What happens when a “pre-revenue” company starts to produce revenue?

David Guy

Leithner & Company Ltd

There is a wonderful TV series called Silicon Valley and I would strongly recommend anyone with even the slightest interest in technology, venture capital or even just financial markets generally to watch it, even buy it outright if you must. In addition to the main cast, there is a wonderful semi-regular cameo from a character by the name of Russ Hanneman. Now Russ is amazing (just ask him) and is famous for putting “Radio on the internet” and being a member of the “Tres Comma’s” club (the Billionaires club).

In one episode the CEO of Pied Piper (which is the fictional company around which the series revolves and into which Russ Hanneman has recently agreed to invest), Richard Hendricks is discussing with his team how they will cover their operating costs:

Richard Hendricks: Once we get a few customers and start a subscription revenue model …..

Russ Hanneman: What?!? No, no, no, no, no, no … No revenue …

Richard Hendricks: What?

Russ Hanneman: Why would you go after revenue?

Richard Hendricks: Because … to make money.

Russ Hanneman: No. If you go after revenue people will ask how much and it will never be enough. The company that was the 100x’er, 1,000x’er becomes the 2x dog. But if you have no revenue, you can say you’re pre-revenue. You’re a potential pure play. It’s not about how much you earn. It’s about what you’re worth. And who’s worth most ? Companies that lose money.

Rivian (NASDAQ: RIVN) is an electric vehicle designer based in California, USA. For the last quarter, its revenues seem to have been in the order of US$1 million, maybe a little less. So, for all intents and purposes, we can call it no revenue. And they lose a boatload of money. This is fortunate for Rivian because the market has certainly taken Russ Hanneman’s views on revenue, losses and worth to heart.

Rivian last week listed on the NASDAQ stock exchange in the USA. It raised US$12 Billion and its market capitalisation reached US$100 Billion on its first day of trading before settling to close at US$85 Billion. By the next week though it had reached US$145 Billion.

But Rivian is about to test Russ Hanneman’s theory; they have started selling their R1T electric pickup truck. They have forecast that they will sell 1,000 of the trucks in calendar 2021. This is only slightly more vehicles than Lotus sell in a year; and even annualised is less than half of what Ferrari sell. But this is a growth company, a tech company, a nil carbon company.

What could go wrong?

Well, history would suggest that an awful lot can go wrong.

Once Rivian goes “ex-pre-revenue” (I just made that up but think I will use it again) then it should start to compete with comparable companies for investor capital.

What would be comparable? Well let’s go out on a limb and call Rivian a vehicle manufacturer and compare it to a slightly smaller company. Daimler AG (ETR: DAI) has a current market capitalisation of US$108 Billion so that will do for our purposes.

Daimler has been around the motor vehicle industry since the beginning because well, they invented the car! (For completeness, the car was invented by Karl Benz, whose company Benz & Cie in time merged with Daimler Motoren to form Daimler-Benz.) But they also have a strong premium global brand (Mercedes-Benz) and produced and sold 2,840,300 cars, trucks and buses, recorded US$175 Billion in revenue and produced EBIT of US$7.4 Billion last year.*

So, for Rivian and Daimler’s market capitalisations to both be correct, Rivian either needs to grow dramatically (and profitably) or Daimler needs to shrink dramatically (or lose profitability dramatically). Is that likely? Who knows. But gee the “Old vehicle manufacturers bad, new vehicle manufacturers good” trade seems to be overcrowded – indeed it reminds me of the theme stocks from the 1960’s Go-go market, and that did not end well. But the main problem as I see it is that not only are Rivian (and Tesla (NASDAQ: TLSA)) priced for their own perfect future execution of R&D, manufacturing and retailing they are also priced for a perfect market response, namely that the incumbent vehicle manufacturers are unable to respond, unable to compete. Is that valid?

I believe that the early evidence should give Rivian and Tesla speculators reasons to wonder. Trade reviews suggest that Porsche may have built a better overall EV than the Tesla S with their Taycan which would be completely understandable as the Tesla S was first released in 2012 (I will probably get attacked by the Tesla fanboys for this; all I ask is that you finish reading the paragraph before you attack). There is every chance that the Tesla S replacement will be better than the Taycan, and then the Taycan’s replacement will be better again … but that is the point; that Porsche got close (whether in front or behind, is actually immaterial) with their first go means that Tesla has competition and I do not believe they are priced for competition.

Secondly, the only area in which the Tesla S vastly outperforms the Taycan is on price; it is much cheaper. However even that is not quite as simple as it seems; Porsche is 100% owned by Volkswagen AG (ETR: VOW3) and represents one of their premium brands (they also own Audi, Bentley, Bugatti, Lamborghini, Seat, Skoda, VW itself and their current market cap is only US$137.5 Billion … whereas Tesla’s is US$1.04 Trillion). As such it is priced as a premium product and as costs (primarily battery production) fall over time the technology will undoubtedly spread through VW’s various brands and various price and profitability points. Tesla does the same thing (releasing the Model S, then X then 3) however VW Group will be spreading their tech and R&D spend through a much broader and deeper branding, distribution and marketing network. Other incumbent manufacturers, depending on their market positioning, will likely compete directly on price with Rivian and Tesla or even undercut them.

And finally, one of Tesla’s great achievements has been in retailing – direct to consumer, online – where it reduced retailing costs significantly thereby increasing its gross margin on sales. But Australian readers might have noticed that Mercedes-Benz has recently been sued by its Australian dealers because they are trying to move them from a “dealership model” to an “agency model”. Be under no illusion this was simply a case of looking at what Tesla has done and deciding to emulate it – if Daimler AG can recoup margin from their dealers without impacting their sales (and they clearly think they can) then we might find that their gross margin moves from 23% to closer to Tesla’s 30% ….. and other incumbent manufacturers will likely then move to a similar model. Or they maintain their gross margins and lower their sale prices – either way it is competition.

All of which is great but, I can hear you asking, what about Russ? What happened to Russ Hanneman? When last we saw him, after walking away from investing in Pied Piper he had put all his money into crypto, lost most of it but had employed a team of workers to scour the local dump to locate a USB / thumb drive that he had accidentally discarded and that contained his last US$300 Million of crypto. Things looked promising for a while:

Russ Hanneman: You found it !!! Ha ha ….. Nope. I said a thumb drive. That’s an actual thumb.

Leaving Russ to cry over his lost “B(illion)”.

Hopefully, speculators in Rivian (and Tesla) won’t be left crying, but history (and nosebleed valuations) are not on their side.

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*Source: Daimler AG 2020 Annual Report

This article contains general information and does not take into account your personal objectives, financial situation, needs, etc. In other words, we (David Guy and Leithner & Company Ltd AFSL 259 094) are expressly not providing any advice to anybody in this article and intend only to discuss topical investment subjects in a light hearted manner.

Joint Managing Director
Leithner & Company Ltd

David has both a Bachelor of Laws and a Masters of Applied Finance. He is also a Solicitor of the Supreme Court of Queensland. David’s career started in law in 1994 before devoting his focus to financial services from 1996. Since then, his career...

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