On Sep. 2, 2019, Elon Musk declared that "China is the future." The celebrity billionaire's words were hardly idle. His company, Tesla Inc. (TSLA, Financial), had officially broken ground on its Shanghai electric vehicle factory nine months earlier. By December 2019, the factory was fully operational and delivering the first domestically produced Model 3 sedans.
While Tesla has undoubtedly made a big splash in China, its long-term success in the world's second-largest economy will depend on its ability to both satisfy Chinese consumers and remain in the good graces of the Chinese state.
Keeping Chinese consumers happy
Tesla's brand has long been its most valuable asset. As the trailblazer for the high-end EV market, it was keenly aware of public scrutiny and has worked hard to maintain a positive image in markets worldwide. Thus, when Tesla found itself inundated with Chinese owner complaints early this year and, in February, was compelled to recall more than 30,000 vehicles, the third such recall since the fourth quarter of 2020, many wondered if the brand would survive unscathed. While a number of analysts and commentators feared this turn of events would sour Chinese consumers on Tesla, these concerns may be overstated, according to analytics firm RIWI. An analysis of Chinese consumer sentiment published by RIWI on April 12 suggests that Tesla's brand appeal remains strong:
"We heard from respondents on a continuous basis from July 2019-March 2021 (and ongoing) for a total of 8,850 randomly engaged Web users. We asked them "What do you think of Tesla Electric vehicles? Good brand to consider / Bad brand to consider". RIWI data show that, day after day for almost two years, among urban consumers earning over ¥5000/month, more than two in three consistently think Tesla is a good brand. We find that these positive perceptions were not impacted significantly by various quality issues, spying concerns raised by the Chinese military and increasingly tense China-U.S. relations."
According to RIWI's study, consumers' view of Tesla remains broadly positive, with more than 60% of respondents still expressing favorable opinions. Overall sentiment appears to be on a slightly downward trajectory, though it has climbed up from the nadir that occurred in the immediate aftermath of the Tesla vehicle recall. Yet while Tesla's popularity has managed to weather the storms of the past few months quite well, RIWI warned that this could change:
"Maintaining this positive image is vital for Tesla's future China sales. If quality and reliability concerns arise, and if tensions between the US and China continue to increase and intensify nationalist sentiment, consumers may be encouraged to turn to domestic alternatives. As Tesla ramps up production at its Shanghai Gigafactory, we will continue to monitor to see if Tesla's brand sentiment changes."
Keeping China's government happy
Consumers are not the only ones Tesla must keep happy in order to succeed in the Chinese market. The company must also maintain its friendly relationship with the Chinese government and the ruling Chinese Communist Party. Things started out well on that front. Musk has powwowed with Premier Li Keqiang, President Xi Jinping's second-in-command, and even convinced the CCP to allow Tesla to maintain full ownership of its Shanghai factory, a departure from the usual Chinese model of compelling foreign companies to joint venture with state-sponsored ones. However, Tesla's "special relationship" with China has looked increasingly shaky of late.
The series of recalls, combined with mounting consumer complaints, have caught the attention of a number of Chinese government agencies, some of which scolded Tesla in early February, as Fortune's Eamon Barrett reported on Feb. 9:
"Chinese regulators this week dressed down Tesla over safety concerns and mounting customer complaints, a worrying sign for the electric-vehicle maker that until now has had a symbiotic relationship with Beijing. On Monday, China's State Administration for Market Regulation (SAMR) said that it and four other regulators had summoned executives from Tesla's Chinese operations and ordered them to 'abide by Chinese laws' and 'strengthen internal management systems' to ensure the quality of its products in China and protect Chinese consumer rights."
Tesla's response to this public rebuke was immediately conciliatory, quite unlike its usually combative attitude toward regulators in other countries. The company clearly understands how important the Chinese market is to its growth, and what losing its favored status would mean. However, no amount of conciliation can guarantee Tesla's protection, especially as relations between China and the United States grow increasingly fraught. Tesla's problems could escalate rapidly should President Joe Biden persist in his efforts to pressure China on the geopolitical stage. If relations between the world's two greatest powers continue to sour, Tesla could prove a tempting target for Chinese retaliatory action.
Big market, big opportunity, big threat
On the surface, things appear to be going very well for Tesla in China. It produced around 150,000 vehicles in the country last year and its vehicles have continued to be top sellers in their segments in 2021 thus far. But beneath the surface, things are less unambiguously positive.
Even though the American automaker has shrugged off its recent public difficulties to little ill effect so far, the risk of consumer sentiment turning against it is still real, especially if stories about quality issues and malfunctioning technology continue to accumulate. As I have discussed previously, Tesla cannot afford to lose its dominant position in the EV space, a prospect that could crush its high-flying share price. Thus, if the company proves unable to address the concerns effectively, it could quickly find itself losing market share to an ever-growing number of domestic EV rivals.
At the same time, regulatory and political risks have multiplied in recent months, adding further layers of uncertainty to Tesla's future in China. Even some of the most bullish Wall Street analysts have started to sound the alarm. Morgan Stanley's Adam Jonas, for example, exhorted investors in March "to consider, among a range of scenarios, the valuation of Tesla with little or potentially no material contribution from its Chinese operations." In other words, investors cannot count on Tesla's guaranteed success in China, especially over the long run. Should conflicts between nations over issues of trade and territory intensify, the company's Chinese operations could be badly battered.
In my assessment, Tesla faces real and serious risks in China, which appear set only to intensify in the coming months and years. The company may not be driven out of China, but its opportunity for market domination could evaporate quite rapidly. Consequently, I would caution investors to temper their expectations about Tesla in China, and would recommend approaching this already volatile name only with extreme caution.
Disclosure: Author is short Tesla.
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