Tesla's China Headache Only Seems to Be Getting Worse

Tesla (TSLA -1.92%) has hit some speed bumps in China of late. Given the size of the Chinese markets, troubles there have the potential to run this growth story off the road. 

On this video clip from Motley Fool Live, recorded on June 29, Fool.com contributors Lou Whiteman and John Bromels discuss what is going on with Tesla across the Pacific and what the issues could mean for investors. 

John Bromels: Yes, it's Tesla. We all know Tesla, we all love and hate and envy because it's Tesla. A couple of things though have popped up with this company just over the last few days. That was what I wanted to talk about today. Just note that this is going to be a brief coverage on a very complex topic and so I'm sure I'm going to miss several little nuances. Don't hold that against me, I'm just going quickly in the interest of time. Here's what's going on with Tesla, lately. Trouble in paradise? Paradise for automakers being of course, China, the world's largest auto market and expected to be the world's largest electric vehicle market, possibly within the next four years. This is a report from CNN Business back in May, but it encapsulates some of the issues that Tesla was having with its Chinese sales and making investors a little bit nervous last month. April sales were down 27 percent from March whereas sales of Chinese electric vehicles from companies like NIO (NIO -5.00%), Xpeng Automotive (XPEV -3.35%) and Li Auto (LI -9.60%), all increased in China during the month of April. Meanwhile, Tesla's share of electric car sales in China, which had been incredibly good, Tesla was for a couple of years, by far, the most popular electric vehicle in China, of course that's because it was way ahead of the pack in terms of availability and technology. However, sales in April, 17 percent of overall electric car sales down from 21 percent in March, so dropping there as well. They had a bunch of negative publicity around the Shanghai auto show and they had protesters complaining about problems with their cars. Those stories seemed possibly overblown, but nevertheless, obviously, they had an impact on China because they were widely reported. No less than five Chinese regulatory agencies aren't investigating the quality of Shanghai Gigafactory-made Model 3 cars. Remember that, that's the Model 3. Remember that for later. Then there were reports that suggested China's military might have banned Tesla vehicles rendering complexes over concerns that its cameras could be used for spying. Elon Musk denied this. The reports petered out. I don't think there was any conclusive resolution to those reports, so who knows? But what this all adds up to is a picture that maybe Tesla is starting to lose its dominance in China and possibly the Chinese government is maybe not as receptive to this American company as they once were in their market. Meanwhile, speaking of NIO, one of Tesla's Chinese competitors, NIO's ES6 in China is probably the most direct competitor to Tesla's Chinese-manufactured Model Y. They're both crossover SUVs with electric power. I just want to show you, here's a shot from the website of NIO and Tesla. This is unadulterated, this is the first shot you come to when you go to the Model Y page on Tesla's site and the ES6 page on NIO's site. Notice any similarities here?

Lou Whiteman: They're both red.

Bromels: [laughs] Well, among other things, yeah. I mean if you did not know what Tesla generally looked like, you would be hard pressed, probably to tell these two websites apart, and that is part of the problem. NIO is clearly gunning for the Model Y in China and directly tackling Tesla's superiority there, and they've got some help from the government. The government established some subsidies that NIO's ES6 qualified for that, Tesla's did not, and they were able to do it by counting NIO's battery packs as lease instead of sales, they didn't count toward the sale price. But basically, it looks like China is possibly tipping the scales in NIO's favor over its American rival. Then just the other day, we have this, nearly 300,000 cars, every single car manufactured by Tesla's Shanghai Gigafactory recalled over cruise control issues. Now, preliminary reports suggest that this "recall" was actually able to be fixed by a software patch that was downloaded over the Internet the way it happens here in the United States. However, this did not help matters for Elon Musk to have news that nearly 300,000 cars every single one from the Chinese Gigafactory, and it's certainly is not good news when you already have Chinese regulatory agencies looking over your shoulder. What does this mean moving forward for Tesla? I mean, it's been clear to me for a while that China was going to promote its domestic electric vehicle manufacturing over Tesla's dominance, and I think this is just some further evidence that either that's working for them. Also, I'm sure the people of China are more than happy to promote their own automotive industry because here in America, we stick stickers on things as Made in America, buy American this is a big point of pride, especially since there has been trade tensions between here and China. Keep in mind that's going to work the opposite direction in China. The upshot of all there is, I don't think Tesla can count on its dominance that it has seen in China up to this point, whether that is going to significantly damage the car company's prospects moving forward, I couldn't say, but it is certainly something that factor in to your investment thesis when you're looking at Tesla moving forward.

Whiteman: That's a good summary, and I think you're absolutely right. We would be very hypocritical if we can play in that Chinese preferred Chinese goods. Made in America is a huge thing. Tesla takes great pride in the fact that they are American build, out of Fremont. But the issue is, and I think you hit on it is that if that means in the Chinese system, if the government is actually tipping the scale, that can be a real issue, if you look at just the change in coverage in the media which is state controlled, if you look at the way accidents, the way these protests have been covered, this is real scary, and to me, the scary thing about it is that in recent months, Tesla has been exporting a majority of the Model 3s it makes in Shanghai, mostly to Europe for now and they do have buyers so I mean, it's hardly alone in a global footprint and taking advantage of that, but they're also building a new factory in Berlin. You wonder that there has to be capacity to be soaked up somewhere. I mean, in Europe you have Volkswagen, very aggressive in terms of a European champion for EVs. That is a developed market where you see the US companies too. The big risk I think with Tesla is that yeah, its competition has arrived and we've got to move metal. [laughs]

Bromels: Exactly. Now, to be fair, Lou, we could say that for the last 10 years about Tesla, that there's always been the risks that some bigger, more established, deeper pocketed competitor is going to come in and eat Tesla's lunch, and so far, that has yet to happen. However, right now, we are seeing more, I believe, every major car company in the world, either has in production or is moving toward production of an electric vehicle of some sort. Ford's Electric F150 and the Mustang Mach-E are just two examples of this, but we are seeing a flurry of cars of all shapes and sizes coming out from big major, deep-pocketed automakers who already have manufacturing facilities, supply chains, all of these things in place. Now, ironically, I think China is in the same boat as Tesla, because China in a broader sense, China is a major player on the world stage, but Chinese brands do not have the global reach and the global recognition that US brands have, I mean, can you think of a Chinese brand that is global? I mean, Alibaba kinda? 

Whiteman: I mean, can I cheat? Geely's Volvo and a couple of those, so if you want to go through the back door that way, but you have a point. I think I just made your point.

Bromels: Exactly, exactly. I mean, you've got Alibaba, which can be accessed from anywhere. I bought things from Alibaba, full disclosure. But China is looking to try to find areas where it can have a brand that becomes globally dominant, globally recognized, and China wisely sees the electric vehicle market as one of these possible places where it could achieve some dominance because it's a fragmented, aside from Tesla, industry and dominated by one small player. I think if China feels like the electric vehicles are its best shot at making an interest on the global stage, you can bet Chinese government is going to pull out all the stops to ensure that they give that company the best shot of becoming a truly global brand, and I just thought of one TikTok, there you go. That's my one that I've got, TikTok.

Whiteman: You're hitting on the bottom line for me, for Tesla, I would be much more confident of the business model if they were taking the Ferrari type approach and just wanted to be a very profitable niche player because there is no doubt the brand is great. They make amazing cars, high-end cars, that people want. There's demand there. The scary thing for me though is again, all of the CapEx they are building in Texas, they are building in Germany. They are putting so much capacity. They're going for mass automaker status in a world, where as you say competition is getting much more intense. I mean, Tesla, I'm very confident there's a place for Tesla on this market. I am not so confident that it'll play out in a profitable way for all the capacity they are putting online, so that's, I think the interesting thing to watch.

Bromels: Well, and all of this, of course, like I said is a huge complex issue, we're not going to have time to talk about all of it, but all of this actually also plays into the question about EVs and affordability. I mean, Tesla, right now, even the Model 3 and the Model Y which are the cheap Teslas, these are $40,000-$50,000 cars for the base trim. A lot of folks are not going to be able to afford that, but BMW, Ferrari, they've made really great businesses out of going for that higher price point, higher margins, fewer sales. I think the big question that we need to answer for Tesla now that it is the most valuable car company on the planet is, are they going to reduce their prices, go for a mass market audience, and settle for those lower margins or are they going to go, as you say, the Ferrari route, BMW route and keep making top of the line automobiles for top of the line prices?