Baron Fund – Tesla: Investors’ Concerns Are Overblown

Summary:

• The vast majority of the Fund’s underperformance this quarter stemmed from the Fund’s 10-year investment in Tesla, Inc.
• A significant decline also occurred at the end of 2022, and in that instance, investors had become concerned about a host of external factors.
• Just like in late 2022, we believe investors’ concerns are overblown.
• After extensive and frequent meetings with Tesla executives and engineers, manufacturing and technology consultants, and competitors, we have increased confidence in Tesla’s ability to accomplish its mission.

The following segment was excerpted from this fund letter.

Tesla, Inc. (NASDAQ:TSLA)

The vast majority of the Fund’s underperformance this quarter stemmed from the Fund’s 10-year investment in Tesla, Inc. Tesla’s shares fell 29.3% during the period and detracted 13.41% from the Fund’s first quarter results. Although Tesla has contributed importantly to the Fund’s performance since 2014, on occasion it has detracted from quarterly performance. In previous instances when Tesla shares have underperformed during a discrete period, they have shortly afterwards reflected the strong growth of the underlying business and the stock has appreciated considerably. We believe that will be the case again, although cannot guarantee it.

A significant decline also occurred at the end of 2022. In that instance, investors had become concerned about a host of external factors. Investors believed the company founder, visionary, and CEO Elon Musk was distracted by his acquisition of Twitter. They also believed a weak Chinese economy emerging from COVID and U.S. government policies would curtail the purchases of Tesla vehicles. These fears proved to be overblown. As the company achieved milestones in the succeeding year, the stock subsequently doubled over the next 12 months.

Today, investors are again concerned. They believe there is increased competition from Chinese automakers who are supported by a protectionist government. They worry about product-level margins after announced price cuts. They are skeptical about whether the company can achieve Full Self Driving (‘FSD’) and wonder about the feasibility of Tesla’s Robotaxi. And they debate if a mass appeal vehicle can be produced at scale and profitably.

Just like in late 2022, we believe investors’ concerns are overblown. Electric vehicle (‘EV’) competition will always be present. The Chinese automakers make a good, value product. But we believe Tesla’s offering is superior and will garner a meaningful market share within China. We also believe the Chinese OEM advantage will be minimized outside of its home market because of tariffs. We are already seeing traditional internal combustion engine (‘ICE’) manufacturers scrap their EV plans as plant conversion is too costly and their technology is inferior. They have instead attempted to fight for market share in the outdated ICE category.

We also believe a lower cost Tesla product will eventually be introduced and gain wide acceptance. Timing is uncertain, however, as the company attempts to develop both the new vehicle and fully autonomous vehicles in parallel. We have experienced Tesla’s FSD versions and believe they are close to achieving success. While the combination of these two feats may extend the timeline, we believe it meaningfully improves profitability and solidifies its competitive advantage. Additionally, other ongoing projects within Tesla (e.g., battery packs, energy storage, humanoids, database, software, AI compute, and distributed inference) make the company a lot more dynamic than when we first invested in 2014.

We initiated our investment in Tesla in February 2014 at a split-adjusted price of $11.88 per share. Over the subsequent two years, we acquired 16.65 million shares at a split-adjusted price of $14.22 per share. At the time of our final purchase in February 2016, the stock represented 9.6% of the Fund’s total investments.

Tesla produced 48,685 vehicles in 2014, the year of our initial purchase. In 2023, Tesla produced 1.85 million cars! Its production and profits per vehicle have since also experienced remarkable growth. Tesla has evolved from manufacturing a high-performance EV for the wealthy to a company producing affordable luxury for the mass market. Tesla’s software, electrification technology, and manufacturing expertise have transformed an important industry. Investors have rewarded these efforts. Tesla’s stock price increased about 20 times to $248.48 per share in the decade following our purchases. Because its share price had increased so substantially and it had become a large percentage of the Fund’s assets under management, three years ago we sold approximately 4.5 million Tesla shares. The weighted average sale price was $218.39 per share. Those shares represented 27% of the Fund’s original holdings. Tesla’s business has since about tripled in size! Its recent share price is now about 50% lower!

We remain focused on Tesla’s ability to achieve its mission of accelerating the world’s transition to sustainable energy rather than on how much it earns in any given quarter. After extensive and frequent meetings with Tesla executives and engineers, manufacturing and technology consultants, and competitors, we have increased confidence in Tesla’s ability to accomplish its mission.