Tesla Inc (NASDAQ:TSLA) owes its massive market cap to an expectation of future growth that has already been priced into the stock. Much of Tesla’s growth will depend on China, the largest population on earth. But doing business in China isn’t easy. While the Chinese market is large and lucrative, the country’s protectionism and capricious government policy make it a double-edged sword for American companies.
The Chinese market is challenging for Tesla because its electric vehicles struggle to compete with fossil fuels on cost. Tesla, and most EV companies, rely on government subsidies and tax credits in order to turn a profit on their vehicles. When government support is scaled back, sales tank. In China, the rules change very quickly. And practically every American automaker has been burned by this is some way or the other. Tesla, as an American firm that imports its products into China, faces another major risk: Protectionism.
Most Americans are scared to start a trade war with China (through tariffs or other policies) which is funny considering China – the country with the most to lose from a trade war – does whatever it wants in terms of protectionism. The Chinese government seeks to support employment and the development of domestic industries. And to this end, it has slapped a staggering 25% tariff on vehicle imports into the country. Trump’s rhetoric on trade doesn’t sound so outlandish in perspective.
This huge tariff makes things very difficult for Tesla, but it helps Tesla’s competitors compete with the American automaker on price by simply making Tesla automobiles too expensive for most Chinese consumers. Tesla’s mass-market Model 3 is attractively priced at only $35,000 in the United States. And the company plans to release the car in China next year. But by the time Tesla makes it to China, domestic competition will be waiting for it, and the 25% tariff on Tesla’s products will make it hard for the automaker to reach its goal of 500,000 in annual sales.
Singulato, a Chinese electric automaker, plans to price its vehicles at between 200,000 yuan and 300,000 yuan ($29,000 to $43,000 dollars). In a fair market, Tesla would crush Singulato with its better costs and pricing, but with 25% added to the Model 3’s $35,000 price tag, Tesla may find it hard to compete.
What’s the Silver Lining?
Chinese companies are not incapable of making good cars, but they can’t compete with foreign cars on price without sacrificing quality – even with government help. Competition is fierce in China, and the lack of intellectual property protection discourages creativity and innovation. Many Chinese companies compete by streamlining costs instead of innovation or product differentiation. The result is that Chinese products are simply not known for their quality – not even in China.
Tesla’s biggest disadvantage (being an American company) may turn out to be its biggest advantage. Foreign brands are prestigious in China, and this will help support Chinese demand for the Model 3 despite its price being unfairly inflated by the 25% tariff. Over the long term, Tesla could see Chinese sales explode by building a manufacturing plant in the country to avoid paying the tariff. Such plans definitely are in the works, but they have been probably deferred over concerns about political backlash.
Overall, China remains a huge bullish catalyst for Tesla, but it’s also a risk factor that must be considered when investing in the stock. Instead of worrying about starting a trade war, American investors should pressure the government to fight back against the war that is already being waged against Tesla and other American companies that operate in China.