“It’s a huge structural advantage not to have a lot of money. I think I could make you 50 percent a year on $1 million. No, I know I could. I guarantee that. The universe I can’t play in has become more attractive than the universe I can play in.”
Warren Buffett had that to say about small-cap stocks, and we’re about to see the underlying reason play out on a much larger scale.
In a potentially rare mistake, he has entered a major position in a universe that simply doesn’t have room for more than one big investor.
And it just so happens he is poised for a showdown against one of the hottest CEOs out there, Elon Musk.
Both are placing their big bets in the same sector, fighting over the same market and resources. It is a zero-sum game.
East vs. West
On the surface, the two companies involved in this showdown are not competing for sales, in spite of what some headlines have claimed. However, a larger battle is raging in the background.
Tesla Motors has depended on domestic U.S. sales to propel its market share, sales, and backlog. Yet it and its investors are banking on quickly growing international revenue and sales, especially from China.
Meanwhile, BYD — which landed a multibillion-dollar investment from Berkshire Hathaway — focuses solely on its domestic market, for now.
That seems to set up a conflict, but dig deeper and the absurdity of the concept reveals itself.
The price points for the vehicles reflect the income gap between the East and West, with Tesla’s Model X costing around $80,000, and BYD’s Yuan SUV coming in much lower at an estimated $9,300.
But the median worker brings in the equivalent of just under $8,000 per year in China, compared to $52,000 in the U.S.
Proportionally, the Yuan is equivalent to a $60,000 car purchase by a median U.S. household, while the Model X is equivalent to a supercar in China.
So a potential sales battle in the coveted China market is hypothetically possible, but would require a convergence roughly in line with Honda Accords and mid-range Ferraris overlapping.
Or, more likely but still highly improbable, a risky change of strategy. BYD could attempt a move into the luxury market with a new model, while Tesla goes for an economy version.
But both companies are trying to drive down costs while ramping up very capital-intensive production for their current models. There are much bigger existential issues to address for the foreseeable future.
The real showdown between Tesla and BYD is over increasingly hard to source, and more expensive resources that both companies immediately require.
The Battery Bottleneck
Lithium is at the heart of every modern electronic device. There is simply no commercially viable substitution for it for power-hungry devices, from smartphones to electric cars.
In fact, moving beyond lithium-ion batteries puts you in the realm of incredibly unstable and dangerous energy density.
Those electric car batteries erupting into raging fires? That gets way more common when you try to push the limits any further than current lithium batteries in the market today.
Unfortunately, all this demand is stressing lithium production to the point of a supply deficit. With the extreme power demands of cars, they require a massive amount of it.
The Dept. of Energy predicted a threefold increase in demand six years ago before Tesla could even dream of a half million cars per year. Meanwhile, Goldman Sachs expects lithium demand to surge 1,000% in the next few years.
There is no room in the market for this. Elon Musk knows it, and he’s been fighting tooth and nail to secure long-term deals for lithium carbonate.
Warren Buffett’s 10% stake in BYD depends on the same, with the company needing to produce similar numbers of electric cars to justify the investment.
Tesla may be able to source enough lithium, or BYD will, or one of many other companies in other sectors that are fighting over long-term contracts today will.
But not all of these companies will, especially the big electric car makers that need to consume so much of it.
Soaring Prices and the Play
The key to investing in the electric car market is going to be investing in lithium. You can strip off branding, manufacturing, shipping, and everything else these companies must do.
Lithium producers will sell to the highest bidder, and thus whoever develops a true advantage. Go straight to the one bottleneck Tesla and BYD face.
Lithium prices are already reacting to the shortfall. Just at the end of last year lithium was trading between $5,000 to $6,000 per tonne.
Now, some lithium contracts are selling in China for as high as $24,000 per tonne.
If demand comes anywhere near the 1,000% increase anticipated, the sharp 400% spike in prices will just be the start.
Right now, a few big players monopolize the lithium supply. They’re not pure plays with a lot of upside. And the others are just small timers with no real proven reserves.
But Nick Hodge has been watching for opportunities for well over a year, and has just pulled the trigger on the only small company that stands out.
This is the kind of play that makes Buffett jealous of anyone who can drive a strong percentage gain from small-cap investments.
