WORLDVIEW: Sorry, but Tesla is not a growth company

By Felicity Duncan.Looking at Tesla's second-quarter results, I can draw only one conclusion: Tesla is no longer a growth company. It may, one day, return to being a growth company, but right now and for the foreseeable future, it isn't one..The basic requirement for qualifying as a growth company is, well, rapid growth. For that popular modern growth company, a social network, this usually means rapid growth in users, which may or may not translate into top-line growth right away. For Tesla, however, it means sales growth, which must translate directly into revenue and profit growth..___STEADY_PAYWALL___.Let me explain..Social networks' strategy is generally to grow users like crazy without worrying about money because each additional user is essentially costless once the platform is built (it costs Facebook basically nothing to add another user to its 2 billion existing ones, because the infrastructure already exists and no more is needed to add users). Once a social network has a billion users, it can figure out how to monetise them, safe in the knowledge that its fixed costs will barely budge over time and that it has minimal variable costs..Tesla does not have the same model. It needs to make a profit on each car it sells because each car it sells costs a lot of money to build. Unlike a social network, there is a variable cost associated with each new customer at Tesla (there's also an ongoing cost to provide services because Tesla does not outsource that to an external network of dealers)..Read also: EXCLUSIVE: BizNews gets inside Elon Musk's Gigafactory, the Tesla nerve centre.Tesla also needs to make money on each line of cars it sells, because setting up production for a new type of car is costly – the FT estimates it costs about $300m to retool an existing production line to build a new type of vehicle and $2bn to build a new production line. In other words, Tesla's fixed costs also rise with new products and users..Thus, it's not enough for Tesla simply to sell a lot of cars. It needs to immediately make money on those cars because that's how auto manufacturers make money. There is no real way for Tesla to generate future revenues from its car owners, barring some limited software opportunities and perhaps money from services (although, as mentioned, this is also a business with significant costs attached)..A tech growth company with negligible variable costs, low and limited fixed costs, and the ability to benefit from network effects can afford profitless growth (for a while, at least). A car company really can't..With that background, let's look at Tesla's Q2 numbers..In the second quarter, Tesla reported a 21% year-on-year fall in Model S and Model X sales, but Model 3 sales grew by 321%. So, you may say, surely this means the company qualifies as a growth business since it means average sales growth of 133% across the range?.Well, not so fast. Tesla needs profitable growth. To paraphrase the old joke, Tesla cannot make a loss on every vehicle and make it up in volume. Nevertheless, that's what's happening – Tesla has grown sales rapidly and lost a fortune doing so. Its operating loss of $167m is down from $621m a year ago, but still not great. Tesla continues to lose money on the cars it makes. It doesn't matter how many cars you sell at a loss, you're going to lose money..Read also: Musk's big dreams are hurting Tesla – The Wall Street Journal.What Tesla needs to do to achieve growth company status is to sell cars profitably and build new, exciting cars that it can sell lots of (profitably). Unfortunately, the direction of travel seems to be the opposite..As Tesla sells more and more Model 3s, its gross margins are falling – this is inevitable since selling mass-market cars is obviously less profitable than selling luxury vehicles. Tesla is also spending less and less on capital expenditure – it's capex was down 59% year-on-year. This has the salutary effect of keeping cash inside the business, where it is definitely needed, but suggests that sexy new products are a long way off..Tesla's goal is to get its Model 3 production line running efficiently so that it can start to sell its Model 3s at a profit (and lots of them, hopefully). It will then presumably use the cash generated to invest in new, profitable product lines to maintain sales growth..This is a good strategy. In its current state, however, Tesla does not qualify as a growth company. It is investing too little in capex and its growing sales are not balanced by growing profits or improving margins. Unlike a platform company, Tesla must make a profit on each sale if it is to build a sustainable business..To me, it seems that Tesla is in a race to find a way to profit before investors lose their appetite for funding its cash burn. I hope that the company achieves this – it makes inspiring products and has done much to change our thinking around cars and sustainability. But there are no guarantees.

WORLDVIEW: Sorry, but Tesla is not a growth company

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