Tesla Passes Ford by Market Value

1: Debt + Equity = Enterprise Value. The value of the equity is determined by the stock markets - and that value can vary a lot.

2: Equity Value therefore represents the market's perspective of the Net Present Value of the future cash flows less the value of the debt. Those flows, calculated using a discounted cash flow spreadsheet, could be from profits, or could be from sale of assets.

3: The analysts will forecast the Enterprise delivering a certain IRR - annualised percentage return, which is split between the debt and equity. This total return is called the weighted average cost of capital - WACC.

4: Debt is cheaper than equity, and it also has a lovely tax shield effect from the interest expense.* Debt holders get the company when the value falls underneath the total value of the debt though, so you don't want to issue too much.

5: Equity (shareholders) demand much higher returns than banks, but accept the greater risk for it. e.g. VCs have much higher expectations than banks about their returns.

6: The more debt you have the higher the returns - and risk - for the equity. Think about the leverage you can get on a house - an asset with low % returns can deliver high value (or high loss) by using a lot of bank debt.

7: There is a body of work around finding the optimum level of equity and debt for a company - basically you want to balance the risk from having too high debt (and the company value falling underneath that value and using all the equity) and the benefits of higher returns to equity=holders from having higher debt.

Going back the the original post - EV is the real value of the company, not market cap. Ford could sell down their debt by issuing more equity, Tesla could issue debt and reduce the share of equity. It all comes back to EV.

*This makes the weighted average cost of capital vary slightly as the amount of debt changes.

> You're insisting that debt is another form of investment, and depending on what you're looking at that makes sense, but when talking about 'value' it doesn't always hold true.

This sort of intuition is seductive, because we're generally told "debt bad, equity good!" But it's not correct, for the very simple reason that debt and equity are, in many ways, fungible: each type of financing can be utilized to replace the other.

To go back to the company A & B example: Company A could decide tomorrow to borrow $500,000 and buy back $500,000 worth of stock. Company B could issue $500,000 worth of stock and pay down its debt. Then, just by shuffling some papers around, the capital structures of the two companies will have been reversed! Yet nothing in the underlying business will have changed for either of them.

But don't just take my word for it! Franco Modigliani won a Nobel Prize for his part in the Modigliani-Miller theorem, sometimes called the "capital structure irrelevance principle" (seriously): https://en.wikipedia.org/wiki/Modigliani–Miller_theorem

It's certainly a complicated subject, but debt is very much a real part of a company's capital structure and can't be ignored when comparing two different companies.

I don't think the change will be quick, but I think you're overestimating the problems and underestimating the potential benefits here.

Cost is a short term problem. Costs will go down. Liabilities can be insured against.

Here is where I see it going:

Stage 1: Taxis start being replaced by self-driving vehicles at much lower cost. Car rentals too - liabilities potentially go down once they reach a certain level of safety as you don't face the risk of a poorer than average driver. Usage skyrockets as costs drop, and as services can cut pick-up times drastically by more optimally having a larger fleet parked around town and/or driving around town.

Stage 2: We start seeing pooling options from more and more rental providers to deal with high demand situations. E.g. Rental company crunches their numbers and see that my road => the local train station always maxes out capacity during rush hour and decides that rather than buying more vehicles, surge pricing coupled with offering a discount that brings the price back towards normal for each rider as long as it at most takes X minutes extra will be popular and more profitable.

Stage 3: They put in minibuses on some of the most congested streches and/or team up with the local bus companies to launch apps where you can tell them you're at the stop and get guaranteed pickup within Y minutes by either the regularly scheduled bus or a car. You pay a slight premium for the guarantee, which covers the car when the bus won't be there and a profit share with the bus company. (For me the only reason not to consistently use the bus is that if I need to be somewhere urgently, I can't always risk waiting for a bus that might be full; if I had a guarantee that if I press the button and walk to the bus stop, I will get picked up in 5 minutes, it'd make me use the bus more)

Stage 4: As self-drive increase in general, cities put the thumb on parking spots. E.g. in parts of London you already won't get planning consent for housing with more than 1.5 parking spaces per living unit as a means to cap car ownership. Expect to see that gradually driven down, with the expectation that people will buy parking space for their self-driven car elsewhere and/or forgo having one. Driving down the limits on parking will allow for denser developments, making ride share options etc. even more viable.

Stage 5: Youth grow up without depending on their parents to drive them anywhere from the moment they are trusted to go by themselves.

Basically, I see it as a process where the convenience of apps to get you somewhere will keep increasing to the point where people will find themselves increasingly opting to check these apps first and find themselves needing a car less and less. Some transport apps are already combining route-finding with then offering to order an Uber for you.

Expect to see more of that making it less attractive to get a car over time.

Especially as youth get used to a greater flexibility and level of freedom using these type of apps before they can buy a car. Car ownership many places represents freedom from parents driving you around, but more and more teenagers can expect to be in situations were parents opt to order them a car instead of driving themselves.

Before long, a whole generation will experience car ownership as irrelevant to the ability of liberating their transport options from parental control.

Sure, some people will still opt to own one, but many already forgo car ownership, and that number will certainly rise rapidly.

That is it, and the ability to use the data to start offering sharing options with either discounts or priority pick up to make people ride share when capacity is full will be a massive change ("we're seeing high demand; you can wait 10 minutes for a vehicle to yourself, or a ride share can pick you up in 5 minutes"). There are plenty of times where I know it will take time to get a car because of demand, and would happily share if it meant I'd get picked up sooner.

Smoothing that out, so that you come to expect a car to be available very rapidly no matter what, with only minor inconveniences, may not end private car ownership but certainly will make a lot more people opt for alternatives - I know for myself (I don't own a car) the occasional lack of predictability in how soon I'll get picked up is the one aggravation that occasionally make me want one.

Agreed. Tesla is a young auto company, who eventually wants to be an energy company. It might happen faster than we all think or expect, but it's not there yet.