In their latest episode of the VALUE: After Hours Podcast Jake Taylor, Tobias Carlisle, and Christopher Tsai discuss:
- Why Tesla Is Misunderstood By Wall Street
- The “3 U’s” to Tesla’s Big Future: Unknowns, Uniqueness, and Unbelievable Growth
- Ron Baron’s Wisdom: Risking Assets for Tomorrow’s Cash Flow
- Musk Borrows From History: How Tesla is Channeling Henry Ford to Dominate EVs
- Nike’s Strong Brand, Efficient DTC Model, And Global Market Potential
- Tesla: From Cash Burner to Cash Cow
- Tesla FSD Licensing Could Be A Lucrative Strategy In The Long Run
- The Future of Electric Vehicles: Room for Many Players Alongside Tesla’s Lead
- Your Portfolio Needs To Mesh With Your Personality
- Getting Started In Investing: Thanks To Johnny Tang & His Orange Beef
- How Gerald Tsai Built Fidelity Investments Into A Mutual Fund Powerhouse
- Build Your Wish List & Swing Hard When The Opportunity Arrives
- Analogies Between The Early Auto Industry And Current Technological Disruptions
- The Problem With Owning Berkshire Hathaway
You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:
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Transcript
Tobias: This meeting is now being livestreamed. This is Value After Hours, the sixth season. I don’t know how we got here.
Jake: Oh, my God.
Tobias: I’m Tobias Carlisle with Jake Taylor, my co-host. Today, our special guest is Christopher Tsai. How are you, Chris?
Christopher: I’m doing great.
Tobias: Chris has been an investor for 24 years. But you may be the–
Jake: Started when he was ten years old, that’s what people didn’t realize.
[laughter]Christopher: That explains why I don’t have any hair left.
Jake: [laughs]
Tobias: Tell us a little bit about you and what you do, Chris?
Christopher: Yeah, we’ve had a pretty consistent approach over those 24 years. I run a company called Tsai Capital. We’re long only and our focus is entirely on growth companies that we think have really, really strong competitive advantages and a long runway, redeploy capital at high rates of return. We’re pretty focused, so we have about 21 companies in the portfolio today, and we’re super long-term oriented. So, when we buy into something, we do so with the idea that we’re going to hold it for a long period of time.
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Why Tesla Is Misunderstood By Wall Street
Tobias: I think one of the stocks that I know that you’ve held for a long time is Tesla. How long have you been in Tesla?
Christopher: We actually haven’t been in it for that long. We bought it in 2000 and studied it for maybe three, four years beforehand. I wasn’t smart enough to buy it earlier. But also–
Tobias: You said 2000?
Jake: I think you meant 2020, uh?
Christopher: 2020, sorry, 2020. And before 2020, I had studied it a lot, but it was not really that investable. It wasn’t a kind of business that we would go into. It had too many potential issues, one of them being it wasn’t profitable. We like profitable companies. And roughly around the beginning of 2020, the stock had really taken off and we missed our opportunity. I had wanted to buy it kind of like end of 2019 or so, and I missed that opportunity. And then, we had the COVID selloff. That was when we swung hard and we made it a top position. We paid around $41.66 on average, so we’re up 6X or so, but we think it’s pretty early on in that story. It has all the kind of characteristics that we like in businesses.
Tobias: Which are?
Christopher: Oh, one of them is that they can reinvest capital at very high rates of return. One of the things we look at is not just return on equity and return on capital but return on incremental capital. That’s really important because it kind of gets at the unit economics of the business. To give you an example, we think about if they put a factory up, how many cars are they going to make? What are the returns on that factory? What are the returns on individual cars? And while the return on incremental capital is coming down from where it was a couple of years ago, couple of years ago it was about 80%, like super, super high, 80% returns on incremental capital, something not really talked about a lot on the street, and that’s come down, but it’s still very, very high, around 50%. And returns on equity and capital consequently are also high. We figure around 30% in 2024. So, it has that kind of element that we look for. It has very strong competitive advantages that I think are still misunderstood by much of Wall Street. And it has a management team that is deeper than it appears, and a management team that, while might create a lot of noise, is actually pretty good at reinvesting that capital.
Jake: What do you think kind of steady state– Not that there’s ever a steady state in the world, but what do you think like EBIT margins might be someday?
Christopher: Yeah, that’s a great question. Steady state is super important to think about in terms of growth companies because they’re often reinvesting now to create a higher intrinsic value later, and that often depresses current margins and current profits. Margins are pretty good right now, actually. So, we think about 15% or so EBIT margins over the next couple of years going to 20% or a bit more, so pretty good margins, and that’s without the software piece. On the software piece, assuming FSD is profitable and it works well, the software margins are 70%, 80% there. So, that would bring up the total profit margins for the whole firm.
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The “3 U’s” to Tesla’s Big Future: Unknowns, Uniqueness, and Unbelievable Growth
Christopher: But longer run, we’re modeling 17.5% percent right now in terms of profit margins. And we think that the revenue potential is gigantic, it’s still very much in the early stages. And that’s not just cars. We’re talking about electricity, you’re talking power storage and generation. And then, you have the software piece. And then, there’s a whole element of Zeckhauser in this because there’s so much optionality. And I don’t think you’re paying for that optionality today.
Tobias: What’s Zeckhauser?
Christopher: So, Richard Zeckhauser said that big returns come from the unknown, unique and unknowable, the three U’s. And in this case, there’s so many unknowns because of that optionality. All these different verticals that the company can go into. And then, they’re creating an ecosystem, similar to what Apple has done, where you’re getting an increasing lock-in of the customer base and you’re able to cross-sell. So, if you think about, you buy a car, what do you want? You want a charging station in your home, so you’ve got that. But now, you’re also generating electricity, which you can give back. There’s revenue associated with that. There’s revenue associated with charging. There’s revenue associated with other individuals who are not driving Tesla, who are charging increasingly on the Tesla infrastructure. So, there are all these verticals, there’s robotics, there’s insurance, which I think is a lot smaller than a lot of people think. But there are these areas that the company is going into, and there are a lot that we don’t know about. So, that’s the unknowable.
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Tesla: From Cash Burner to Cash Cow
Tobias: A few years ago, I think 2020 or something like that, I ran analysis of the rate at which companies in the US were reinvesting over and above their depreciation amortization using that as a proxy for maintenance capex. So, what is the true growth capex? And the two biggest in the country were Facebook, because that was deep in their Metaverse spending. And the other one was, of course, Tesla. It’s kind of amazing that they generate such huge returns on incremental capital when they’re investing more than anybody else.
Christopher: Yeah. Free cash flow has been slow to take off, but now it’s taking off very rapidly. And the alignment between free cash flow and net income is getting much, much closer. So, over the next year or so, call it 12 to 18 months, they should produce around $10 billion of free cash flow. I mean, it is pretty massive free cash flow generation, and I wouldn’t be surprised if five years from now, maybe even less than that, you get a share buyback. Now, I don’t think that the dilution is going to continue at the rate that it has, simply because they are printing money now.
Jake: What capex do you use for that? And that you kind of modeling out?
Christopher: Sorry?
Jake: What capex do you think will be against that free cash flow?
Christopher: Yeah, the way I look at it is the net income plus D&A versus the capex spend. And so, I think that the capex spend is probably going to be no more than 5% to 10% above the net income. So, put differently, there is a very close relationship between the net income and what we would call owner earnings. So, if you were to look at what the company is doing on a net income basis and what the company is producing from an owner earnings standpoint, it would be– in our calculation, everybody, thinks about a little bit differently, but we add back D&A, we adjust for working capital, deferred taxes, and then we back out capex. It’s going to be pretty close going forward, the owner earnings in the net income. So, you can think about the net income as close to the amount of money that shareholders could actually take out of the company, and you can use that as a proxy then to discount back future cash flows. And that number is ramping very, very quickly. So, call it $3.5, $4 a share of earnings over the next 12 months or so, going to $7.50 in a few years, 2026. And then from there, this ramp because you have this S-curve kind of pattern in place.
Tobias: And the catalyst for you was the approaching profitability. [crosstalk] positivity.
Christopher: Yeah, let’s just say that we don’t like to invest in unprofitable companies, so it was just something that I wouldn’t touch. Tsai Capital manages money for charitable organizations, retirement accounts. It’s just something that we wouldn’t go into, we’d rather sacrifice some potential upside for having the visibility of earnings now.
I’d say that the catalyst was twofold. It was that part, the company turning profitable toward the end of 2019, plus a price that made sense. As I mentioned earlier, I missed that first entry point because the stock had just taken off very quickly as it did turn profitable. And then, we had the COVID selloff and Tesla, like other companies, got hammered. So, we used that opportunity to take our initial position and we paid about three times or so revenue at the time, three times revenue, which was equivalent of roughly 65 or so times forward earnings. But I don’t think about things in terms of forward earnings, not on a 12-month basis.
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Ron Baron’s Wisdom: Risking Assets for Tomorrow’s Cash Flow
Christopher: One of my mentors, Ron Baron, taught me very early on how companies that are growing very rapidly are investing now to create a higher intrinsic value later, and that can depress earnings. So, you have to think about where earnings are going to be not just now, in 12 months, but a few years out. And obviously, you need to have some sort of visibility and believe that the company is going to hit those numbers.
But if you do, a company that might look like it’s selling at 65 times might only be actually selling at 20 or 25 times a couple of years from now, and the street eventually catches up and that’s why growth companies often never look cheap, because people are only focused on 12 months and they’re not seeing this S-curve formation in terms of the earnings growth. At that point, it looked good to us in terms of valuation. And interestingly, today the stock is selling at roughly the same valuation as it was back then, even though shares are up 6X. That should give you an idea of how quickly net income, GAAP net income has grown from just 2020 to today. Stock up roughly 6X and the multiple roughly the same.
Jake: And I think it was Peter Drucker, said something like management’s job is to risk today’s assets for tomorrow’s cash flows. So, in early companies especially, it could be hard. The future profitability can be very obscured from today’s vision.
Christopher: It can be, absolutely. And the problem is that a lot of companies don’t come through with their projections. And there are base rates, and there are all of these things that people don’t consider. But on the flip side, sometimes companies do defy base rates, there are exceptions, and that should also be taken in consideration. And sometimes, because of that unknowable element, you can find value in places that other people might have just overlooked or simply don’t want to even go there, because they’re only thinking about base rates.
Jake: When you were buying Tesla, did you feel like that you were going with or against base rates?
Christopher: Definitely against, definitely against. It’s still against base rates today. I mean, you have roughly a 760-billion-dollar market cap that we think is going to 3 trillion by roughly 2030. So, it’s a 20% CAGR in terms of per share value, a bit more in terms of market cap. So, when we factor in dilution from current levels, we get to roughly 20% stock price CAGR from here to 2030, that would be a $3 trillion market cap plus in six years’ time, that’s definitely against base rates. But I always remember this conversation I had with Charlie Munger when I was fortunate to meet him in 2018. And he said to me, it’s the nature of the world for the large to get larger.
And so, in certain markets, you have these competitive dynamics where you have winner take most or winner take all, and especially with technology products. And ultimately, this is a technology company selling a technology product that’s a computer on wheels. And so, there’s room for other players. But ultimately, I see a world in which there is a winner take all or winner take most dynamic at play. So, Tesla plus one or two other players will grab most of the market, most of share of wallet, maybe even more share of wallet than they have share of market, if that makes sense.
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Tobias: How do you assess Musk and Tesla in relation to all of the other things that he has going on?
Christopher: Yeah, well, there’s certainly a lot of noise. It’s not been fun for a lot of people to own this company. I’ve been told that there have been divorces as a result of families owning this stock. Separations, certainly. But it’s important, I think, as an investor to sift through noise.
Jake: And what is that, politics that’s driving that? Is that what the stories that you’ve heard?
Christopher: A lot of politics shake. For sure, there’s a lot of politics. He seems to fall in like the Trump-Biden camp. You either– So, like a 50/50 camp, right? People either love him or hate him. But at the end of the day, people tend to vote with their wallet. It’s just the way people are. And if you can sell a superior product at a price that makes sense, people move. And again, we’re talking about a massive market, right? A massive market with over 2 billion cars around the world in terms of the fleet, 100 million here. So, there’s room for more than one player. And I expect Tesla market share to drop quite a bit over the years to come. But the whole tide is changing. The whole market of EVs is increasing. So, volume of this company will increase pretty dramatically, even though they lose market share. So, there’s that kind of noise. So, you’ll see a headline like–
Jake: Yeah, BYD overtakes Tesla, that kind of thing.
Christopher: Yeah, yeah, you see BYD overtakes Tesla. BYD allegedly overtook Tesla a long time ago, but it is not really because BYD includes in its numbers, electric vehicles and hybrids, so it is not a direct comparison. I think today they’re pretty equal in terms of pure EV, almost identical. And maybe BYD overtakes Tesla, but I think Tesla is far more profitable, it’s my hunch. And again, there’s room for more than one player. And so, if you think of like the tide is moving in their direction, they’ve got the wind at the back, the volume increasing, the revenue is increasing very rapidly and profits are increasing very rapidly. It’s hard for the stock not to do well over time because they have all of these tailwinds underpinning the equity.
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Your Portfolio Needs To Mesh With Your Personality
Tobias: How representative is Tesla of the rest of the portfolio? What does the portfolio look like? If you don’t want to names, just in general terms.
Christopher: Yeah. I can tell you that we have– Tesla is one component of the portfolio. It is our largest piece for a number of reasons. Number one, it’s our highest conviction idea even at today’s prices, even though that it’s 6X higher than we paid. The appreciation has helped push it up in the portfolio, so that’s another reason it’s a top position. But we have 21 companies and we’re across whole bunch of industries. Our largest positions tend to be more in the tech side, but we own companies in the food services, we own companies in data, in pharmaceuticals, all over the place. So, we’ve got 21 companies. We’re diversified enough where I think it makes sense for charities and retirement accounts to consider Tsai Capital for portfolio. But we’re not like overly diversified where we can’t add alpha over time.
I think it’s also a personality trait. You guys know more than anybody that your portfolio has to mesh with your personality too. If you’re uncomfortable with something, your portfolio shouldn’t be structured in that way. So, it’s a reflection of my personality as well in 24 years of thinking about what makes sense for our client base.
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Tobias: How did you get started? How did your career start and how did you launch Tsai Capital?
Christopher: Well, when I was like 11 or so, I bought my first company and it was like a very, very small amount of money, $100. I bought five shares of a company called [unintelligible 00:19:44] at $20 a share, it was a reinsurance company. I knew very little about the company, but I had met the CEO and I really liked the guy. So, I decided to buy five shares of this stock with my gardening money, and it went to $25, I was super excited, so I called my broker, Bruno, up to say, “Hey, I want to sell. I made $25 on $100 investment.” I thought it was the greatest thing in the world. And Bruno said, “Fantastic, the only problem is your commission is $110.” [laughter] So, that was the nature of brokerage back then. So, I convinced Bruno that I will be a long-term client and I convinced him to waive the commission. So, I sold it and that was kind of my first experience with investing.
And then, I went to work for Waterhouse Securities in Stamford, Connecticut, in the Stamford Mall. It’s connected to the Stamford mall. And my job was to stuff the envelopes with the trade confirmations because everything was by paper then. The guy who was doing that job before finished like at 3 or 3:30 in the afternoon, I finished stuffing all the envelopes by 12, so I had four hours to kind of watch what was going on. Waterhouse was one of the few– The first companies where people would come in and they would sit down at the quote machines and they would trade, so it was really exciting for me.
And I noticed that every day, there were more and more confirmations. I was finishing like at 12 and then at 12:10 and 12:15 and I said to myself, “Wow, business must be really doing really well.” WHOO was the symbol, they had just gone public, so I bought a stock and it did extremely well, so that was also a positive, kind of reinforcing event in my early life.
I think that if you have positive events, you’re more likely to go in a particular direction as opposed to if you have negative events. I once went to this acting audition. I wanted to do acting for some crazy reason and I totally embarrassed myself and I came out of this audition mortified. So, I decided that I’ll never set foot on a stage again. But my experience with investing was pretty good.
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Getting Started In Investing: Thanks To Johnny Tang & His Orange Beef
Christopher: And then I really wanted to manage money, so I went around town and there was this restaurant I used to go to all the time, and it was called Lotus East, and it was run by this amazing guy, Chinese guy, Johnny Chang. Johnny Chang made best orange beef and it was my favorite dish. And Johnny would go to the supermarket, he would buy me special filet mignon to make orange beef. Orange beef is usually like skirt steak or something. He bought me filet mignon and he would make special orange beef for me. So, I got the chance to talk to him a lot and you know how Chinese like to gamble and they love the stock market. I convinced him that gambling is not the way to go, you’re not going to make a lot of money over time that way, and you should give me some money to invest.
So after about a year or so, he gave me $400,000 to invest. He became my first client. It was his entire lifesavings. I was super nervous about it, but fortunately I did very well for him. And then I collected some money from other people around town. So, they became my first investors, and they joined me later on when I launched Tsai Capital in 1997, our first account came in 1998. These are all local businesspeople that I had met in my teens who kind of funded the very early stages of the business. So, it’s a long way of answering your question, Tobias, it’s how I got started.
Tobias: That’s a good story.
Jake: It was all positive, like positive experiences.
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Tobias: I have to do a shoutout to all of the folks who’ve dialed in. We’ve got Feliz Ano Nuevo from Santo Domingo, what’s up? Antigonish, Brandon, Mississippi. Lewes, Delaware, thank you for correcting my pronunciation. Bellevue, Winter Park. Petah Tikva, still there good for you. York, UK. Riga, Latvia. Toronto, Winnipeg, Lancaster, Malaga, España-
Jake: Wow, great.
Tobias: -Edmonton, Kansas, Dubai, Kennesaw, Sugarland, Lima, Santa Monica, Tucson, Old Ocean, Texas, Philly. What’s up? Downtown NYC. Good, thanks for coming.
Jake: Truly Worldwide.
Tobias: I didn’t see any Townsville in the house today.
[laughter]Christopher: Because of you guys, not because of me at all. Because of you guys.
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How Gerald Tsai Built Fidelity Investments Into A Mutual Fund Powerhouse
Tobias: Miami, what’s up? That’s a great story. Your father was a well-known investor as well, wasn’t he? Do you talk about that or is that a secret?
Jake: Will you indulge us in a story?
Christopher: Sure. It’s not a secret. And he passed away in 2008. I learned so much from my late dad. I really admire what he did. So, his backstory was that he grew up in China and he was born in 1929. My grandmother, Ruth, who we can talk about as well because she was a pretty cool lady, she forged his passport, from what I understand, she changed the nine into an eight in order to get– And nobody knows this, actually. This is the first time I’m telling this story. She changed the nine into an eight. And so, she got him out of China one year earlier than she would have been able to do. And she made some money herself, being the first woman to trade on the floor of the Shanghai Stock Exchange. She was trading stocks. She made a killing, from what I understand. And she used some of those earnings to help send my dad over to the states.
My father comes over around 17, 18 years old. Goes to Wesleyan, transfers to BU. Gets an MBA from BU and works for Prudential Beige for a bit and then goes off to Fidelity. So, he was one of the first employees over at Fidelity. He becomes president of Fidelity when Edward Johnson Sr. was really like the vision behind that company and they were building it and they had very little AUM at that time, like $50 million, $100 million, something like that.
So, he convinces Edward Johnson to get some capital and create the Fidelity Capital Fund. That was my dad’s first fund, Fidelity Capital Fund. Did extraordinarily well. And then, one day, apparently, he spoke to Ed about becoming CEO of Fidelity. He was then president of Fidelity, and Edward Johnson said, “Unfortunately, that’s never going to happen for you because I have a son. My son, Ned, is going to take over.” So, my dad said, that’s understandable, and he left and he launched Manhattan Fund.
So, Manhattan Fund is still today, from what I understand, the most successful mutual fund offering in American history in present value terms. They raised a ton of money, and he rode that up through the 60s during a very strong bull market and sold out at the top. And then went on to do other things like run a Dow Jones 30 company. He was CEO of American Can, sold off all the canning divisions, low-margin business, moved into financial services, bought Smith Barney, changed the name to Primerica and merged it with Sandy Weill’s Commercial Credit.
So, I don’t know a lot of stories where somebody’s gone from fund management to running a massive corporation.
Tobias: One springs to mind.
Jake: [laughs] Yeah, some guy in Omaha.
Christopher: True, true. Yeah and, but there are not a lot of people who’ve done that, I think. And certainly, if you think about the so-called glass ceiling at that time where you have a Chinese person running a Dow 30 company, it was unheard of. And I think he’s still the only Chinese American to run a Dow Jones 30 company. So that’s his background. I learned so much from him, so much from him. He’s not an easy father by any means, but I learned a lot from him.
Tobias: It’s a great story. I watched Mr. Chow over the break. Are you familiar with that documentary?
Christopher: I’m not familiar with– Actually, I rephrase, a friend of mine and a client of mine actually produced that documentary.
Tobias: Oh, wow. Really? [crosstalk]
Christopher: I have not watched it yet.
Jake: What’s it about?
Tobias: It’s about Mr. Chow, the gentleman [crosstalk]
Jake: I gathered that. Okay.
Tobias: And his story, and I was just reminded of it because he had a similar story where he escaped from China to London and basically started with nothing. And it’s his story of building from– And he created these restaurants that were and continue to be phenomenally successful. But as a result, he came in contact with all of these painters and artists and he collected– Not only does he have a collection of all of these incredible artists, all of the names that just escape–
[laughter]Jake: Yeah, you’ve heard of all of them, but.
Christopher: And he’s an artist himself too.
Tobias: He’s an artist himself. He became an artist himself subsequently, but he’s featured in all of the art of all of these people, that’s the most amazing– Like, from Basquiat to Rothko to all of these guys actually made paintings of him and that was how often he would let them pay to eat at the restaurant with the art. And so, his collection of art is just incredible. And he’s also featured and he’s in all of the art. It’s a great documentary, I recommend it to anybody.
Christopher: I’ll have to check it out.
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Build Your Wish List & Swing Hard When The Opportunity Arrives
Tobias: When you look around the market as it stands at the moment, how do you feel about the current market in terms of your opportunity set and sort of what the future holds?
Christopher: Yeah, so 2022 was a tough year for us and was a tough year for a lot of people. And in 2023, we had a great year, we were up 55, little over 55% net. So, there’s been that massive reversion. But even today, we have to consider that what happened in the previous year in 2022, valuations were just overly punished and now they’ve corrected quite a bit, but they haven’t corrected fully to where I think they should be, even in this higher interest rate environment. In addition to that, the fundamentals of these businesses are doing really, really well, at least the companies that we own. So, I feel pretty good about our portfolio today. The discount is less than it was certainly last year, but it’s still there and the tailwinds are still there. In other words, revenue per share, earnings per share continue to grow very nicely. And that’s pretty much across the board of the 21 companies we own.
Tobias: What about the opportunity set?
Christopher: There are 20 companies on our wish list. They’re pretty stretched in terms of what we want. So, our current portfolio of 21, feel very comfortable about it. There are a few companies on that wish list of 20 that I would really like to own, call it three or four, and those three or four are actually exceedingly expensive right now. So, we just wait, we’re pretty patient and just wait for the opportunity and if the opportunity comes around, then we swing hard, but otherwise we try not to do too much.
Jake: Yeah.
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Analogies Between The Early Auto Industry And Current Technological Disruptions
Tobias: JT often does vegetables roundabout now. How do you feel, JT? You got vegetables on deck?
Jake: Of course. I’ve been saving this one because I knew Chris was coming on the show and I knew his Tesla position. We have the history of the automotive industry, how it started, early years. A lot of this comes from interesting book called Engines That Move Markets by Alasdair Nairn, I believe his name is. He was actually analyst for John Templeton, and he wrote this kind of historical book and friend of the show, Chris Pavese, sent me a copy of this for Christmas. Shoutout to Chris.
What this book does is it looks at ten historical episodes of major technologies. You have like railway booms in the US and Britain, electric lighting, oil, telegraph, wireless radio and tv, IBM and the PCs, internet and dotcom. And then of course, you have the automobile industry. And so, we’ll preface this with a funny– This was advice to Henry Ford’s lawyer regarding a potential investment in the Ford Motor company. He was told, “The horse is here to stay, but automobile is only a novelty, a fad.” Couldn’t have been more wrong on that.
So, in Britain they had powered vehicles, but they were hampered by these so-called red flag laws, and basically what it was is a man was required to walk in front of the car with a red flag to make sure for safety reasons. And in Germany, there was a similar speed limit to that, and it was set in place by the Ministry of the Interior. And in 1893, this inventor, his last name was Benz, and he had constructed this elaborate hoax. Here’s what happened.
This bureaucrat who was responsible for the speed limit was visiting the town of Bodden, I think it’s pronounced, and Benz invited him for a demonstration of his vehicle. And what the official didn’t know was that Benz had paid the local milkman to overtake the vehicle, of course, because it’s going so slow, like this horse-drawn milk cart, and shout obscenities at them as he goes by. And so, the official, he’s all hot and bothered by this, and he demands the driver to pass the milk cart so that he could get off his retort to him. But the driver then cites the official’s own regulations, like, “Oh, well, we can’t go any faster, sorry.” So, in a fury, the minister recants all of these regulations, and once they were discarded, they could then pass the milk cart and allow the verbal retribution to be exacted. Pretty funny.
Tobias: That’s great.
Jake: Yeah. By the way, there was a wealthy commercial magnet named Emil Jellinek. He had ordered four vehicles from Benz, and actually he resold two of the vehicles to Baron Henri de Rothschild, who couldn’t stand that Jellinek was passing him on the roads of Nice. And Jellinek used his– He entered races with these cars under a pseudonym, and he used his daughter’s name, which was Mercedes. And so, the two of them teamed up to form Mercedes Benz. There were three competing forms of prime mover at this time. You had steam, electric, and then, of course, gasoline. And it wasn’t entirely clear which one of those three was going to be the winner. And in fact, in 1900 in the US, the steamer was the best selling at 1681 units produced, compared to 1575 of electric and 936 of gasoline. So, gasoline was actually sort of like the least productive. And it sort of makes sense that steam was the early winner because you already had roughly 100 years’ worth of usage in railroads at that point, so it was kind of a known technology.
But the gasoline powered ended up winning, but why? It actually had a lot to do with racing. The gasoline was superior for the endurance of the longer run relative to– And then, also higher speeds. But not necessarily for small trips to the grocery store, probably the steam or the electric was better suited for that. But Americans love to race, so the gasoline engine is the one that sort of ended up being the dominant form. It’s really interesting to see where all the early manufacturers came from, like what was the industries.
William Chrysler came out of the railroad industry. There were a bunch out of the bicycle industry. Henry Ford was an electrical engineer basically. He was chief engineer for Detroit Edison. James Packard was out of electrical parts. This guy, Ransom Olds, of Oldsmobile came out from machinery. Studebaker was from horse carriage industry. And between 1900 and 1908, there were 500 automobile manufacturers that entered the industry. I mean, just more than half of them died in that same span. For the most part, production was small and amateurish, and the financing of most of these companies was really fragile, like any downturn in the economy, just completely wiped them out.
Now, how about Henry Ford? He left Edison in 1899 to found Detroit Automobile Company. The company folded within 12 months. He lived with his father from 1899 to 1901 to save up enough money to build a racecar. He enters a race, he ends up winning, and he won the equivalent of about a $70,000 today purse. That publicity allowed him to start another company called the Henry Ford Company. And he wanted to keep building racecars, but his financial backers wanted him to build a car that could be sold to the public. So, Ford, disgruntled, left. Company folds– actually, not quite fold just yet. It was then taken over and run by this guy named Henry Leland. And the name of the company was then changed to Cadillac. Leland left Cadillac in 1971 to start Lincoln Motors.
And then, there were these two brothers, John and Horace Dodge, who were parts suppliers. They agreed to assist Ford in creating a new company, and basically, they traded parts for stock in the company. And there was a falling out between the Dodge Brothers and Ford. The Dodge Brothers, of course, go off and start their own company, Dodge, and Ford had to buy them out. He bought out their 10% interest for $25 million, which is like $1.1 billion today. After a few uneventful model launches, Ford eventually launches the Model T in 1908 and of course that worked out okay for him. But he was the first one to produce a low cost, commercially viable, and reliable vehicle. And as production rose, the unit costs fell and the cost of production could be amortized against an increasing volume and that allowed the prices to keep falling, and it put pressure on all their competitors.
How about General Motors? This guy, William Durant, he wanted to own a portfolio of models to basically shield his company from changing tastes. So, they went on an acquisition spree, like he was trying to buy market share basically. He got control of a company called Buick. He then purchased Cadillac, Oldsmobile, Pontiac. He used debt and equity to finance all these transactions. In 1910, that profitability tanked and they were rescued by a financial consortium. Durant was kicked out. He teamed up with this Swiss immigrant named Lewis Chevrolet to build a new car. And with the help of the Du Pont family, Durant merged Chevrolet back into GM, and he regained control of it. Five more years of running the company with really loose finances, Durant’s kicked out again. Of course, GM, Alfred Sloan at that time was the one who came in and took over. He was like a VP in the company, and that ended up working out pretty well.
Interestingly enough, the provisions of the credit facilities really greatly improved the sales volume. Basically, you had to help your customers be able to finance these big purchases, and only major companies then could be the ones to obtain access to that level of funding, to be able to supply for their customers. And to give you a sense of how expensive cars were back then. In 1907, the median price was $3,700, which is the equivalent to about $210,000 today. I mean this is almost more like buying a yacht than like an everyday tool. In 1916, so just nine years later, the median price was down to $1,000, which is actually the equivalent to about $45,000 today. So, still relatively expensive. And it took really 10 to 15 years before the top group of companies resembled any kind of permanence. I mean, there was just constant turnover at the top. And, of course, they were all still very economically sensitive. Anything with that large of a price tag, that much fixed cost, you can really run into operational leverage issues.
So, the selection of which companies were going to end up being the winners of any permanence was really almost all but impossible. You had so much churning around, like literally hundreds of companies sprung up. Most were genuine manufacturers, but there was a ton of just stock market scams at the time that were, “We’re starting a new car company, we have a patent on something,” that’s not even a real thing. And even the winners, it was not any kind of a smooth path to the top. Ford was the only– He was successful on his third try at a company. And, of course, GM had to be rescued two different times by financial consortiums to survive.
I guess, some of the takeaways, and, Chris, I’d love to hear you fill in with this with your understanding of maybe the analogs of today. But, boy, it’s not easy to get to the top. There’s lots of pain, lots of consolidation, lots of treacherous, rocky road to traverse to get there, but I thought I would save up the automobile one for Chris because I knew he would have some good insights to add.
Christopher: Well, I’ll add that– That’s pretty cool, pretty cool history, Jake, thanks for sharing that with all of us. There was this really well-respected industry publication around the beginning of the 1900s called Carriage Monthly, and the editor of this magazine said, paraphrasing, “Human beings have been carried by beasts for thousands of years. Why should the future look anything different?”
Jake: Yeah.
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Musk Borrows From History: How Tesla is Channeling Henry Ford to Dominate EVs
Christopher: And like to your point, things changed pretty quickly. There’s a guy by the name of Tony Seba. If anybody is not familiar with Tony Seba, definitely check him out. He’s a great thinker on disruption, and he influenced my talk that I recently gave called Investing in an Age of Disruption. And he basically shows how all of these technologies going all the way back to the Gutenberg printing press, then to cars, to cable, to streaming, etc and you see an S-curve kind of formation, and you see that the market is initially slow to take off, right? The new product or service is slow to take off, but then you hit a tipping point and you just get this S-curve until you hit 80% of the market, and it kind of slows down. And that formation is the same with all of these disruptive, innovative technologies. And I use the word disruptive loosely because horses and carriages were disrupted by auto. And so, I see the same thing playing out in the EV world today. I see EVs being increasingly disruptive, replacing ICE vehicles. And eventually we’re going to get to a situation where almost, maybe not 100%, but almost 100% of the market will be EVs. It’s just a better, more cost-effective product, and there’s a cost curve associated with that as well.
Musk is certainly, I think, copying the playbook of Henry Ford in the sense that Henry Ford was–. Before Bezos, Henry Ford to me was the– He understood this idea of scale economy shared that Nick sleep always talks about with respect to Amazon and Costco. It was Henry Ford who implemented the scale economy shared business model first, I think. I haven’t found anyone before Ford, so if anybody knows of anybody, let me know. But Ford, to your point earlier, dropped prices which made it very hard for the competition to keep up. And as he dropped prices, as his costs were falling, he maintained his margins, but he increased his competitive positioning and Tesla’s following the same playbook.
Tobias: You require profitability or sort of the path to profitability is one of the things that you need before you invest.
Christopher: Very, very clear path. A very clear path.
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Tobias: So, that probably precludes a few of the more popular things, but just that the talk of new technologies. AI has got to get a shoutout here somewhere. Have you participated or do you watch that sort of looking for an opportunity or let it come to you? What are your thoughts on Nvidia and all of that sort?
Christopher: Yeah. I haven’t spent enough time on Nvidia, but I can tell you that we own Amazon, we own Microsoft, we own Alphabet, and we own Tesla. Tesla is a completely underrated AI play, but besides Tesla, we own the other three. So, we’re covering that to some extent. I don’t have a pure play on AI. It’s not an area that I’ve–Company that I’ve found yet that I feel comfortable with. But I do believe that the portfolios have exposure to the world of AI from many angles.
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Tesla FSD Licensing Could Be A Lucrative Strategy In The Long Run
Tobias: When you look at something like Tesla’s FSD, how do you rank that against all of the other competitors in the market? Because there’s this chart that does the rounds every now and again that says Waymo is way out in front and Tesla’s sort of lagging behind, which honestly I have a little bit of trouble believing because there’s so many Teslas on the road, surely they’re getting much better data and feedback than Waymo. But I don’t know, I’m not close enough to it to know.
Christopher: Jake and I have a mutual friend who’s a Google engineer, and I’ve spoken to him at length about the FSD and the company’s lead in FSD, it’s substantial. I’ll leave it at that, that I think that the company’s lead in FSD is substantial. There’s nobody close, at least for now, and it needs to be watched because things change quickly. But at least for now, with the amount of miles and data that they’ve collected as a result of the driving, as a result of the millions of cars, in terms of the installed fleet on the road, collecting data every year, every day, every minute. I think that from what I understand from all of our research, from all the people that we’ve spoken to who are kind of insiders in this space, in the world of technology, in the world of FSD, we think that Tesla is leaps and bounds ahead of the competition.
Tobias: If Tesla is, in fact, leaps and bounds in front of a competition, how do you think about FSD in an absolute sense? Does it meet the claims that Tesla is making?
Christopher: I don’t know if it meets exactly the claims that it’s making, but it will. And I think ultimately, we’re looking at an Intel Inside type of situation. Tesla does not want to put all the other car manufacturers out of business, in my opinion. Why would you want to do that? Because they’re never going to grab every single car on the road. Just people have different tastes. People don’t necessarily want what everybody else has. So, there’s going to be room for some other players, but ultimately, this is a technology product, as I said earlier, and it’s going to be driven increasingly by software.
The other companies are way too far behind, and so for them to have any sort of viability. I’m not even talking about manufacturing competitive advantages because they don’t have that right. They’re losing money. Ford is losing $35,000 to $40,000 per car sold, per car sold.
Jake: But making it up in volume. [laughs]
Christopher: And the problem is. Yeah, I mean, the problem is every new EV that they sell, they lose money on that, and they also are now not selling an ICE car on which they would have made money. So ultimately, I see these companies, legacy auto, as licensing the Tesla FSD from Tesla. The Tesla FSD becomes like Intel Inside, on which Tesla gets recurring high margin revenue.
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The Problem With Owning Berkshire Hathaway
Tobias: What about competitors like Rivian or BYD, or sort of the more EV-native type companies?
Christopher: Yeah, I mean, there’s definitely room for more than one player, and I would probably bet on BYD. Personally, we don’t own BYD, but if I had to bet on another player, I would bet on BYD. We don’t own BYD is simply because we have we think enough exposure in that area, and we want to create a diversified portfolio that is not diversified just in terms of number of companies, but industries as well. But there’s room for more than one player, and there will be more than one winner in this race.
Tobias: Does Berkshire still hold BYD, or they are selling down some of their position?
Jake: I believe so. I think they still– I don’t know if they’ve trimmed it. I think they’re still in there though.
Tobias: Do you hold any Berkshire, Chris? That’s outside your sort of remit?
Christopher: We don’t own Berkshire. We have owned Berkshire in the past for many years.
Tobias: What led you to divest?
Christopher: The problem with owning Berkshire, at least for us, is that I want to give our clients something that hopefully does not resemble S&P 500 and hopefully is better than S&P 500 after fees. At the current valuation of the company, at the current size of the company, given the current kinds of businesses that they own, and given my conversations with Charlie about Berkshire, I don’t think that– Put it this way, I think that we can add more value to our clients by choosing something that is not a broad proxy for the S&P 500, which it seems to be today, or very close to a broad proxy for the market as a whole, and a great proxy and maybe a slightly better proxy, but I think we can do better than that.
Tobias: What do you see as the future for you and the fund? Are you going to move into industry? Stay as a fund manager?
Jake: Yeah, when are you taking over a Fortune 500 company?
Christopher: I’m having a lot of fun managing money for others, and so it’s not on my radar.
Tobias: You don’t want a real job?
[laughter]Christopher: I like to have my time to read like you guys, to think critically, to control stress to the best that I can. And this particular job seems to suit me pretty well for now.
Tobias: Do you have a holding in Nike?
Christopher: Yes.
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Nike’s Strong Brand, Efficient DTC Model, And Global Market Potential
Tobias: I’ve got a question here from Lotto Allocator. Does Chris think Nike is making a transition to a higher quality business model by going direct to consumer and will they start doing more technology-enabled product?
Christopher: That’s a great question. Over 35%, I believe right now of their business is direct to consumer. And it’s up pretty sharply over the past, call it five years. I like that business model. It’s not only because of the margins within direct to consumer, but because the company can pivot more quickly. It’s a more efficient business model. And so, yeah, I think that they have upgraded the quality of the business. I think that Nike is interesting in that. it’s really been Adidas and Nike and if you think about it over 50 years, it’s really been Adidas versus Nike, it hasn’t been anybody else. And any other player that has come into the market has not done so well. And we’re talking about-
Tobias: Reebok.
Christopher: -so Reebok was sold. Reebok was sold during not a very good time; they had a lot of issues. We looked at Reebok closely back then, or I did. I was still in college at the time, but I looked at Reebok. I remember analyzing, going through all the annual reports in Reebok, they were eventually sold.
Jake: You are talking about the shoes though/ That was cool.
[laughter]Christopher: The new brands that have come in like Under Armour and even specialty brands, they haven’t been able to make inroads and Nike will just go and acquire something that– or Adidas will go in and acquire something that really has a competitive threat. It’ll be interesting to see what happens with on with Federer shoe, but these are two, I look at them as kind of duopolies. And I’ll share this with the audience, so, I have a friend who used to work with– Actually Jake and I have a friend who used to work with Lou Simpson and apparently, he asked Lou, he was taking– No, Buffett was talking to Lou years ago. And Buffett asked Lou, “What’s a better company, Coca Cola or Nike?” And Lou apparently said, “Nike.” And so, it’s been that way in my opinion for that whole period of time. And if you look at Nike versus Coca Cola, Nike has way outperformed. So, it’s a long way of saying that it’s a really strong brand. I look at it as a duopoly, and I look at the business model as improving in terms of quality, becoming more efficient, becoming higher margin, and still having a lot of potential to grow over time because the number of feet in this world are– There’s just more feet every day.
Tobias: They’re twice as many feet as mouths.
[laughter]Christopher: There you go.
Jake: That’s why it’s better than Coke.
Tobias: There’s probably not quite twice as many feet as mouths, but that’s funny. I was going to ask you exactly that question because I think it was Sun Valley where that exchange happened between Simpson and Buffett. And Simpson was pushing for Nike. I don’t think there’s a record of what Buffett said, but yeah, I remember Simpson pushing for Nike.
Christopher: A lot of people don’t like it because they think of it as a fashion brand, but they’re in so many verticals, they lose one area they gain in something else. I don’t really look at them as a fashion play. I look at them as something that everybody needs and goes to, and it’s very popular amongst the younger generation today.
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The Future of Electric Vehicles: Room for Many Players Alongside Tesla’s Lead
Tobias: Can I just ask you, just to play devil’s advocate, when you say that you view Tesla as a technology company, do you think consumers view Tesla as a technology company or do you think that– ultimately, they often say that– I forget who exactly said it, but a man comes into a hardware store looking for a drill, what does he want? What he wants is a hole, not a drill. Man comes in to buy, or a woman comes in to buy a car, what does he or she want? A method for getting from one place to another as easily as possible, probably not so much technology. Do you think that’s the case or what do you think about that?
Christopher: I think that people ultimately want to get from point A to point B, so that’s first principles. They want to get from point A to point B, but how they get there, I think, matters. And I’ll give you an example, a really close friend of mine, Julian, he got his first Tesla, and he says it’s his peace chamber. He’s got a lot going on in his life, got the kids screaming, he’s got work, but when he steps inside his Tesla, it’s like a peace chamber. So, the experience is very positive for a lot of people, and that’s creating a very deep loyalty. But there’s room for more than one player. It doesn’t mean that Tesla will not be the– Doesn’t mean that Tesla is going to be the only success. It might be that another company gets person from A to B with as nice of an experience, and that’s fine. The market is enormous. The whole market is shifting, so you have a huge pie that is expanding in which there’s room for several players to take a bite.
Tobias: Is that unique to Tesla, or is that an EV phenomenon, or is that even just a car phenomenon?
Christopher: It’s definitely unique to Tesla for the moment. And the technological lead in terms of the functionality, the ease of use, the whole experience is definitely unique to Tesla for the time being with that lead that I mentioned.
Tobias: JT, you’ve driven some other EVs, how do you rate that?
Jake: You know, my experience is too limited to really say very much I would say. I would discount anything that came out of my mouth.
Christopher: And you have to also think about like when we’re talking about stocks, you could have a company whose earnings are not doing well, and you make a lot of money on the stock because of your starting price or some other factor. And you can have a company that is doing extremely well, and you don’t make any money on the stock, you might even lose money because you pay too much or for whatever reason. So, there’s that whole other element. So, when we talk about Tesla as a stock, we have to frame that a little bit differently, as Tesla as a company. And you can have Tesla as a company lose market share which it will. And you can have tesla maybe sell less vehicles than people expect. You can still have the stock do well. It all depends on what are the other dynamics in that situation. And so, the way we look at it is from the current valuation, we still think it looks really, really good.
Tobias: And on that note, Chris, we’re almost out of time. So, if folks want to get in contact with you or follow along with what you’re doing. How do you suggest they go about doing that?
Christopher: I’d love to hear from you guys. Just email me, ctsai@tsaicapital.com.
Tobias: Easy. Thanks, Chris. Thanks, JT. Thanks, everybody.
Christopher: Thanks, everyone.
Jake: Good seeing you, Chris.
Tobias: We’ll be back next week. Same bat time, same bat channel. See everybody then.
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