Seeking Alpha
What is your profession? ×
Commodities, macro, gold & precious metals, long/short equity
Profile| Send Message|
( followers)


Tesla is betting on success in China this decade, hoping it will become by far its best market. It just announced a deal with China's Unicom to build 400 charging stations.

China's demographic includes fewer millionaires compared to the US, as well as a very thin strata of high-earning professionals, therefore smaller potential market for luxury cars.

China's EV market has some potential but competition is already starting to intensify, while Tesla is years away from having a factory there.

Earlier this year Tesla (NASDAQ:TSLA) CEO Elon Musk announced plans to build manufacturing capabilities in China within a few years. He expects China to become a very important market for Tesla's EVs. He ventured to claim that it might become Tesla's most important market by 2020, with half of all revenues coming from there by then (link). If we extrapolate this based on Tesla's other goal of reaching worldwide sales of 500,000 cars per year by 2020, it would mean that it would have to reach sales of a few hundred thousand cars in China by the end of this decade.

The latest sign that Tesla is going all-in on China is the fact that it signed a deal to build 400 charging stations in 120 cities in order to make Tesla car ownership more desirable in that market. It signed a deal with China Unicom (NYSE:CHU), which will allow Tesla to build the stations near its telecom stores. Tesla wants to offer Chinese customers these charging sites free of charge.

I stated my doubts about Tesla's ability to reach its goal of selling 500,000 cars per year by 2020 in previous articles. I just don't see the path towards such a goal. Tesla will sell an estimated 35,000 cars this year, which will be a 50% increase compared to last year. If such a pace would be kept up until 2020, Tesla would come close to its goal, selling 400,000 units per year. Given that the US market is already showing signs of saturation, with sales seemingly not looking like they will be much stronger than last year, there is reason to doubt the viability of the momentum going forward. If the US market shows signs of flattening out after reaching sales of under 20,000 per year, I doubt Tesla's current vehicle lineup could ever reach global sales of 100,000 per year.

The counter-argument of the Tesla bulls is that the current Tesla model S and the upcoming model X, which sell at an average price of just under $100,000 in the US when all options are included, are not accessible to the less affluent. But the model 3 will have a base price around $35,000 and it is due to hit the market in 2017. In reality, the average Tesla model 3 will sell in the $45,000 range by the time options will be chosen. In this price range, the competition is already rather stiff, including from other luxury car makers which are now offering EVs for a similar price, including BMW and Mercedes.

There is also the popular EV version of the Nissan Leaf, which sells for a significantly lower price, starting at $29,000, which is currently the best selling EV. Volkswagen is expected to come on the market with a Golf EV starting at $36,000, not including incentives, as well as a luxury EV through its Audi brand called the Q8 e-tron, which will have a range of as much as 430 miles, which is significantly more than Tesla's 300 mile range, but will also have a price tag in the $130,000 range. The EV lineup in the $35,000 price range is increasing in the US, EU and elsewhere, but as we can see, there is also a challenge coming in the luxury market. Not to mention that there is also the conventional gasoline or diesel powered competition to contend with, which currently can offer much more for the same price, given that the technology is still much cheaper, and the infrastructure we drive on is better suited to these cars.

The China Bet

Based on comments made lately we can conclude that Elon Musk believes he can sell Tesla cars better in China than in any country on earth. Based on stories of a growing Chinese middle class and increasing wealth, the world's largest population and so on, one would think that this is a no-brainer. After all, China is now the world's largest car market. In order to really understand the nature of China's market potential for Tesla cars, we need to dig a little bit deeper.

While we heard plenty of talk about China's rising middle class in the past decade or so, I believe most people in the Western world are failing to grasp what middle class in China really means. I was born in Romania, and even though I left as a child, I still have strong ties to the place, including family and friends, so I am familiar with life there, including the profile of the typical middle class family. That is perhaps why I am more skeptical about Tesla's China potential. In Romania, the average net wage per month is about $550, or $6,600 per year (link). In China, the average family yearly income in 2012 was $2,100 (link). Average gross urban salaries in China are about $7,600 per year (link). The middle class in these two countries is in many ways comparable, so I have some understanding of Chinese middle class consumer patterns, even though I have never been there.

It is important to understand that in a place like Romania or China, the typical middle class family will not come close to being able to afford the cheapest Tesla model, which will have a base price of around $35,000. Even here in the United States as well as in Europe, cars in this price range are accessible to the upper middle class. It is true that if Tesla begins manufacturing cars in China, production costs, and therefore the sale price, could drop somewhat, but still not enough to make these cars affordable to the wider population, even if the Chinese government will step in to offer incentives.

What remains as a market in a place such as China, is the growing ranks of millionaires, which officially we are told that there are a million of them, but it is suspected that the true number may be as high as 3 million. That is still less than the four million official millionaires in the United States. This segment in China contains very few wage earners. It is mainly made up of business owners and investors who were successful and desire to show their success, therefore are likely to be potential customers for a model S or model X. For the more inexpensive model 3, there is a very thin Chinese demographic segment made up of high-earning professionals. Business owners who do not belong in the millionaire category might be able to afford a Tesla model 3, but will be very unlikely to purchase such a vehicle, because they are still in the process of accumulating wealth, therefore they tend to invest their capital in assets that offer a return on investment. In Romania, I know of very few wage earners who can afford to purchase a car that costs more than $20,000. The new car market for the middle class is dominated by cars in the $10,000 range, and even this is reserved for the upper middle class, which as I pointed out, is very thin compared to the Western world. It is not much different in China. The model 3 will be considered a luxury model as far as price goes, but with a size that is reportedly 20% smaller than the model S, its look might not scream luxury. so it is a big question mark how the Chinese market will react to it.

The entire luxury car market in China is currently about 1.5 million sales per year. It is forecast to double to 3 million sales per year by 2020. I think that such a forecast is highly optimistic, given that everything in China is slowing down, including the increase in the number of millionaires. I think a 2-2.5 million range is more realistic. If Tesla will, hypothetically speaking, manage to capture 5% of that market by 2020, it would mean annual sales of roughly 100,000-125,000 per year. Even if current trends in China improve and the 3 million luxury car sales volume will be reached, a 5% share for Tesla will mean annual sales in the 150,000 vehicle range. It is possible that Tesla could capture a higher share of the market, but I find it unlikely, with German luxury brands currently in a very dominant position and growing in sales volume.

Even in the electric car segment, it is possible that there will be very strong competition in all price ranges in which Tesla currently sells its models. I think, even the assumption of Tesla capturing 5% of the luxury car market might be very optimistic, because it would mean that EVs would have a roughly 20-30% share of the luxury market at least, which I doubt will happen. In 2013, total all-electric car sales in China numbered less than 15,000 units (link). Sales will more than double this year, but still, this is a very small base to grow from. As for the competition, there are already local EV makers, including BYD, which is likely to sell as many as 20,000 all-electrics and hybrids this year, and is launching an all-electric in partnership with Daimler called the Denza, which will sell for roughly $60,000, or $42,000 once all subsidies are used (link). The Denza will have a range of 186 miles, which is close to Tesla's model 3, which will have a 200 mile range. Not to mention that it has established pedigree given its Daimler connection, as well as preferential treatment from the authorities, given the BYD partnership. The Denza is set to hit the market this year, while a Tesla model 3 does not really exist yet, and while the launch date is set for 2017, it is not set in stone.

Tesla currently lacks a local partner, and is unlikely to be allowed to move in and manufacture without taking on one. If it does, it will mean that there will be significant technological transfers taking place, and within a few years, its local partner will also become a competitor as it will no doubt use the gained knowledge to strike out on its own. If Tesla does take on a partner in China within the next few years, it will be very late to the Chinese EV scene, because by then there will be already well-established competitors to contend with. If it decides to rely on exporting from the US, it is likely to face serious price disadvantages as the price of transport and duties, as well as a less preferential treatment on behalf of the Chinese government when it comes to subsidies, will significantly impair its competitiveness. For all these reasons, I believe Tesla's China potential for this decade is highly over-estimated and results are likely to deeply disappoint current shareholders, who at this point are holding a stock that already has success on all fronts priced in for this decade and further into the future as well.