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Tesla is driving through the auto-industry, but will it ever make a profit?

Elon Musk’s vision is to form a new sustainable future for the planet, but is Tesla itself sustainable? The company joins an ever-growing group of big business giving fundamental investors a headache, boasting huge valuations on the back of exponential growth rather than profits.

Source: Bloomberg

Tesla chief executive Elon Musk causes division between investors, with some seeing his projects as over-ambitious and unlikely to make profit, while others are more than happy to put their money behind the eclectic entrepreneur and his idea of a better future. Amid his many projects attempting to reshape the future - from tunnelling under the US to shoot people down tubes through a ‘hyperloop’, making space travel as normal as taking a flight, and creating a 'brain-machine' to connect humans and computers – Tesla seems the most realistic, and is the only one open to investors.

Having sold its first electric car, the Tesla Roadster, back in 2009, the company listed on the Nasdaq a year later at an initial public offering (IPO) price of $17 a share. Fast-forward eight years, and shares have been comfortably trading above the $300 mark since April 2017, even flirting with a $400 price tag. With a valuation of about $56 billion, Tesla is worth more than Ford Motors and is hot on the heels of General Motors.

Tesla’s valuation is based on the future, not current profits

And yet, the closest Tesla has got to making money is a measly $22 million net profit in one quarter of 2016, and that offers little comfort when combined losses in the other three quarters of 2016 amounted to almost $700 million. In fact, in the nine years between 2007 and 2016, Tesla reported losses of $3.05 billion. So how, and why does it demand such a valuation?

Money may well be the way many measure success, and Musk has not disagreed, stating Tesla is 'absurdly overvalued' based on past performance. His argument, and what we can assume investors believe, is that Tesla’s price tag represents a risk-adjusted outlook on its future.

Although Apple was riding off its success in computers and then iPods, the idea that the company would be one of just two dominant players within the mobile phone market today was hard to swallow when it began telling the world about how it was to revolutionise smartphones. According to Statista, Nokia held nearly half of the global market in the third quarter of 2007 before plummeting to just 3% by the second quarter of 2013, and today consumers are more aware of Nokia’s revamped 3310s than its modern-day smartphones.

Will Tesla become the Apple of the car industry?

Tesla is not unique in the way it believes it should be valued, and the riskier investment model based on belief has proven fruitful for investors in the likes of Google and Microsoft, and is still the main ideology of investors in social media companies like Twitter and, more recently, Snap.

Prior to listing in March 2017, Snap – the owner of Snapchat that classes itself as a camera company despite making almost all of its revenue from advertising like its bigger social media rivals – revealed it had generated net losses and negative cashflow every year since starting in 2011, and famously stated it 'may never achieve or maintain profitability'. Having set an IPO price matching Tesla’s at $17, the initial hype around Snap sent shares as high as $27.09 to value the company at over $35 billion. However, the faith in Snap’s future seems to have faltered with shares having traded below its IPO price since mid-July 2017.

Companies can endure a lack of profit and investors can still book returns, but basing value on traditional metrics doesn’t work and the risk differs compared with other investments. Tesla does aim to make profits one day. But this is ancillary to Musk’s wider vision.

If Tesla, Snap or anyone else wasn’t eyeing profit – be it in a few years or 15 (think British online grocery delivery company Ocado) - then the stock market would simply be being used to subsidise the company’s development.

Still, Snap is currently valued at $18.50 billion, which is only $100 million off Twitter’s market cap. Twitter may too still be pursuing profit, but it is much closer than Snap, with potential to turn a profit in the last quarter of 2017.

So, what drives the valuation of a company reporting heavy losses, struggling cashflow and expenditure levels that challenge even the deepest of pockets? In simple terms – rampant growth. However, the picture is more complicated.

Tesla still investing heavily

Tesla’s revenue, still driven by sales of its Model S and Model X cars as well as its new, cheaper Model 3 (despite selling a swathe of energy generation and storage products) jumped from $3.2 billion in 2014 to $4.1 billion in 2015, and then to $7.0 billion in 2016, with gross profit also climbing annually. That looks set to continue, with a target of producing 500,000 vehicles in 2018. Having only delivered its 250,000th Tesla in the third quarter of 2017, no one can fault the company’s ambition.

Where does all the money go? In a similar fashion to Amazon, heavy ongoing investment is at the heart of the Tesla’s case. Both firms attract investors based on continued growth, not profits, although Amazon’s investors can have more confidence at the fact Amazon has made a net profit for the past two years. Tesla’s investors will have to wait longer. How much longer no one knows.

Tesla, in common with Twitter, is trying to carve out a larger presence in its industry, albeit at a huge cost, with the aim of eventually reaching sustainable profitability. This differs from the likes of Snap and Uber, which have investors that focused on the incredible initial growth and brushed-off any early losses.

Many of these companies share some significant things in common that also help form the investment case, including for Tesla. Most have been led by iconic leaders, whether it be Musk, Jeff Bezos, Steve Jobs or Bill Gates. Twitter shareholders were buoyed when its founder Jack Dorsey returned in 2015, while Snap’s two founders Evan Spiegel and Bobby Murphy will be in charge of the company for life.

Amid the growing popularity of asset-light start-ups, particularly in the tech space, Tesla is a vertically integrated company willing to bring anything it does outsource back in-house if it needs to (the latest being its autopilot system), and at least backs its valuation with large-scale assets like its Gigafactory in Nevada and its second one in New York. Musk and Tesla, like Amazon with its investment in warehousing, is not willing to wait for infrastructure to be developed before launching new products, but instead creates it. Tesla is building up charging points around the world, ensuring its cars are economical even without government subsidies, and even sharing its patents with anyone who wants them.

Musk’s vision goes beyond Tesla

This all boils down to another common theme shared between these giant start-ups, which is believing in a higher purpose. While it is obvious Musk would want to make Tesla profitable, as well as his other eccentric ventures, you would have to be brave to bet that he would prefer that over achieving a sustainable future for the transport and energy sectors.

Tesla, despite the late arrival of conventional carmakers, is leading the electric car market and has been at the forefront of the technology that has disrupted the petrol-guzzling, and even hybrid, car market. As other familiar names focus on improving the range of their electric cars in order to charge a higher price, Tesla, demonstrated through its newest model, is now chasing affordability. The company plays to one tune and one tune only, and that is its own (or maybe Musk’s).

So, will Tesla ever make a profit? Musk said back in 2015 that Tesla might not be profitable until 2020, but that was before accelerating its growth targets. In every annual report, Tesla is the first to admit there is a million-and-one things that may delay its development or severely impact the business – from new technology failing to a lack of core material supply – and that has proven true countless times. As Musk once said, there’s 10,000 unique parts and it only moves as fast as the slowest one.

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