As we have pointed out a few times in the past, Tesla's (NASDAQ:TSLA) product tall tales, especially about Autopilot, have come back to bite the company. Readers can review the following articles for a history of Tesla's problematic AP2 rollout:
In essence, Tesla has been selling customers a feature set that does not exist. The company has missed several self-imposed deadlines for product delivery and last check does not even have an ETA for the feature set. In our most recent note we suggested that the problem is getting progressively worse and Tesla has a disclosure obligation to investors. We said:
"One of the key challenges in this regard to Tesla is that existing customers may ask for refund of previously purchased products (not just what they paid for AP2.0 feature but potentially what they paid for the car). As the awareness of the problem increases, new potential customers may also be less inclined to purchase products that lack the advertised feature set."
This risk has now become reality with Hagens Berman Sobol Shapiro LLP, a class action litigation firm, representing three Tesla owners, filed a class action lawsuit against Tesla for misleading customers about its Autopilot technology. According to Hagens Berman Press Release:
"Tesla owners today filed a class-action lawsuit against the automaker for knowingly selling nearly 50,000 cars with nonfunctional Enhanced Autopilot AP2.0 software that still has not met Tesla's promises, including inoperative Standard Safety Features on affected models sold in Q4 2016 and Q1 2017, according to a lawsuit filed by Hagens Berman.
Though sold as premium automobiles with a focus on safety, the cars lack basic functions featured in cars at half the price. Further, the "Enhanced Autopilot," for which customers paid an extra $5,000, is "essentially unusable and demonstrably dangerous," the complaint reads."
Now that our prediction about the class action lawsuit has come true, we will further prognosticate how bad this lawsuit, and other related lawsuits, could get for Tesla.
First, there is one bit of good news for Tesla in this lawsuit that we will get out of the way. The good news is this: In spite of Hagens Berman'sactive recruiting, the initial class consists of only three Tesla customers. This, we believe, is likely a testament to Tesla's fanatic customer following. Tesla customers, enamored by the coolness of the Model S and Model X, are cultish and have been known to put up with terrible product quality.
What this goodwill means is that Tesla still has time to avert disaster if it can fix its Autopilot problems. A lot of Tesla customers love Tesla cars so much that they would probably not join the class action if Tesla can come up with a solution soon. With this piece of good news out of the way, let's look at the bad news.
Readers should note that the size of the initial complaining group hardly matters in class action lawsuits. Once a class starts, things can snowball quite quickly, many new lawsuits will come into play, and the entire class covered by the final lawsuit will have a claim regardless of the number of initial plaintiffs.
The allegations from the lawsuit are as expected and damning. Here are some of the more salient ones:
98. In the course of business, Tesla willfully failed to disclose and actively concealed the defects in the AP2.0 system discussed herein, and it otherwise engaged in activities with a tendency or capacity to deceive. Tesla also engaged in unlawful trade practices by employing deception, deceptive acts or practices, fraud, misrepresentations, or concealment, suppression, or omission of any material fact with intent that others rely upon such concealment, suppression, or omission, in connection with the sale of Affected Vehicles."
99. Tesla knew that it had designed and installed a defective AP2.0 system and knew that the system would not be ready as advertised. Tesla knew this information but concealed all of it.
100. Tesla was also aware that it valued profits over safety, and that it was manufacturing, selling, and distributing vehicles throughout the United States that did not perform as advertised and that jeopardized the safety of the vehicles' occupants. Tesla concealed this information as well.
101. By failing to disclose that the AP2.0 system was defective, by marketing Tesla vehicles as safe, reliable, and of high quality, and by presenting Tesla as a reputable manufacturer that valued safety and stood behind its vehicles after they were sold, Tesla engaged in deceptive business practices in violation of the Colorado CPA.
107. Because Tesla fraudulently concealed the defective nature of the AP2.0 system and the true performance of its vehicles bearing the AP2.0 system, resulting in a raft of negative publicity once the defects finally began to be disclosed, the value of the Affected Vehicles has diminished. In light of the stigma attached to those vehicles by Tesla's conduct, they are now worth significantly less than they otherwise would be.
108. Tesla's fraudulent sales and deployment of the defective AP2.0 system and the true performance of Tesla vehicles equipped with this system were material to Plaintiff and the Colorado class. A vehicle made by a reputable manufacturer of safe, high-performing electric vehicles is safer and worth more than an otherwise comparable vehicle made by a disreputable manufacturer of unsafe electric vehicles that conceals defects rather than promptly remedying them.
109. Plaintiff and the Colorado class suffered ascertainable loss caused by Tesla's misrepresentations and its concealment of and failure to disclose material information. Class members who purchased the Affected Vehicles either would have paid less for their vehicles or would not have purchased or leased them at all but for Tesla's violations of the Colorado CPA.
111. Tesla's violations present a continuing risk to Plaintiff and the Colorado class as well as to the general public. Tesla's unlawful acts and practices complained of herein affect the public interest.
117. Tesla concealed and suppressed material facts concerning the quality of Tesla vehicles and the Tesla brand.
118. Tesla concealed and suppressed material facts concerning the safety, performance, and quality of the Affected Vehicles. As alleged in this Complaint, notwithstanding their promises as to the readiness and capabilities of the AP2.0 system, Tesla knowingly and intentionally designed and incorporated a system that would not permit safe operation of the vehicle.
119. Tesla did so in order to boost confidence in its vehicles and falsely assure purchasers and lessees of Tesla vehicles that Tesla is a reputable manufacturer that stands behind its vehicles after they are sold, and that its vehicles are safe, reliable, and perform as promised. The false representations were material to consumers, both because they concerned the safety of the Affected Vehicles and because the representations played a significant role in the value of the vehicles.
120. Plaintiff and Colorado class members viewed advertising on Tesla's website and elsewhere that touted the features and availability of the AP2.0 system. They had no way of knowing that Tesla's representations were false and gravely misleading. Plaintiff and Colorado class members did not and could not unravel Tesla's deception on their own.
123. On information and belief, Tesla has still not made full and adequate disclosures and continues to defraud Plaintiff and the Colorado class by concealing material information regarding the safety and performance of its vehicles.
124. Plaintiff and the Colorado class were unaware of these omitted material facts and would not have acted as they did if they had known of the concealed and/or suppressed facts, in that they would not have purchased the AP2.0-equipped vehicles manufactured by Tesla, and/or would not have continued to drive their Affected Vehicles or would have taken other affirmative steps.
While the language above is pertinent to Colorado class, similar language exists in the lawsuit for classes in New Jersey and Florida. It is easy to see that such language could be extended to other states over time. Legal claims and challenges in California, a very consumer friendly state, are likely to be worse.
In terms of relief, here are the salient requests being made by the law firm:
B. An order temporarily and permanently enjoining Tesla from continuing the unlawful, deceptive, fraudulent, and unfair business practices alleged in this complaint;
C. Injunctive relief in the form of a recall;
D. Equitable relief in the form of buyback of the Affected Vehicles;
E. Costs, restitution, damages, including punitive damages, penalties, and disgorgement in an amount to be determined at trial;
F. An order requiring Tesla to pay both pre- and post-judgment interest on any amounts awarded;
G. An award of costs and attorneys' fees; and
H. Such other or further relief as may be appropriate.
There we have it. Claims of willful nondisclosure, deception, concealment, defective product, unsafe product, etc. A remedy that includes buying back the affected vehicles, punitive damages, penalties, and attorney fees.
At the end of the day, this all boils down to Mr. Musk's chutzpah of selling an absolute vaporware of a system without even a proof of concept - a system that may never meet the promises made to customers at least in the time frame that is meaningful.
While this class action in itself might look small, the problem for Tesla is that this type of legal action is unlikely to stop here and will likely spread to other states and other countries. The class also may slowly expand to cover future sales of Tesla automobiles.
Effectively, Tesla has a potential liability on all cars sold from October of 2016.
Tesla can cap of the risk if it stops marketing the Enhanced Autopilot, or EAP, and Full Self Driving, or FSD. However, that would require Tesla to take a big hit on its marketing message.
If Tesla chooses to continue with the current EAP and FSD marketing, the company's risk is open ended and can become very large until it can deliver an acceptable solution.
In our view, Tesla has a two-pronged risk profile here:
- On EAP, we believe Tesla has a realistic chance of getting to an acceptable solution in the not too distant future. Based on the current product performance, we are skeptical that Tesla can get there in Q2, or even Q3. However, in a few quarters, Tesla may be able to offer a solution with an acceptable safety profile. We would not be surprised if it takes Tesla into 2018 to deliver a product with acceptable safety profile.
- On FSD, we believe that Tesla is very far from being able to offer an acceptable solution. As such, we find it unlikely that Tesla will ever be able to offer the promised Level 5 autonomous solution with the current hardware. We are skeptical if Tesla can offer a less capable Level 4 autonomous solution even in 2018, let alone 2017. We find Tesla at a huge risk on this front. In the future, potentially almost every Tesla automobile sale with the FSD may become eligible for a buyback or a full refund.Summary:
Tesla has opened itself for potentially very expensive legal action by selling features that do not function. Tesla can cap the legal risk by not marketing the unavailable feature set. Time will tell if Tesla will take this path.
If Tesla chooses to continue marketing EAP and FSD, the odds of expensive litigation go up dramatically. Tesla may save itself from some of the claims if it can get the EAP to work in the next quarter or two. However, the company is hugely exposed on its FSD feature which will likely never come to fruition with the current model cars.
With a huge cash burn and an ongoing need for capital, it is extremely unwise for Tesla to be selling features that are not ready.
Our View of TSLA: Sell short.
Note: The author is not an attorney and nothing in this article should be construed as a legal opinion.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.