Why did Tencent buy 5% of Tesla?

The Chinese electronics giant Tencent Holdings Limited has purchased 5% of Tesla (NASDAQ: TSLA)?

Investors that have seen Tesla’s earnings report will be shaking their heads at this deal. If the reports are true it means that Tencent just spent $2.271 billion to buy a stake in a company that reported a negative net income of -$674.91 million, and a profit margin of -5.31% on December 31, 2016.

The $2.27 billion estimate of the stake’s value is based on Tesla’s market capitalization for March 31, 2017 which was $45.42 billion. From a strict value investment point of view; Tencent got a pretty bad deal, because Tesla is burning through cash at an incredible rate.

Elon Musk’s energy company lost $123.83 million in cash from operations during fourth quarter 2016. It also reported a “free cash flow” of -$1.129 billion for the same period.

It is a certainty that Tencent will lose money on its investment. Tesla shareholders were punished with an “earnings per share” number of -4.82 and a return on equity of -28.1% on December 31, 2016.

So why is Tencent Buying into Tesla? Technology that’s Why

There are two obvious reasons why Tencent is buying into Tesla: technology and market share. Despite all its’ problems Tesla has a lot of great technology; including a functioning autonomous vehicle that has been proven in the real world, a practical electric car, some really great solar electric technology, tremendous experience in batteries and a lot of tremendous automotive features.

To that we can add a lot of expertise in vehicle design, battery design, manufacturing, battery and solar system manufacturing and commercialization of next generation technology. The knowledge and experience that Tesla has might be priceless.

One area where Tesla has a vital lead is in battery storage, particularly in the construction of battery farms and the creation of power systems for electric vehicles. This is going to be a huge market in the future, particularly in the creation of backup power systems for homes and businesses.

Another is in the design and manufacturing of electric drive components even if lithium batteries fizzle electric-drive cars are the future. Tesla’s a leader in this area; especially with high-performance features like its’ “Ludicrous Drive.” Another area where Tesla has a big lead is the integration of autonomous vehicle technology with electric drives.

By buying into Tesla, Tencent gets its hands on a lot of cutting-edge automotive, solar and energy technology. Even if Tesla collapses, Tencent can leverage that intellectual property using its Chinese manufacturing capabilities to create a line of next-generation vehicles and solar energy systems.

Telsa has Some Real Market Share

Beyond the tech, Tesla has some real market share in the solar, battery storage and electric vehicle markets. It reported revenues of $7 billion on December 31, 2016, that have been growing fast.

Tesla’s revenues actually grew by $2.954 billion in 2016; rising from $4.046 billion in December 2015 to 7 billion a year later. That’s a pretty impressive feat for a company that’s on such shaky ground and meeting an incredible amount of market resistance. Buying a stake in Tesla gives Tencent access to that market share and two respected brand names; Tesla Motors and Solar City.

More importantly it gives Tencent access to a network of Tesla stores and Solar City installers in the United States. Tencent might be able to use the Tesla Stores in the malls, as sales outlets for some of its electronics products. It might use the Solar City crews to install some of its other products.

A Pretty Smart Move for Tencent and Tesla

All this makes a stake in Tesla, a pretty smart move for Tencent. Despite that buying Tesla stock is still a very dumb move for average investors because it is incredibly overpriced ($278.30 a share on March 31, 2017).

Selling a 5% stake to Tencent is also a pretty smart move for Elon Musk because it makes it harder for other automakers to buy into Tesla. One major threat Musk faces is that some of the other automakers are sitting on huge piles of cash.

Ford (NYSE: F) reported cash and short-term investments of $38.83 billion on December 31, 2016. Fiat Chrysler Automobiles (NYSE: FCAU) reported $19.11 billion in the bank on the same day. General Motors (NYSE: GM) reported $24.80 billion in cash and short-term investments and Toyota Motor (NYSE: TM). Volkswagen (OTC: VLKAF) reported $49.21 billion in cash and short term investments on September 30, 2016, enough to buy up every share of Tesla at market value.

This means that any of those companies is in a position to swoop in and buy up huge amounts of Tesla for cash at any time. If Tesla’s share value were to crash dramatically, one of them might be able to buy up the entire company.

Since both Ford and Volkswagen are making huge investments in electric vehicle technology a Tesla acquisition would be a logical step. Ford plans to spend $4.5 billion on electric cars and invest $1 billion inn artificial intelligence over the next few years. Volkswagen is also planning to spend several billion dollars on electric car development.

Obviously the last thing, Mr. Musk wants is one of the old-line automakers he despises swooping in and buying up his energy company. Selling a stake to Tencent helps him block such a move.

The Tencent deal is a pretty shrewd stratagem that once again shows Elon Musk is a far better business man than he is usually given credit for. It also shows that Tesla and its technologies; battery storage, electric cars, self-driving vehicles and solar panel may have a bright future ahead.

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