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What investors can learn from all the Tesla, Rivian buying and selling

Rivian shares have been beneath stress, however at a market capitalization of over $100 billion, greater than GM and Ford, it might be laborious to say the electrical automobile upstart is not a significant success. The buying and selling motion in EV shares recently has been intense, from all the fuss over Elon Musk’s selling of Tesla shares to former Tesla government Peter Rawlinson’s Lucid Group, which went public earlier this year and is now at a valuation over $80 billion, nearly as large as the Detroit stalwarts.

As the stock market faces a brand new take a look at after President Joe Biden reappointed Jerome Powell to steer the Federal Reserve, resulting in market calls that investors are about to cycle again into worth shares and away from the hottest progress names forward of curiosity rate hike pressures, Tesla’s rivals have been giving again some good points. Are EV shares in a bubble?

CNBC just lately spoke with Nick Colas, co-founder of DataTrek Research and a former Wall Street auto trade analyst, about what is going on on in the EV area.

Rivian and what makes market bubbles

A Rivian R1T electric pickup truck during the company’s IPO outside the Nasdaq MarketSite in New York, on Wednesday, Nov. 10, 2021.

Bing Guan | Bloomberg | Getty Images

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.

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 when the case can be made it is the proper 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 current analysis notice. 

Cost of capital and the EV battle

If GM and Ford keep on with their present company structure, Colas sees few to no benefits and one distinct drawback: their price of capital.

It is far larger for Ford and GM, each beneath $100 billion in market cap, than it’s for Tesla at $1 trillion. This is the Tesla stock sale meaning much more to the EV market competitors than the current Musk motion.

If Tesla wants $10 billion in capital, it can promote $10 billion in stock at 1% dilution for present shareholders. If GM or Ford did that, it is 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 stated. “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 automobiles ultimately indicate autonomous automobiles and a reshaping of worldwide transportation. That would require corporations to have appreciable fairness forex 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 current notice.

This is a giant purpose why Colas sees a stand-alone valuation for the EV business as a bonus. “It is not that Ford and GM can’t compete in EVs or AVs – they can,” he wrote in a current notice. “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 actual money king and the automotive of the future

When it involves money to spend money on the way forward for autos, there’s a purpose why a lot hypothesis surrounds Apple’s curiosity. With a business producing as a lot money as Apple’s quarter after quarter, investors do have to take Apple’s potential entry into the autonomous automobile and electrical automobile market critically, Colas says.

Apple will not say something, with Tim Cook’s most up-to-date remark about vehicles being one other deflection when requested by Andrew Ross Sorkin at the current Dealbook convention. But Apple did hit a brand new all-time excessive final 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’s too giant a market to disregard, and the strategy to autos from large know-how corporations is probably going being designed with the expectation of a brand new financial mannequin targeted on “transportation as a service,” not essentially requiring possession. “That’s a revenue model any tech company would understand and embrace.”

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