and EVs and there is a real shortage of opportunities, and that's why a Tesla or Rivian is so highly valued. Because there aren't enough EV stocks out there," Colas said. "You do have to provide the market with what it wants, or it creates bubbles to some degree."
Why investors can't ignore EVs
Colas, though, isn't ready to call a bubble in EVs. He says the whole ecosystem of EVs is exactly the way the auto industry was a century ago, which started out very fragmented and then took 80 years to come down to the Big Three. "In EVs, it could be eight years," he said.
And Rivian, at a $100 billion valuation, is a company no institutional investor can afford to ignore.
"They saw what happened with Tesla and know what can happen in this space," he said.
With a $100 billion market cap, every institutional investor in the U.S. and around the world has to take Rivian seriously. And if they own Tesla already, the investors need to make a decision to keep all their Tesla or sell some and buy some Rivian, "just on the off chance that maybe it's not a Tesla but a half-trillion company, and in that case, it's a five-bagger from here," Colas said.
"We've done enough IPOs over the years to know some investors cycle through new companies as they go public, selling the 'old' name and replacing it with the 'new,'" Colas wrote in a recent note to clients. "Tesla has been the only 'real' EV play in U.S. equity markets for years. Now it has competition for the marginal investor."
EV stocks are less bubble-like than options-like
Rivian is a hot stock, and it is very volatile, and it will continue to be volatile, Colas says, because EV stocks trade more like stock options than underlying stocks.
"It's a long-dated option more than a stock," Colas said. "It's an option on Rivian being highly successful in EVs. Tesla was the same way earlier in its history, an option on the potential future."
So the recent volatility in Rivian will repeat for reasons other than a Fed-induced growth to value cycle, and investors should remember that options are always more volatile than underlying stocks, and that volatility will move around with how much the market discounts its chances of being highly successful.
Trading in Tesla options, as an example, has dwarfed that of the broader market and other mega-cap tech stocks like Amazon, according to a recent FT article.
Where GM and Ford fit in the EV equation
Given the volatility in EVs, investors probably should play both sides of the trade, with some of the exposure to the upstarts, including Telsa and Rivian, and a foothold in the legacy players, "not necessarily because they are going to win the space, but they do have the building blocks that can allow them to win," Colas said.
That's something Ford's CEO said last week when it announced that a deal to jointly develop an EV with Rivian was being scrapped (it's still an investor in the company). Ford CEO Jim Farley referenced the automaker's "growing confidence" to "win in the electric space" as reasoning to end the collaboration.
But the current market approach to valuing EV pure-plays higher than Ford or GM is showing the long-term risk that is in the older automakers.
"The legacy automakers face some incredible challenges, the likes of which we have never seen, and it makes the incursion of the Japanese and South Korean automakers look small by comparison," Colas said. "It is a big change in technology that so far they have addressed by building out EVs in-house and leaving the companies combined."
He doesn't view that approach as an advantage.
Right now, the way the market is valuing Tesla, Rivian and Lucid Group relative to Detroit is sending the message to investors that "the combination of the old combustion engine business and EV business tied up in that is not a great investment thesis," Colas said.
The critical factor will be to what degree GM and Ford might ultimately spinoff off EV operations, and that presents one potentially compelling reason to hold onto the shares.
"The two themes have nothing to do with each other and that breakup is a possibility and one reason you might want to own the stocks," he said.
But he is not confident that Ford or GM will ever make that move, even if the case can be made it's the right one.
"GM and Ford still have time left on the clock. But as for a dramatic corporate remake that reflects the existential challenges they face … We're not holding our breath," Colas wrote in a recent research note.
Cost of capital and the EV battle
If GM and Ford stick to their current corporate structure, Colas sees few to no advantages and one distinct disadvantage: their cost of capital.
It is much higher for Ford and GM, both under $100 billion in market cap, than it is for Tesla at $1 trillion. This is the Tesla stock sale that means a lot more to the EV market competition than the recent Musk action.
If Tesla needs $10 billion in capital, it can sell $10 billion in stock at 1% dilution for current shareholders. If GM or Ford did that, it's roughly 10% dilution.
"That's how big the difference is in cost of capital. ... GM and Ford's combined cost of capital and is ridiculously high and unsustainable," Colas said. "Because the minute the EV industry gets a big tailwind from mass adoption, we will see a lot of new technology come out and all of these companies will have to invest a ton and the big domestic automakers will not be as well positioned as a Rivian or Tesla."
Electric vehicles eventually imply autonomous vehicles and a reshaping of global transportation. That will require companies to have considerable equity currency for M&A and strategic investments.
"With where GM and Ford's stock prices currently sit, they will be bringing a penknife to a gunfight," Colas wrote in a recent note.
This is a big reason why Colas sees a stand-alone valuation for the EV business as an advantage. "It is not that Ford and GM can't compete in EVs or AVs – they can," he wrote in a recent note. "It is that their chances improve materially if they can have an equity currency that goes toe–to–toe with Tesla and (now) Apple."
The real cash king and the car of the future
When it comes to cash to invest in the future of autos, there is a reason why so much speculation surrounds Apple's interest. With a business generating as much cash as Apple's quarter after quarter, investors do need to take Apple's potential entry into the autonomous vehicle and electric vehicle market seriously, Colas says.
Apple won't say anything, with Tim Cook's most recent comment about cars being another deflection when asked by Andrew Ross Sorkin at the recent Dealbook conference. But Apple did hit a new all-time high last week when Bloomberg reported that Apple's car plans are accelerating and a debut expected by 2025.
"Everyone has to pay attention to Apple in autonomous vehicles and EVs if for no other reason than its cash on the balance sheet," Colas said. "Money doesn't solve every problem in R&D, but it certainly helps with the ones you know about and so you have to take it seriously if only because they have the resources to do it more than anyone else in the business," he said.
GM and Ford are financially healthy today, generating cash flow from their internal combustion engine operations. "But what happens in the next recession? Or if there is a technological breakthrough in batteries that requires a lot more capital?" Colas wrote in a recent note.
"In those scenarios, 'old' GM and Ford – with a mix of ICE and EV products and a stock valuation to match – are stuck. .. The auto world is nothing if not profoundly capital intensive so this is far from an academic problem."
The flipside of the cash problem, as noted in a recent note on Apple and AVs by Colas, is that investing in autos "has historically been a graveyard for capital."
But he argues it is too large a market to ignore, and the approach to autos from big technology companies is likely being designed with the expectation of a new economic model focused on "transportation as a service," not necessarily requiring ownership. "That's a revenue model any tech company would understand and embrace."
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