Eric Markowitz worms his way through the Tesla bull thesis... plus a little Spotify $SPOT $TSLA

Eric Markowitz, director of research at Worm Capital, discusses Worm’s investment in Tesla.

You can find Worm’s Q3 letter here, and my tweet thread on Tesla here. You can follow the podcast on Spotify, iTunes, or most other podcast players, as well as on YouTube if you prefer video! And please be sure to rate / review the podcast if you enjoy it, or subscribe to this Substack (it’s free!) to get all new podcasts and transcripts delivered right to your inbox!

Disclaimer: Nothing on this podcast or on this blog is investing or financial advice; please see our full disclaimer here. The transcript below is from a third party transcription service; it’s entirely possible there are some errors in the transcript!

Transcript begins below.

Andrew Walker: All right. Hello and welcome to the Yet Another Value Podcast. I'm your host, Andrew Walker. With me today, I'm happy to have Eric Markowitz. Eric is the Director of Research at Worm Capital. I believe he's referred to himself as the "head research grunt".

Eric, how's it going?

Eric Markowitz: Yeah, I'm good. Thank you. A research grunt, that's fine with me.

Andrew: Well, let me start this podcast the way I do every podcast. First, a disclaimer to remind everyone who's listening, nothing on here is investment advice. Please do your own work, consult on your advisor. Second, a pitch with you, my guest, I've heard of Worm for a couple of years in 2019, when I was deep in the Tesla Q[?] universe. I think I've heard of Worm and said, “Oh, those guys are swinging really hard at Tesla. What crazy guys."

You and I connected after I read Worm's Q3 letter, which I said online, I'll say it again. It was just so enlightening to me. I really enjoyed it. It was thought-provoking. It was all about marginal gains, and I'll be sure to include in the show notes for anyone who wants to go follow up, but after that, we connected, and I've just found you to be a thoughtful investor. I think that's going to come out in the convo we have today. I've enjoyed getting the weekly Worm crawler emails that you send out, some great links in there. Really happy to have you on the show.

That out of the way, let's just turn to the company we're going to talk about. It's this little-known, under-followed car manufacturer, Tesla. We can start by talking about how you guys found it. We can start by talking about all the misperceptions that everyone has. I'll just turn it over to you. What do you want to talk about with Tesla?

Eric: Yeah. It's been in position for more than 5 years now. It's a company we've covered and followed, and really spent years researching. It really goes back to our founder and CIO, Arne Alsin. Really sort of experienced the product himself firsthand. We drove a Model S, and I think, for him, that was the Aha moment, getting in the car, driving it, realizing what the potential was, and then also seeing the people on the street look at the car. That was late 2015. I think this was really before Tesla had overtaken the media. There were still, even back then, a lot of commentary about the company. Obviously, it's led by a fairly well-known individual.

We can start wherever, but fundamentally, we believe that the company has really been transforming the overall transportation and energy industries. Obviously, it's a company with a massive vision. It's a company that I think is, for better or worse, largely still misunderstood in a lot of ways. I think that we are attracted to companies that are complex. I think that we personally, as investors, find a lot of opportunity when there's a lot of disagreement about what a company is and isn't. We're kind of drawn to companies like Tesla because their vision is so large and grand. They're actually putting the pieces together to make that future a reality. I remember visiting the Gigafactory 4 years ago at this point and just seeing the enormity of what they were trying to build and what they're still building today that's expanding internationally with Gigafactories in Shanghai, Texas, and Berlin.

Big picture, it's a true disruptor. It attracts a ton of scrutiny, which is good. I think there's an element of, if it's easy, it's probably not a great investment. This should be hard. We are attracted to super complex situations. Tesla just happens to be one of them.

Andrew: Yeah. I've got a lot of baggage with Tesla. I've always hate-loved Elon Musk, if that makes sense. I love the vision, but a lot of his stuff he does I always look at, I'm like, "Ugh."

You mentioned several times you think Tesla is misunderstood and we're going to talk valuation. We're going to talk about some of the questions that I've had with Elon and Tesla, and everything. What do you think maybe one of the main or a couple of the main misunderstandings of Tesla today is?

Eric: The classic one, you see it all the time, is Tesla's valuation stacked up against the other car manufacturers.

Andrew: That was going to be one of my questions. Yeah.

Eric: That's a chart crime, if I ever saw one. I guess my perspective on that is it's fundamentally not a car company. This has been said by other Tesla analysts and investors. It is very much fundamental to trying to understand what the company is building; it's a highly vertically integrated hardware and software manufacturing firm with a lot of optionality baked in with artificial intelligence and other sorts of software-enabled platforms. The first modality of transportation is a consumer-facing sedan. Eventually, we'll have a cyber truck, and longer-term, we'll have the semi, but there are other verticals that Tesla is pushing forward into. It's just not fair to necessarily lump it into how it values, the valuation versus a GM or a Ford. It's just a company with a much different DNA. That would be maybe the first serve[?].

Andrew: Let me push back on that. You said it is a company that is vertically integrated hardware and software, which I don't disagree. If you've ever driven in a Tesla and then driven in another car company's car, the difference in integration, it reminds you of that old Apple thing like, yeah, you could go buy another smartphone or something, but Apple, it just works. There's just a little magic in the consumer DNA in the company, and Tesla's clearly got that. Why couldn't I go say, "Hey, GM is a relatively integrated hardware and software company, and yeah, they produce cars, but they're collecting lots of data, right? They've got a vision of doing other stuff." Why doesn't that apply to every other car company, or why is Tesla particularly unique in that?

Eric: For a lot of reasons. Start with A: GM is not building electric vehicles at scale. I mean, they've only built about 150,000 volts and they all had to be recalled recently. I think the principal difference is that Tesla has manufactured these cars since the very beginning with 8 cameras around them that's collecting data constantly. It's feeding into the neural net. No other car manufacturer is doing this. Tesla, at this point, has many billions of miles of data collected from its fleet of million-plus vehicles around the world. That's a data advantage that is not easily replicable. The incumbents really have no chance of competing with at this stage.

Frankly, going back 4 or 5 years at this point, GM and Ford, they've put out a lot of press releases about the future of electric vehicles and their participation in that future. If you look at just wheels on the ground at the actual ability of these companies to manufacture at scale, it's a much different story. I think that if I'm thinking about the existential risk for investors, it's looking 5 years out. If the incumbents really have the ability to sell a product that consumers really want, at the end of the day, the consumer decides who wins this disruption. I think it's fairly clear that Tesla does have a head start and advantage, and consumers have gravitated towards Tesla. As investors, we like to keep an open mind and look at other brands and even look at the incumbents and their ability to scale up and compete with Tesla.

If you look just a snapshot of today, the ability of the current incumbents to put a product that is really from a range perspective or software perspective, it's just not comparable. I think you're seeing the results of that playing out in market share and sales. Ultimately, like I said, the customer decides and that's how we view, not just investing in Tesla, but across all of our positions. We look at what customers are going to and it’s a pretty clear winner right now.

Andrew: I might come back to valuation in a second, but you mentioned something with the neural nets with Tesla. They've got 8 cameras around their cars. They've had these for years, so they've got this data advantage. I think anyone who is a Tesla Q person, which I was for a while, has been proven dramatically wrong, and now my questions are being on valuation and I don't super care, right? I don't super care on the new horse in the street anymore, but when I was deep into it, one question I always had was, "Okay, they had the neural nets and that was great," but I would always wonder, to use something with that data would require a huge R&D budget, right? You look at what something like a way more or something would spend interpreting that, or even just simple neural nets that people run online. It takes a lot of R&D, huge computing budget, and you don't see that on Tesla's balance sheet, right? I'm just looking at their 10-Q. They spent 2 billion dollars in R&D. I would assume neural nets included somewhere inside of that. With that, they're doing cyber trucks, they're doing everything else. It's not a huge research budget. What gives you the confidence that neural net is one of the edges that they're going to have?

Eric: Yeah. I mean, for one, experiencing it myself, I think that even Tesla autopilot is an incredible product. Again, it draws a lot of scrutiny, but if you actually sit in the car and take it out, I'm not even talking about FSD beta right now, but just basic autopilot, it's best in class. As far as R&D spend, I take a bit of a different perspective there, which is they’re highly efficient. Tesla attracts some of the best software engineers in the world. There's no doubt in my mind that the team that they've collected is one of the best, if not the best in the world, working on this problem around artificial intelligence. I think that you see it playing out in some ways as planned. The FSD rollout, for as much attention as it’s gotten, maybe to the downside, if you watch some of the currently available videos on YouTube just of the beta testers, this is a product that's in my mind, the closest to achieving full autonomy at scale. It's clearly not there yet. We're progressing towards that future.

We've looked at companies like WEMO and a bunch of the other LiDAR-based technologies. You hit a local maximum with LiDAR pretty quickly. It's an expensive piece of hardware. Ultimately, the only true way to solve full autonomy is through vision. The car just has to be incrementally better than a human at driving. We think that the car can do it with 8 cameras. It was impressive that the team took radar off of the camera for the next generation of full self-driving beta. I think the system is only going to get better with time. One of the limitations of the human brain is considering exponential growth. The full self-driving capabilities, I think, is a perfect example of how hard it is to conceptualize how the increasing production of Tesla vehicles, having more data being collected out in a real-world fleet, having more edge cases being solved, being fed back into the neural net, plus just the insane efforts that the team is going through with Dojo and just the training computer, the system is getting better with time. I think that there is a bit of patience required to see this future play out. Everything that I've experienced and seen, and people I've spoken with, it’s highly encouraging about the future.

Again, I want to caution, it's not perfect yet, right? Tesla knows this and it's an iterative process. This is what I was hinting at in the Q3 letter about just trying to keep improving the product. It will get better over time, or perfect, but it is all about striving of improving the system.

We see that, certainly, with neural nets, but also in the production capabilities at Tesla, just reducing costs throughout the company while increasing the efficiency of the products. It's just a culture of constantly improving and trying to increase efficiencies across the board.

Andrew: Yeah. One thing you've said on the best team, it just reminds me of when I was very bearish of Tesla, people would do the semi day or the AI day, and you'd hear everybody be like, “Oh, there's nothing new here," then somebody told me once, they're like, "You don't get it. This isn't for financial analysts, right? This is part of consumer marketing, right? Tons of consumers are going to watch and it's going to build up Tesla buzz." It's part marketing. Tesla has a zero dollar budget and they're more buzzy than every other thing because Elon can attract tons of people with tweets and stuff, but, it's part consumer working and it's part, “Hey, if you're the world's top AI researchers, come work for us. You're going to be at the sharpest, most fun, the edgiest place to work.” It's consumer marketing and it’s marketing to potential people to work there because the best engineer is worth a hundred times more than the second-best engineer or something. That was one of the things that just really changed the way I perceived Tesla, and it speaks to the quality of the team you mentioned there.

Eric: Yeah. I think we were always attracted. I do think that talent can be a leading indicator for the success of a business. When you see top talent flowing to a certain organization, it's a good reason to take a close look at the business. Same thing with an exodus of talent. I do think though that, because I'm thinking through some of the headlines that I've seen over the last few years with Tesla, but also other companies about "so-and-so executive left the company and went to a competitor", as you know, all investing is part psychology and just waiting information appropriately. As far as if you see headlines around about "so-and-so is leaving a company", it's just an input to factor in, but I think that you have to go a little bit deeper and really try to understand the organizational DNA and the types of people that work at these places. Turnover will be high at super hard-charging, fast-growth tech companies. Amazon is another big position of ours and still is. I remember stories in 2016, 2017, how tough it was to work at Amazon, the turnover, as far as [crosstalk].

Andrew: If you have seen this email from Jeff Bezos, one character was either a question mark or an exclamation point, and either way, it wasn't good.

Eric: Right. Those are the sorts of organizations that you want to bet on. I think that as an investor, I'm personally attracted to companies where there is a mentality around pushing hard and pushing things forward, and not being slow and just being obsessed with the product and obsessed with perfection because ultimately, that will bear out success. You'll see over time, I think, that the investment returns of companies that have this obsession with the product and obsession with the consumer, those companies will likely win over time. Those companies also probably happen to be run by the founders. They happen to be very hard places to work. They attract top people. I think the goal is we want to find companies where just the top people are going there. It's a good indicator for us.

Andrew: You and I've talked and people can read your letters and see the positions where Tesla, Amazon, Spotify is one that we have in common that we talked about. You just mentioned the hard-charging, it's returned to scale, these winner-take-all type dynamics in these markets with infinite scale possibility. That's obviously a common theme through what you're investing and weren't investing in. Twenty years ago, that type of theme didn't exist. Do you think Worm could have invested 20 years ago, or is its style just particularly suited for today's market, which is likely to be even better suited for tomorrow's market?

Eric: Yeah. Just some historical background on Worm Capital. It was founded by Arnie Nelson, who I speak to every day. He was turnaround investor for many years in the 90s and early 2000s, and he was kind of classic cigar butts, looking for value, really had a transformation in 2010, 2011, 2012. He was reading a lot of Clayton Christensen, innovators dilemma, thinking a lot about disruption, really focusing at that point on Amazon and AWS. His, I think, Aha moment, going back to 2011, 2012 was, the internet itself was our big bang. It was the defining moment for what changed the future of business. We have this internal lexicon at Worm Capital. We call it the "fully connected world", and it's the single room hypothesis.

The internet created this entirely new structure of business where everything happens and everything's out in the open. There's full transparency. What does that do to valuations? What does that do to the ability to scale businesses? Ultimately, a lot of the reason why we believe this is a winner-take-all dynamic is just full transparency. No one wants the second-best product. I think a good example that everyone can relate to is Google. You probably, I'm guessing, don't use Bing, because everyone knows Google has really the best search engine. [crosstalk]

Andrew: For a while, Bing had something, I can't remember the exact, it was several years ago, but if you Binged, they would basically give you a rebate for Binging, right? If you did a thousand searches, you would get a dollar. It was very small, but they were literally paying you to use the second thing. I'm a value investor, I was like “Oh, I'll get paid for it." It wasn't even the quality of the search. I just couldn't bring myself to break the habit of, "When I want to search for something, I go to Google or I just type it in my browser," but it just speaks to what you're saying, right? They couldn't pay you to use the second-best product.

Eric: True. I think that will continue to happen both in consumer businesses, in transportation business, it'll happen to every vertical. This was the core thesis to our firm. Disruption is happening and it's going to happen to every vertical. It's just a matter of time. If you looked at the portfolio 10 years ago, our long, only track record goes back to 2012. Arnie was really focused on the disruption of brick-and-mortar retail, looking at Amazon and the ability for Amazon to just scale. It was just this incredible scale business, and so the valuation techniques needed to change. In a disrupted vertical, cash earnings, it's just not that important. We're just not focused on cash earnings. The goal with any sort of disruptive business is land grab. It's just a territory shift. We just need to get new customers, grow our product or service, and so earnings will come. You have to find the right leadership and the right businesses that can eventually spin off a ton of cash.

I think, just going back to your comment about the internet and just sort of winner-take-all, that's very much how we view every vertical that we study, which is that everything is probabilities, right? Is there a chance that the future of transportation is evenly split among 10 companies? Sure, there is a small chance that there's something like that. I think the more likely reality is that we'll begin to see a winner take most dynamic continue to expand across the industry. That creates natural fair trading that this is a super messy time. If you just look at the industry, we're still really early and it's going to get even messier over the next decade, specifically in transportation. I think that you're going to see small companies today get really big. I think you're going to see big companies today get small. For us, that just creates opportunity. All this change creates opportunity. It’s healthy. We're going from less than really 5% of new sales being electric to eventually 100%. No question in my mind that eventually, it'll be 100%. It's just a question of when that happens. I think it could be a lot sooner than people realize. I think that the core focus for us right now is everyday is a new day. We just start with everything with the first principle approach and just ask, Who's got the best product today? Who most likely has the best product tomorrow?" Then, we can make our decisions accordingly from there.

Andrew: I liked that you used the first principles. Again, coming from a little bit of a Tesla Q, which is the symbol for people who thought Tesla’s going to go bankrupt thing, one of the big pushbacks on the AI driving was, "Hey, Tesla doesn't use LiDAR and everyone else uses LiDAR." One time, I heard Elon Musk say, “Hey, humans don't use LiDAR and humans are able to drive right now. LiDAR is this big expensive thing. If you want to solve this cheaply and cost-effectively, you need to do it without LiDAR." It's just one of those things. He went to first principles and he rebutted this thing that, again, that had been a big bear point for a long time.

Let's go back to valuation for a second. When we first started talking, one of the first things you said was it was a chart crime, right? Tesla is valued against every other car company and they're worth more than every other car company, and people obviously look at them and they say, “Toyota's selling a hundred times the amount of cars Tesla sells and look at all these big plants[?] and all this history.” Obviously, a lot of that goes away in the technological change, but at some point, valuation has to matter, right? Tesla's over a trillion dollars worth more than every car company, combined, worth more than any other car company, combined, at the height of all of their value and stuff. How do you look at the Tesla valuation?

Eric: You have to look forward. With any business like Tesla, you have to look at least 3 to 5 years out. We look out 3 to 5 years, and then ideally, we're even looking towards 2030. Three to five years is where we can really get a significant degree of confidence in where the business will be operating at. Look, there are very few, if any, historical examples of manufacturing firms at scale and growing 50% a year. I would challenge anyone to find a 10 billion dollar or more market cap company with hard manufacturing growing 50% a year for the next decade. They just don't exist. Tesla really is, in my opinion, the only large-scale manufacturing firm that has this growth trajectory. When you look at some of the, I suppose, maybe the sell-side analysts and how they're modeling out the growth over the next 3 to 5 years, I don't think that they're factoring in necessarily truly 50% growth.

The company is opening factories today. I think it's more than likely that they will be opening new Gigafactories years from now, as well. That growth will compound over time. The other main thing that we focus on is really the manufacturing techniques that are completely new to the auto industry. This is really one of Tesla's core competencies and core advantages, being able to not just manufacture at scale, but manufacture with improving margins over time. In Q3, we started to get a glimpse of some of the gap margins, 14.6% I think in Q3, at the time when the average selling price which vehicles are going down 5, 6%. This is a result of just completely retooling what it looks like to make, in this case, a car, over time, with the other products. That's a profound revolution across the manufacturing industry.

Andrew: This reminds me of the stuff with Toyota in the 70s and 80s. At some point, there is a limit to how far ahead you can get with the marginal efficiency, right? There's a limit to how far ahead you can get in terms of manufacturing. Why is that such a sustainable advantage for Tesla? There is the question, could they really commit themselves for 5 years, the cultural imperative? Maybe a ribbon[?] or something. If one of these guys commits themselves, is Tesla going to be able to have that big of an edge for that long from manufacturing EVs better?

Eric: Yeah. It's not purely also of hardware manufacturing. It's also the software that enables these cars to actually improve over time with increased range abilities. I think the 4680 production line, we'll see when it gets up and running, the scale and efficiencies that it can reach. I don't know what the future looks like in 5 years. All I know is what's in front of us today. Tesla is probably at least 5, 6 years ahead of the competition. I think that you will find the competitors coming to market. I think you're already seeing it with both startups like Lucid and Fisker, and all these other EV companies, but also GM and Ford. They are producing electric vehicles. They're not doing it necessarily at a level of scale and profitability that's anywhere close to Tesla right now. I think that the other thing that's hard to conceptualize but I think is very realistic is Tesla's gains in manufacturing capabilities only compound over time. Because they have this culture of innovation and just constantly retooling the process, it's not a static sort of production line, right? The production capabilities are only going to increase from here, and the efficiencies are only going to increase. Three to five years out, I don't really see a meaningful competitor to Tesla that’s able to produce cars at scale with a certain level of operating margin. We'll see, though. It's very encouraging to see companies review[?] and come to market. We'd love to see this competition. I think that having more electric vehicle companies expands the market for Tesla. I think that you see that with just how the whole auto industry has woken up in the last year about talking about this. [crosstalk]

Andrew: Does it expand the industry? The way I've thought about it is the competition, in general, is a bad thing for business, right? In many ways, electric vehicle competition expands the industry because it builds out all the infrastructure needed for electric vehicles. First, you get the consumer adoptions with shelf pull, but one big question, if you're doing a cross-country road trip, how are you going to do that? Well, if electric vehicle adoption expands, then there are going to be charging stations everywhere. Maybe it's a Tesla charger or maybe it's just the convenience store down the streets, which is from gas to electric. Is that why it would expand the market? I think a lot of value investors will hear competition coming and say, “Oh, Eric's being silly, the competition's bad," but it actually grows the market for everyone?

Eric: Yeah, absolutely. I think that the customer decides. I think that if you just talk to people over the next year, you will increasingly find people say, “Yeah, I think my next car is going to be electric.” I think that's on an exponential growth curve, right? I don't think that's a linear thing where 20% a year, more people are going to buy electric, no. It becomes, who has the best value proposition? Value proposition is not just the quality of the car, it's not just price, it's all the things wrapped up into one. You hinted at the charging network. If you try to take a road trip in a non-Tesla vehicle, it's really challenging. The supercharger network is an incredible advantage for Tesla as a selling point, as just something that the products experience. The thing that keeps me up at night and makes me nervous about the industry is seeing how slowly some of the incumbents have actually moved.

I think a lot of the focus on Tesla is around just the valuation. Obviously, that's something we think about a lot. The real risk I see in the auto industry over the next 5 years are what if some of these companies can't transition? What if they just can't do it? What if, despite their best efforts to create new products, customers just don't want them? You could see the potential for a very big blow-up across the auto industry. These are companies like GM and Ford and they have a significant amount of debt. Their ability to survive, I think, over the next decade will be decided in the next couple of years. It's a really interesting time in the auto industry. If we will see this true consolidation into one company, it remains to be seen. I think that right now, Tesla is building more durable advantages and their competitors have been really slow. We'll see what happens. We're watching it, obviously, pretty closely.

Andrew: There's lots of growth optionality with Tesla. One of the things, I think, investors have learned over the past 10 years is if you've got a company that consumers love, there's always going to be lots of great growth optionality, but Tesla, in particular, has some pretty interesting- If consumers love you and they give you $100 for your product, that's one thing, but if consumers love you and they give you $50,000 for your product, that's another thing. Tesla’s got great growth optionality. I think the biggest one, obviously, would be if they win self-driving, autonomous network of vehicles going across the country, that's kajillions. There's been lots of debates around things like Tesla Insurance Operations or a couple of others. Do you think there are any particular places where there's a debate that you just think silly, or are there any growth optionalities that you think are particularly exciting that you think might be understated?

Eric: Yeah, that's a great question. I think when we think about Tesla internally, we think that there's a few lotto tickets, right? For me, I focus a lot on just the possibilities of end-to-end trucking logistics. That's a trillion-dollar vertical that Tesla has a meaningful ability to really disrupt. Another one is energy storage. If you look at what the future of energy distribution looks like, it's more than likely a much more decentralized future than what we have today. Right now, you have local utility and you buy your energy from them. That's great for the utility companies, but what if you have a battery pack in your car, a battery in your home, and you're able to sell excess energy back into the grid when you're not using it? I think that virtual power plants and Tesla's Autobidder software are another potential lever of optionality, in addition to just the overall energy storage business. If you look at some of the projects that they've done, particularly in Australia, the Horns Dale Project is one, it's really compelling just for stationary storage. I think this is just based on pure cost and efficiency. We are headed towards a solar and wind and battery-powered future. The limitation right now is just battery production capability.

Over time, you're going to see Tesla just continue to grow their battery energy business. Over time, I think also, the consumer solar business will grow. That's obviously not the most focused part of the business right now because Tesla's just going after bigger opportunities with Megapack and some of the utility-scale projects that they're working on, but I think that there's a ton of optionality within the energy. Elon's commented, I think, going back to Q3 2019, maybe 2020, but just that energy revenues could eventually eclipse the auto revenues. That's a big statement. I think that what's so attractive about it is its recurring revenue. It's recurring revenue if they take a transaction fee off of any sort of on Autobidder or just the utility-level energy distribution software. It's super scalable. We just need the batteries right now.

Andrew: Yeah. I used to cover utilities and this was always the dream and this is what you hoped. I'll come to the SolarCity stuff in a second, but this is what you hope, right? The dream would be, if you can get batteries cheap enough and they can store enough energy, you literally give every home on the block a battery, you put 4 solar tiles on the roof. When they're not using energy, it just stores it in the battery, and then when they are using energy, solar tiles or the battery charges it. You're basically going to need a grid for backup or for high demands and stuff, but you can pretty much power every home and your Tesla, and you've got the best battery and solar panel, you're going to own that consumer once you put it in their house. It's a pretty crazy optionality. What's the EV of every electric utility in the country because that's pretty much what that could replace? If successful, obviously, you said it was a lotto ticket. I'm fine saying that's probably a lotto ticket, but that's a dream, right?

Eric: Yeah. Tesla has filed to become an electric utility in a couple of places and so I think over time, this is uncharted territory and there are other companies that are competing for this business. We're watching a bunch, but as far as the ability for one company to both manufacture the batteries, to distribute the energy, and to really expand global footprints pretty much everywhere, it's a massive opportunity. It's just something to keep an eye on X auto and X truck and all the other stuff that they're working on.

Andrew: Forty-five minutes in this conversation, Tesla, obviously, the story is great and they dream big, but let me come back to the thing that was always a sticking point in my mind, right? That's just the red flags that come out to Tesla. The biggest one to me, you can go on Tesla Q Twitter and find some quirky red flags if you want to get really in the wings, but the biggest one to me was always, the first thing that jumped out to me, I remember the Ashlee Vance Tesla book where I think it was Kimball who said, when Tesla was struggling in 2009, he said, “Oh, Elon pulled some tricks that I think if it hadn't gone well, he would have gone to jail for it.” Right? That always stuck in the back of my mind because then, when the SolarCity thing came up and there was the Potemkin village of SolarCity houses that he used to sell the deal to Tesla shareholders, when I saw those two things together, I was like, “Oh, that was just the screaming red flag.” There are a couple of others that we can talk about that I'm happy to talk about, but that was the biggest one where I saw that quote and then 7 years later, I saw the Potemkin village. Are you familiar with it? I'll put the Vanity Fair or Rolling Stone article or whatever it was in [crosstalk] is what they called it.

Eric. No. I'm familiar with it. Yeah. I’m familiar with all of that. [crosstalk]

Andrew: I was sure you were, but that was the red flag that jumped out to me that I wanted to ask you about.

Eric: Yeah. I've read everything that you've probably read, too. I think that what's so shocking to me, and frankly, it's probably a good thing, I just take such the opposite approach of how I think about Elon. He's obviously a "controversial guy", but I think that he's done some incredible things for the transportation industry. He's a guy who's landed rockets that no one has ever. It's just like, I suppose that I'm not a fanboy, whatsoever, but I'm more just shocked at how much negativity is associated with Elon.

Andrew: The craziest thing is when you hear Elon haters say, “Oh, what SpaceX did isn't impressive,” I'd be like, “Are you kidding me? The man revitalized American space flight. This is insanely impressive. What are you talking about?"

Eric: Yeah. This is business. This is not a popularity contest. I get that people don't like the guy. I think that Elon is an individual and he's super interesting. Obviously, I think he's one of the smartest leaders out there in corporate America today. I think if you stacked up a bunch of CEOs, he's an engineer, Elon fundamentally understands how his products are made. He's not a sales guy. I think he's a brilliant marketer, but principally, he's an engineer, so that's his focus. He's super quirky, but at the end of the day, he has 65 million Twitter followers and he sets the conversation. Tesla's never spent a dollar on advertising. There are all these sorts of benefits of him being out there in the media and capturing headlines.

I think that this is another one of those situations where investors, historically, maybe get a little bit tripped up with waiting[?] information. They weigh the information of what they see of Elon acting quirky, but if you actually go and spend time at the factory at Tesla and talk to customers, Tesla is a much bigger organization than Elon himself. He has built this organization, for sure. I think he's very much imparted his own DNA into this organization, but the company is way bigger than Elon at this point. I think that takes a lot of risk off the table. They're going to be producing next year over a million cars, and they have some of the best engineers in the world. I think that the whole Elon hating thing, over time, I think that goes away. Does he do things that are provocative? Absolutely. But when I look at some other CEOs and listen to how they manage their businesses, that honestly makes me a little more queasy, just thinking about, especially some of the competitors in the auto industry, just talking about the supposed transition to electric vehicles, and then not seeing it. I don't know. I take very much the opposite perspective on Elon. [crosstalk]

Andrew: Do you get bored following other companies after following Tesla for a while? Are you like, "Oh, this company, they're trying to grow earnings 4% per year and the CEO isn't tweeting at senators that their profile picture looks like they're post-coitus."

Eric: Yeah, no comment. I just think that he has created a product and a company that people are fascinated by. I think that there's a ton of value in that. You can't see it maybe today, but I think over time, the value of the Tesla brand will become pretty apparent. People love the product, of course, but people just know the brand internationally. I think that this is a huge strategic advantage for the company going forward, which is that they simply don't have to do much advertising at all. In fact, now, you see other companies using Tesla in their own advertising campaigns, like the Hertz deal with Tom Brady. I think that's just an incredible situation to be in as an investor where you own a company that doesn't have to advertise, and other companies advertising on your behalf. You’re talking about NPS scores and just consumer satisfaction, and I think another huge element here is just the brand, especially in a post-internet world where everyone's connected, everyone knows everything, the Tesla brand is a massive advantage.

Andrew: It's legit crazy. I watch My Beloved Saints on Sundays and I see if there's 5 commercials per commercial break, 3 of them are for cars, and at this point maybe 1 or 2 are for car manufacturers trying to pump their new electric vehicle. The auto manufacturers are advertising everywhere and despite that, when you talk to someone who is getting a new car, the top of their wish list is probably going to be a Tesla, and Tesla has spent, again, zero dollars. It just speaks to the consumer level.

I think we've addressed most of the thoughts I wanted to. I've got one more question on Tesla and then I want to talk on Spotify for a quick second, but is there anything else on the red flags at Tesla that we haven't addressed that you think maybe get people up in arms that you wanted to address?

Eric: No. I think a lot of those red flags are frankly kind of bullshit. I think that Tesla is so fascinating to me because it's a Rorschach test. Two people can look at the same bit of information, the same data, and walk away with it with two totally different perspectives. I think that I just love messy situations like this. I think it's just like we're drawn to this complexity because this is all a big puzzle, we're just trying to put together the pieces.

Andrew: What's the red flag at Tesla that you see bears[?] cite the most that you think is the silliest or you guys seeing just laugh at the most?

Eric: There's a whole bunch, but Tesla will never be profitable. That's something [crosstalk].

Andrew: That's been disproven.

Eric: Yeah. That's okay. I don't mind any of these critiques. I think that they’re healthy and they've created a great opportunity for us. If all information was accurate and there was no misleading articles, our edge would decay. A lot of edge just comes from knowledge and time arbitrage. This has been historically one of the most divisive companies which creates opportunity. It’s frustrating when I hear the bears'[?] arguments, but I also have to give thanks for them.

Andrew: My favorite is, just because it's so disproven, is the competition is going to kill Tesla. I think if you were citing this 3 or 4 years ago, it made sense. There's a particular Tesla bear who just publishes the list of all the upcoming EVs that are going to be Tesla killer. You've been saying this for 8 years and that's not really the main problem for Tesla. We haven't seen one. If the competition was going kill them, it's not to say that a new product can come along and supplant Tesla. Markets evolve, but at this point, that's been so disproven. GM's not going to come all of a sudden with the Tesla killer or something. It's been so disproven. You're just citing the same old things for 7 years at this point.

Eric: Every day is a new day. Maybe tomorrow, there is a competitor that comes out with a product that has a better value proposition. I always want to keep an open mind. I will say it's pretty shocking to me. I used to live in New York so I feel like I can criticize New York guys, but a lot of guys [crosstalk].

Andrew: Hey, watch it. You're talking to someone coming to you from Manhattan right now.

Eric: I lived in Manhattan for 10 plus years, so I have a little street cred. There's a New York mentality of saying things but not being able to back it up. That's one example of this whole "competitors are coming for Tesla". I go out and I speak to dealers and I test drive all of the competitors. I think that the research process, you have to just get out there and talk to people and experience these products for yourself. I mean, it's crazy to me that people talk about the Tesla competitors, and then have never actually driven any of these cars themselves. I mean, it's ludicrous. It's a product that you can just go easily walk into an Audi dealership and test drive the E-tron. I guarantee that a lot of these guys were criticizing Tesla and saying that E-tron's going to kill the Model 3, they've probably never even driven one. It's just maybe a bit of laziness, or I'm not sure exactly what it is that compels people to have such a strong opinion about something without really just doing the basic homework, but again, that's good for just a market and creating opportunity.

Andrew: There's a limit to what you can do, right? If you're looking at a space shuttle company, obviously, you can't go fly a space shuttle yourself to test drive the product. I was very bearish Peloton for a long time until I got the product and tried it, then I was like, you can debate whether the stock's undervalued or an opportunity or not, but there is something different about this product and in hindsight, I look at it and that was pretty lazy, right? You don’t have to go buy the Peloton, but you could have at least gone to the Peloton store down the street and tried the product or something, right? I agree with you on Tesla.

The last thing on Tesla, we mentioned valuation a few times, I just want to come back to it. Tesla, I don't know where it is right now. It's around $1,100 per share, about a one trillion dollar market cap. We've mentioned valuation a few times. I just want to ask, what's the fairish valuation for Tesla? Obviously, there's a whole range of outcomes, but how do you guys look at the fair value for Tesla?

Eric: I don't want to do specifics, because I think that's just out of deference to our partners and just how we view proprietary information, but we have, really, a 3 to 5-year outlook and we just think that the business is still really early innings. We look for just the risk-adjusted opportunity of businesses that can really compound that at least 20 to 25% a year. Tesla's materially higher than that. In addition to just the baseline growth at the business, we think there's a lot of optionality, especially on the software side. Our value is, much to say, significantly higher than where it's priced today.

Andrew: I know we've gone for almost an hour, but if you've got 2 minutes, I just want to ask you a couple of questions on one of my favorite companies, Spotify, if you've got a second.

Eric: I love Spotify. Yeah.

Andrew: Spotify. Let's start with the same question I asked with Tesla. What is the biggest misperception about Spotify?

Eric: You know that it's a commoditized music service and that they are forever going to be paying out 75% of the labels and never be profitable in the podcast that didn't work out. I think that's probably maybe the perception among the bears, at least. I think that dramatically underestimates just the power of the platform to grow to a billion users and find new ways to monetize those users, but more importantly, just create opportunities for creators.

You're now a part-time podcaster, in addition to the next one investor. You know that this is early. We're early in this journey of audio, in general. Daniel Ek likes to say that videos are a trillion-dollar industry and there's no reason that audio can't also be a trillion-dollar industry. I very much believe that he's right and that over time, the audio industry will be much more than just music and audiobooks, and frankly, more than just podcasts, as well. I think it'll be more interactive. I think it will be a hybrid between video and audio.

I think that when I look at companies that are really trying to disrupt an incumbent industry, I just see what Spotify is doing. They're going after linear radio. They're going after the music industry by potentially disaggregating the labels. There's a lot of optionality in what Spotify is building. The number one thing that the company is focused on is just market share, just growing the business. Daniel talks a lot about this, about growing the user base to about a billion users, but more importantly, even growing the creator base from about, I think it's 8 million on the platform, getting up to 50 million, and eventually, maybe they'll have 200 million creators on the platform. Earnings are not nearly of prime concern for a company like Spotify right now. It's really just land grab and territory growth.

Andrew: I 100% agree with you. I can't remember his name, the old Spotify CFO who was also the old Netflix CFO. He was so great because he framed it for investors so simply. He'll be like, "Look, I was at Netflix." This is Netflix 2.0, right? Everybody's down to sit Netflix and every time we said, "We're going to go into the content, it's going to create this sticky platform. Our skills are going to be unbelievable." He would say the same thing at Spotify.

Do you think the Netflix 2.0 comparisons are fair? Over time, I've started to think that the stocks have got the same potential, but I think it's going to look a lot different for Spotify. If I said Netflix 2.0, would you agree, disagree, do you have tweaks to that?

Eric: There are elements that I agree with, which is the structural shift to own content through the exclusive podcast. It's certainly Netflix-like dynamic. I'd say what's more unlike Netflix is the growth in the advertising business. You heard Daniel talk about this, that the business is really going. In the future, the advertising revenue of Spotify won't just be 10% of overall revenue. The goal is really 20%, but maybe even 30, 40%. Unlike Netflix, I think that Spotify is creating some really compelling opportunities for advertisers. This is unchartered territory. What Spotify is doing is building like Google AdSense for audio. That doesn't exist at scale right now. If you look at how media buys work across the radio industry, it's all regional, it's just based on personal relationships. You can't just go and have a 30-second audio ad and just distribute it immediately to the world that hit your demographic. Because it's available and anyone can do this, if people are curious about Spotify, sign up for an ad account if you are an advertiser and just see what the platform looks like, and see if you were going to advertise a product or service, how the back end looks. I’ve done it and it's remarkable. It's very much like a Google-like platform for advertising, and I think that's going to be a real differentiator for the company, going forward.

Andrew: I'm saying this off the seat of my pants, but you said, “Hey, I think they could get up to 40% revenue from advertising.” I think it could be higher in the long term if they pushed on the podcast and the own content because I think people just don't get podcast the original. They're so untargeted with the advertisements. I use this example all the time, but I listened to a Bill Simmons podcast once where he did an ad read for FanDuel online sports betting. At the time, online sports betting was legalized in 8 states, and they weren't even 8 of the largest states in the US. It wasn't New York, which is where I live. It wasn't California, it wasn’t Texas, but he did the ad for 8 states, and I just listened to that. That was one of the things that clicks for me. I was like, "If Spotify figures this out, they could just have Bill Simmons do two ad reads right here, one for the 8 states where sports betting is legal, and then one for 42 other states, which could be anything. They could just segment it and FanDuel would probably pay the exact same rate just to get those 8 states, and then the other 42 states, they could do a different thing. It's a better experience for me because I'm not hearing something from FanDuel saying, 'God, I wish I could bet on the Saints this weekend.'" It's a better experience for everyone, makes a ton more money.

That was just one of the little things that I heard where I was like, "Oh my God, the advertising opportunity on podcasting could be huge." I listen to podcasts and music. I know this is unique, but pretty much 10 hours a day, I'm listening to music in the background. It's just so much opportunity with that user base and everything.

Somebody tweeted this day, "How many companies are there with the potential to get to a billion users in the world that are trading for under 100 billion dollars right now?" Spotify might be the only one.

Eric: Yeah, there's only a handful. I totally agree with all of that and I think that if you just look at the CPM, some of those ads, it's really attractive. We'll see how it shakes out over time with what those percentages look like, but it's triple-digit growth in the ad business right now at Spotify. They're firing on all cylinders.

Andrew: What worries you most about Spotify?

Eric: That's a good question. There isn't anything that is materially threatening in the short term. I suppose you can make the argument that some of the bigger tech companies like Apple and Google really prevent Spotify from growing into what they can be. I think that with the Apple tax just paying out and just Apple limiting the ability for apps within their ecosystem to grow and flourish, that's, I suppose, just a headwind or something that's concerning.

Andrew: Isn't that Spotify playing on hard mode right now, though? At some point, if that had whenever headwind ever dissipated, the company would be free to really unshackle?

Eric: I think so. I think that you just have to think through some of the downsides. Maybe growth is slower than anticipated, I think that's very unrealistic. I think that everything that I've seen in all the leading indicators, there's ample opportunity to head for the company to grow internationally. Some of the developing markets, especially, where it's hard to launch and develop a market where you're still trying to figure out pricing options, advertisements, but I think over time, as long as management stays focused on this goal, there's no material concern on that front. Like any company, if they lose the plot, if the strategy shifts, we already had this maximum of like, every day just start with a blank sheet of paper. Every day is day 1 to us. If Spotify, if the position, if it's not working out, if things aren't going as we planned, we’ll reassess, but for now, we're really liking the next couple of years, in particular.

Andrew: I didn't hear anything on music labels in that question. Music labels don't concern you?

Eric: Not particularly. The way I look at the music labels is, the value of the 2-way marketplace to them is huge. At the end of the day, Spotify serves the artist, and so artists want a bigger fan base. Everyone wants to be a superstar. That is the core value proposition that Spotify can offer the artist. There's a great podcast a couple of weeks ago from an investor, UMG, and just talking about why Taylor Swift still signs with the label.

Andrew: Was that investment[?] the best one?

Eric: Yeah, it was. [crosstalk]

Andrew: He did a lot of work, it was the Rhone kind of guy. I enjoyed that one. I did a lot of work on UMG when PSDH was going to buy them. I really enjoyed that.

Eric: Yeah. I guess, my thought there is, it's a complementary relationship between Spotify and the labels. As much as there's this tension and the payout ratio and all that, which is healthy, I think that Spotify will have more leverage over time. I think that it's not a zero-some relationship. I think they both win. As long as you grow the audience, as long as you grow the number of people on the platform, both sides win in that equation.

Andrew: It's not perfect, but I came to look at it as, Spotify is the lost leader for music labels and artists. It's not even a lost leader. They get paid money for streaming on Spotify, but they need Spotify to get the money from where they're really going to get the money, which for artists, it's tickets, advertising, sponsorships, all that. For the labels, they're really going to get paid from all the external things like getting paid from Peloton streaming, getting paid from TikTok, for Roblox, from all this sort of stuff. That's kind of how I came to look at it.

One of the things that really clicked for me was in South Korea, one of the small labels pulled their music from Spotify. All the South Korean fans and the artist blamed the label, and eventually, the label caved and came back to Spotify on Spotify terms. That was one of the things that really instructed me on the dynamic there.

Eric: Yeah. I firmly believe that Spotify's mission is to serve creators and enable creators to augment their craft for a wider audience. If you just look at the creator tools for podcasters, and then similarly, just the ability for an up-and-coming artist to get discovered and to push their craft on Spotify's platform, the value proposition for them is having an audience of, right now, about 400 million people, but eventually about a billion people worldwide. If you're an artist and you're going on tour to be able to advertise locally to fans that listen to your stuff on Spotify, if you're going to Duluth or if you're going to Des Moines, to be able to push just ticketing to those areas, because it's an incredible data-driven platform that, I think, again, is working complementarily with the labels for a positive outcome on both sides.

Andrew: Perfect. Any longer and we're going to have to just turn this into a two-part podcast session. Eric, this has been fantastic. Thanks so much for coming on. I'm looking forward to keeping the dialogue going forward both offline, and maybe having you on for another podcast because you guys run a concentrated textbook. It's pretty easy to call you out and talk about one of the things you guys are working on. It's been great and we'll keep it going.

Eric: All right. Thanks, Andrew. Thanks for having me.

[END]