Surely you have read the headlines. “Tesla is worth more than Ford,” “Tesla surpasses General Motors in market value”. The question is, are we in front of a bubble or a reality? A little of both.

Let’s start with the reality. The electric car, as we explained in ” The Energy World Is Flat” (Wiley) is an unstoppable alternative and part of the process of flattening the world of energy and using less oil. There is no doubt that the future of transportation will come from a combination of electric, alternative and hybrid vehicles.

Global electric vehicle sales totaled 222,000 units in 2016, and growth – while positive – has proven to be well below the overly optimistic market estimates. How does this affect Tesla?

Let us forget arguments like “it’s a good company”, “it’s a new paradigm” or “it grows a lot” and go to the data.

Tesla has sold, in 2016, about 77,000 vehicles. To give you an idea, the Renault-Nissan Alliance alliance  sold more than 94,000 electric cars.

Tesla’s revenues are around $ 7 billion, which means it trades at more than 6.5 times sales, and an enterprise value of eight times its sales, 164 times its EBITDA (Earnings before Interest, Tax, Depreciation and Amortization). That is, it discounts that sales and profits will multiply exponentially without resorting to more debt or sell new shares.

In 2016, Tesla reported a loss of $725 million, and has only recorded two quarters of clean positive results. Along the way, it has carried out capital increases and convertible bond issuances at almost $ 1 billion a year, increasing its debt to 12.3 times its EBITDA. Tesla does not pay dividends, of course. All in its valuation comes from expectations of growth.

If we compare it with General Motors, revenue is about $166 billion, which means that it trades at about 0.3 times sales (enterprise value is 0.24 times sales, since it has no debt, and 1.9 times its EBITDA). A net positive result of $9.9 billion, and a dividend yield of 4.4%.

General Motors generates $7.3 billion in free cash flow, a Free Cash Flow Yield of 13.3%. Tesla consumes $1 billion of cash a quarter, and its working capital requirements lead to the increased debt.

Since all the difference between one and the other come from estimates of the future, we must analyze what that future costs and its probability.

The reality is that the race for the electric cars market is not a matter of innovation or ideology, but of the ability to manufacture and sell them massively, in addition to offering them at a competitive price.

If our analysis is who will reach one million electric vehicles sold and what is needed to achieve it, we will not be surprised to see that Tesla will need at least three further capital increases similar to those already made, or a disproportionate increase in debt. As its shares are at historic highs, the best way to finance Tesla’s growth will be issuing new equity. You can, therefore, expect that demand for new shares to be greater or not.

The reality is that the investment to reach that same million electric vehicles in General Motors does not suppose neither an increase of debt nor impact in its dividend or a significant reduction in its enormous free cash flow. Of course, with more than nine million cars sold, General Motors has a manufacturing, development, sales and after-sales network that is already operational and can be adapted to new technologies with very little investment. In the case of Renault-Nissan, also with more than nine million cars sold, the burden to reach massive electric car sales is also very low. Therefore, the technological or innovation premium may seems exaggerated in Tesla while it is discounted at zero in its competitors. Interesting, because that “premium” needs capital, a lot, to become tangible sales.

The most optimistic estimates of investment in capacity for Tesla are $5 billion over the next few years, and others exceed $8 billion, which will continue to burn cash.

Many expect Tesla will be sold to one of those conglomerates that deserve to trade at such low multiples. What investors should analyze is whether that acquisition will be made before or after the day of reckoning. Betting on the “greater fool” theory is always dangerous.

Make no mistake. Tesla surely deserves a premium to the sector, just as any focused, innovative company deserves higher multiples than integrated conglomerates. The question is, what premium? And how much will it cost investors in capital increases?

The achievement of its objectives, to justify such multiples, may require almost 20% of its market capitalization in new equity, and estimates a 100% success rate.

We are faced with a case where the market seems to discount the perfect future in a stock that, moreover, has neither the cash nor the balance sheet to undertake it, while the markets values negatively that same business in its established incumbent competitors, which can massively develop electric vehicles without blinking.

No, it’s not the same as Apple or Amazon, Netflix or Google. Tesla’s multiples need, anyway you look at it, a massive capital investment to turn the idea into reality. Another completely different thing is whether shareholders accept such risk. While other technology companies have a much higher return on capital employed, their investment needs are much lower to get the estimated sales into reality. One thing is technology and another, cars.

Tesla’s shares can continue to rise, of course. Euphoria and fear are essential market factors. But what investors must analyze is whether the euphoria discounts a perfect scenario, and whether the market is willing to participate in the following capital increases and dilutions that are necessary to undertake the expansion of the company.

If it is a credible scenario, it is worth that Tesla uses the current environment to clear the balance sheet concerns. Working capital can be a big risk.

In investment it is essential to differentiate technology from business model, and not fall into quasi-religious faith arguments when it comes to buying a stock.

Do you remember the solar stocks trading at a premium on future installations? Hundreds of bankruptcies later, the mirage has dissipated. And what about the wind manufacturers and developers discounting the “pipeline“of estimated projects? Gone. Do you remember the valuations of technology stocks discounting earnings on future emails? Goodbye.

The bankruptcy of ‘bubbles’ in solar, technology, financials, oil and gas or wind has always been due to two common factors. Excess debt and impossible expectations.

We have to be careful not to confuse a technology and its support, from an emotional or ideological point of view, with a stock and a business model.

Tesla is and should be smarter than all of its competitors and use its valuation to strengthen its balance sheet. I would love to see them succeed, not defend a bubble.

Daniel Lacalle is a PhD in Economics, fund manager and author of Life In The Financial Markets, The Energy World Is Flat (Wiley) and Escape from the Central Bank Trap (BEP).

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