The story you’ll hear about the Chinese electric-vehicle (EV) market is that it’s a bonanza — a wild, wild East where money is getting thrown around and billionaires with no experience in the automotive industry (or even sometimes in manufacturing) have opened their wallets to see who will win the future of mobility.
On top of money to be raised, there are incentives to buy. The Chinese Communist Party has decreed that more than 20% of the country’s automotive fleet will be electric by 2025. So despite a vexatious slowing economy and poor car sales over the last year, the EV market is still growing.
And so Tesla, the US EV company helmed by Elon Musk, has chosen this moment to throw its hat into this ring of riches. Tesla plans to start manufacturing cars for China out of its Shanghai factory by the end of the year — a factory on which the company broke ground just a few weeks ago. It also just started shipping its lower-priced Model 3 sedans to China this month.
In reality, it is entering a market far more complicated than it seems. China’s unique way of building its auto industry has led to pricing and sales dynamics that will make the near term challenging at best.
“I think supply is going to outstrip demand over the next 24 months, especially if the economy stays slow and the auto market doesn’t grow,” said Tu Le of the Beijing-based consultancy Sino Auto Insights. “That’s where there’s this huge dichotomy. If more people don’t want cars and I [a manufacturer] still have to make them what do I do? In the US they just manufacture them at a loss. In China, you’re going to see pricing pressure because there’s going to be more supply than demand.”
That is why Le commends Musk for his company’s recent layoffs in January.
“I feel that he’s preparing for battle as much as he’s looking at his balance sheet and seeing gross margins and seeing they’re not where they need to be.”
Were you affected by the Tesla layoffs? Have a story to share about the company? Contact Business Insider’s Linette Lopez at email@example.com.
Riding in cars with the CCP
The history of cars in China is one of government mandates and incentives. That hasn’t really changed. In the 1990s, China’s National Development and Reform Commission came up with a plan meant to encourage Chinese people to ditch their bikes — the main form of transportation in cities — for cars. That started a car-buying boom that has only just started showing signs of busting last year.
Chinese policymakers continue to use their control of the auto market to influence the economy. During China’s last two big economic downturns (in 2009 and 2015) the government created more incentives to buy (tax breaks and such) in order to keep money flowing.
The government’s approach to EVs has been much the same. That has led to what Le called “free money” for those trying to enter the market.
But that hasn’t necessarily led to major innovation in the space, Anne Stevenson-Yang, founder of China-based J Capital Research, told Business Insider. That’s because Chinese automakers are first and foremost incentivized to produce a lot of cars fast.
“As a consequence, domestic makers shifted away from ‘indigenous innovation’ and have as a rule taken advantage of technologies developed overseas and leaned on government subsidies to produce in volume,” Stevenson-Yang wrote in a note to clients in 2016.
This, she said, could mean that China gets caught in the same “value trap” in the auto industry that it has been caught up in with cellphones — a trap in which it merely manufactures technology developed in other nations. Automakers (Tesla included) have been careful to manufacture more complex cars outside of China, too, in part for fear of intellectual property theft.
Subsidies create dislocations in manufacturing costs as well, Stevenson-Yang said in a 2018 note.
“In an industry like BEVs [battery electric vehicles], direct and indirect subsidies are a critical fuel for market growth. When a vehicle brand from another province comes along, the brand owner is often required to manufacture locally in order to realize the subsidies. That practice ensures that manufacturing will be unprofitable and contributes to the unsustainable crowd of BEV upstarts. This ultimately will lead to a costly and dangerous winnowing out of all but a few of the current aspirants.”
There aren’t just subsidies for manufacturers, of course. Historically consumers have gotten them, too. But that’s changing. In 2019, the subsidies for consumers will start to disappear and be replaced with a cap-and-trade system that rewards EV manufacturers.
“The nonfinancial incentives in China — free licenses for cars, driving in certain lanes, free parking — are very important, and they’re probably going to have to increase those if they plan on pulling back the very generous consumer subsidies,” Ryan Brinkman, an automotive analyst at JPMorgan, told Business Insider.
So Tesla is not just making a major push into the market during a downturn, it’s entering at a time when the government is trying to cut back on some of its giveaways to consumers. We should also note that the government is a major buyer in this space, accounting for 25% of sales, Stevenson-Yang said.
Timing (and money) are everything
The company just broke ground on a factory outside Shanghai in January, and on a conference call with investors, Musk said that the company was planning on manufacturing Model 3s from there by the end of 2019. In 2020, it plans to manufacture the Model Y — a crossover based on the Model 3 — at the plant, according to internal documents viewed by Business Insider.
However, on the call, the company did not provide guidance as to how the factory build-out would be financed.
“Producing vehicles in 2019 for a plant that has just been broken ground on … I think that is subject to delay,” Brinkman said.
“It would be helpful for the investors to know how much this will cost, in what years there will be capital expenditures, and what is the interest rate that debt will have and what assets will be pledged to secure that debt. They [Tesla] said we shouldn’t be that concerned about the finance because it will be financed out of China, but I still think there are critical details that are lacking at this stage.”
Analysts at Morgan Stanley seem to agree, writing in a recent note that: “China stands out as an intense area of focus [for Tesla] for which we continue to apply little long term or terminal value for in our calculations.”
Part of that, Brinkman said, is because comparisons to previous Tesla projects simply don’t hold in this case. For example, comparisons to the New United Motor Manufacturing Inc. factory Tesla purchased from Toyota for pennies on the dollar don’t work because this “is going to be a much more capital intensive operation.”
“Tesla is going to have source components locally perhaps more so than they would otherwise have been inclined to do,” Brinkman said. The Chinese government has shown a preference for using domestic battery manufacturers, for example.
That’s just part of doing business in China. Tesla may not have been forced into a joint venture, but it will still have to change its supply chains, which could lead to bottlenecks, according to Brinkman.
And then there’s charging. Most Chinese city dwellers who would buy an EV also live in apartment buildings where there are no single-car garages. That means coming up with other ways to charge vehicles.
A Tesla spokesperson told Business Insider that “over the last six years, we have opened 60 Tesla locations, nearly 1,500 Superchargers, and more than 1,850 destination chargers in China, and we will continue to expand our presence in the country. ”
But that costs money, and so far no one seems to have even begun calculating how much.
There are a bunch of EVs in China, sure, but not all of them can be Tesla killers. For one thing, Tesla’s brand is incredibly strong in China. For another, it’s priced completely differently from many Chinese EVs.
The long-range Model 3 sedan, the cheapest Tesla you can buy in China, starts at $64,300. That puts it in the luxury-car bracket. Big manufacturers such as Geely and BYD sell EVs for much cheaper. For example, the BYD e5 electric sedan, a best seller in the country, costs $20,756.
“In my opinion, there’s probably eight companies that could vie for competition with Tesla,” Le said. “They’ve established themselves credibly in China, the major thing is if they can sell 200,000-300,000 Model 3s in the next 18-24 months and the government will genuinely help them from an infrastructure standpoint.”
In 2017, Tesla delivered just under 250,000 cars globally.
Competitors such as Nio, the “Tesla killer,” have other concerns. Nio is sleek, and its price point is about the same as Tesla’s Model 3 — a Nio ES8 SUV starts at $67,000. It unveiled a smaller SUV, the ES6, in December.
“NIO delivered 3,318 ES8 vehicles in December and 11,348 in 2018, beating its target of 10,000 ES8 deliveries by year-end. However, January deliveries are likely to be softer as consumers sought delivery ahead of potential changes to electric vehicle subsidies in the 2019 calendar year,” Brinkman wrote in a note to clients in January.
Until Tesla starts selling the Model Y, its only SUV is the Model X, which costs $171,000 in China. Nio will need to seize on that window of opportunity, especially in a downturn. Like a lot of Chinese auto manufacturers, Nio outsources its manufacturing. Le said this takes control out of a carmaker’s hands because these manufacturing agreements come with minimum buys.
“Their [the Chinese EVs] window to cut out their competition is China is limited unless they execute perfectly,” he said, adding that by 2020 the “free money” will be all but gone. That’s when it’ll be time to look around and see who’s still alive.