Tesla Has a Thousand Problems, and China Isn't the Big One

For a Tesla that plans to sell 500,000 cars in 2020, China is not the thing it most needs to worry about.

On the morning of February 12, Beijing time, Tesla released its results for fiscal 2014. The fourth quarter, which ended in December, can only be called dismal. A loss of more than US$100 million was worse than the previous quarter's and dragged down the whole year: Tesla lost nearly US$300 million in 2014, four times its 2013 loss.

For months, Tesla CEO Elon Musk seemed to be preparing people for bad numbers. As early as November he cut his profit forecast by 50%, and a month ago he personally admitted that the China market was in poor shape, a confession that made the front pages of the major financial media.

The morning after the earnings call, Tesla opened on the Nasdaq at US$193.75, down 9% overnight. That wasn't even its lowest price of 2015. People seem to have grown used to a company whose story is wonderful one moment and bleak the next, and the expectations priced into its shares rise and fall like a roller coaster.

The contradiction may be a mirror of Tesla itself. Ever since its first car went on sale, every reaction has shown that Tesla is very good at making cars that drive people wild. But for a carmaker that runs its own retail stores, is making a great car enough?

Tesla says its results were bad because its luck was bad

Elon Musk is not the most skilled CEO at running an earnings call. Tesla's call was postponed to make way for a rocket launch by his other company, the space exploration firm SpaceX. And Tesla long ago abandoned the conventional format of presenting the financial details first and then taking questions. Its earnings calls are all Q&A, with no prepared remarks.

So how did Elon Musk spend an hour explaining Tesla's 2014 loss? The quarter fell short, he said, because: in pursuit of perfection, Tesla had delayed the launch of the new P85D; bad winter weather kept it from delivering cars on time; customers weren't home to take delivery; and a stronger US dollar caused foreign-exchange losses.

Translated, his message was: Tesla's luck in the fourth quarter was terrible, so of course it lost money. Profit? Wait until 2020.

Everyone is watching China

The word "China" came up 35 times during the Q&A, and the weak China market was the focus of everyone's attention. Almost every analyst asked some version of these questions: Why is China going badly? Just how bad is it? Will it get better?

One interesting detail: in the first answer about China, CTO JB Straubel said, "I think in China, the most fundamental thing is that we need to make sure we don't create any difficulty or obstacle for the customer experience. Because of regulations and various obstacles, installing charging stations has become a bad customer experience, and they hope to do that through..."

Musk cut him off with a fit of coughing. The biggest difficulty in China, he said, is actually people's belief that charging is hard. "Unfortunately, our sales team tells customers that charging is a problem in China, even though it isn't true. That's silly."

One question, two almost opposite answers. How hard is it, really, to charge a Tesla in China? The New York Times gave an answer quite close to my own impression.

But does China matter that much to Tesla?

Look closely at the financials, though, and the "terrible China market" looks more like a cover for Tesla's other problems. Although Elon Musk himself was the first to tell this story, the China market should not be the excuse for poor results in any case.

In his own words on this quarter's earnings call: "Even if sales in China were zero, I'm very confident we can reach" 55,000 cars, Tesla's sales target for 2015.

However warmly Tesla was received when it first arrived in China, common sense tells us that Europe and the United States are the biggest markets for electric cars, even for an unconventional luxury EV. Denmark produced the famous electric supercar Zenvo. And the Toyota Prius, today's most popular hybrid, chose the United States and Europe as its first overseas markets in 2000.

Europe now accounts for 30% of Tesla's sales, and deliveries there have doubled from a year ago.

If China isn't the problem and Europe is selling well, why did Tesla miss its sales target? There are several answers: production that is still stuck at a paltry 2,000 cars a month, repeated delays to new models, and selling costs that have soared out of proportion.

Production capacity caps Tesla's real sales for the next five years, drives away the many buyers who lack the patience to wait, and gives competitors plenty of time. The long-delayed new model can only be a sign that management and R&D schedules are out of control. Tesla's erratic, up-and-down spending is also puzzling: in 2014 its selling costs and operating costs equaled 72% and 34% of sales respectively, against 49% and 15% in 2013. Spending is supposed to grow in proportion to sales. A gap this large means Tesla has become extremely inefficient at spending money.

For comparison, the Toyota Prius took ten years to sell its millionth car, and Ford sold 2.49 million vehicles in 2013. Against that background, Tesla's share price looks incredible.

The only explanation is "it's a startup": a company founded 12 years ago, worth nearly US$25 billion, that plans to turn a profit in 2020.

Tesla will sell well, but that doesn't mean it will earn back its costs

There is no denying that the Model S is a beautiful car and that the electric car is a good idea. If you have been lucky enough to test-drive a Tesla, you will probably agree with me.

Tesla is also trying to solve the problems we have mentioned: capacity, positioning and cost. On paper, the cheaper, mass-market Model 3 looks like the perfect answer. It is aimed at a far wider group of buyers, and by the time it arrives Tesla's capacity problem will have been solved. That would multiply sales several times over while spreading the R&D and selling costs of its high-end cars.

The other side of the story: the Model 3 won't reach full production until 2020; outside the luxury market, the price of oil becomes a major factor in whether people buy electric cars, and no one knows what oil will cost; and in the meantime, Tesla's capital spending in 2015 will reach US$1.5 billion, up 50% from the year before.

CTO JB Straubel said, "We will be spending a huge amount of money on capital expenditure." Elon Musk then repeated the point. The Gigafactory battery plant under construction in Nevada, the continued expansion of capacity, production that may eventually move to Asia: all of this points to future capital spending far beyond US$1.5 billion.

After the 2014 results came out, Deutsche Bank analyst Rod Lache still believed Tesla would be able to seize the opportunity when the electric-car era arrives. But while he recommended buying the stock, he cut his price target from US$310 to US$245, saying, "Even if Tesla is a long-term growth stock, delivering on short-term targets remains crucial to investor confidence."

JPMorgan went further, downgrading Tesla and recommending that investors sell.

Morgan Stanley analyst Adam Jonas has long been one of Tesla's strongest backers, but late last year he predicted that the company would sell only 300,000 cars by 2020, far short of the 500,000 Elon Musk claims. After this year's earnings call, Jonas flatly called Tesla's US$1.5 billion in capital spending "insane". In his view, demand for Tesla's cars is strong, but the capital needed to reach a profitable scale of production "looks eye-wateringly high."

Will investors have enough patience, and enough money, to sustain Tesla's wild growth plan? How will oil prices and the electric-car market develop over the next decade? Will the economy stay steady long enough for Tesla to reach profitability safely? No one can reliably predict any of this, and that is why Tesla is dangerous.

Tesla may be a company that loves innovation, but it has set off down a road many carmakers have traveled before: a good car is not enough, and you have to watch your cash flow.

If you are interested in how Tesla is doing in China, see this report from The New York Times:

What Happened to the People Who Bought Teslas in China?

By Dan Levin. Translated by is Translation Studio and Qian Gongyi.

BEIJING — For US$104,000, Yu Hangmei (name rendered phonetically) wanted a car that could at least be driven. She said she spent that much on a brand-new Tesla Model S, only to find that its charging stations often failed.

Ms. Yu, 45, exports handicrafts and comes from Zhejiang, a coastal province of China. Recently, driving in her hometown, she found that although she had plugged the car in, the battery had taken almost no charge. "I thought charging it for a day should have filled it up, but it hadn't charged at all," she said.

Tesla owners need a charging post whose voltage and current meet particular requirements, and such posts are hard to find in Ms. Yu's hometown. "Luckily, I met another Tesla owner who let me charge at his place, and it took only three hours."

Tesla owners in China tend to have high social status, and most are well off. They live on social media, so when something goes wrong with a car, the complaints spread online before long. The difficulty of finding charging posts is a constant source of grumbling.

Chen Zhong (phonetic), in the Tesla Model S he bought last year: "We are willing to be lab mice."

It turns out that if Tesla Motors wants to make its mark in the world's largest auto market, it first has to solve the big problem of hard-to-find charging.

For Tesla, based in Palo Alto, California, China seems to have all the right ingredients.

The country has the second-largest number of millionaires in the world, behind only the United States. And the Chinese government believes electric vehicles can help solve China's notorious smog problem.

Yet Tesla's expansion in China has been an uphill struggle. Worries about charging, and government policies that to some extent favor domestic companies, may be the two reasons the company's performance in China was mediocre last year, and the reason Tesla's China president resigned.

A report Tesla released on Wednesday said the company is currently doing poorly in China. Last month in Detroit, Tesla CEO Elon Musk admitted that Tesla's 2014 sales in China were "unexpectedly low." He blamed it all on "people's misunderstanding about how to charge cars": owners worry they won't be able to charge at home.

Tesla is working hard to win the China market. Last April the carmaker began exporting the Model S sedan to China. It has built 52 free Supercharger stations in 20 Chinese cities, plus 800 charging posts in shopping malls, hotels and restaurants in more than 70 cities. At a Supercharger, a car can be fully charged in about an hour.

In its shareholder letter for the third quarter of 2014, Tesla said it now has nine stores and service centers in first-tier cities such as Beijing, Shanghai and Guangzhou, more than it has in the major cities of most other countries. In the United States, Tesla has more than 60 stores and more than 40 service centers.

"Over the past few months, Tesla has made considerable progress in China," Tesla China wrote in an email.

In fact, Tesla's sales in China have been lukewarm. The company had hoped to sell 5,000 cars there, 30% of its global sales. So far it has exported and sold only about 3,500. According to Zhang Yu (phonetic), general manager of Automotive Foresight, a Shanghai-based auto market research firm, total sales of electric and hybrid vehicles in China last year were 80,000.

The Chinese government hopes to have 500,000 electric and hybrid vehicles on the road this year, rising to 5 million by 2020. To encourage drivers to buy green electric and hybrid cars, the central and local governments together offer buyers of domestic electric vehicles combined subsidies of 120,000 yuan (about US$19,000). Because Tesla is a foreign company, its owners have not received this subsidy. The Shanghai municipal government, however, gives free license plates to all electric vehicles, saving each driver about US$12,000 in plate fees. In October, 400 Tesla owners received these free plates.

The Chinese government offers six-figure sums in yuan to promote electric and hybrid vehicles, while the US government is more generous, with subsidies of up to US$70,000. Chinese Tesla owners miss out on this benefit, but they don't really care. "Frankly, for people who can afford a Tesla, this money is nothing," Mr. Zhang said. "Tesla's success isn't about how popular it is. To people, it's a rich man's toy."

A Tesla charging post in the basement of a Beijing shopping mall. Such posts are scarce, and Tesla owners complain bitterly about it.

What owners really care about is where to charge. Many American owners live in houses with private garages. China is different: most city residents live in compounds of low-rise apartment blocks shared by many families. To install a charging post in such a compound, you have to negotiate with the other owners and residents.

Xie Yujian (phonetic), 39, runs a trading company in Hangzhou, a coastal city in China. He keeps four cars in his apartment garage, but his Tesla charging post is installed at his factory. "I heard you have to apply to the property management company to get the kind of cable used to charge a Tesla. If I put the charging post at my factory, I don't have to go through all that," he said.

Mr. Xie likes taking short trips in his Tesla, but he doesn't like waiting for it to charge. In Hangzhou, he said, Supercharging the car takes two to three hours, including the round trip to the station. "I think this may be the biggest problem Tesla has to find a way to overcome."

Compared with conventional gas stations or charging stations, Tesla has too few charging posts, and people's worry about not finding one is holding back its push into China. China currently has 52 free Supercharger stations. In Europe, Superchargers are everywhere, numbering more than 120, and the United States has more than 150.

"It will still take time to build comprehensive charging infrastructure across China," Tesla China said.

Besides building more Superchargers, Tesla plans to export high-power wall-mounted home chargers to China in the first half of this year. These chargers cut charging time: on an ordinary household circuit, a full charge takes 10 hours, but with the wall charger it takes 5. A full charge usually gives the car a range of 310 miles.

For now, though, Tesla owners have already found their own workaround. Many join QQ or WeChat groups, where they discuss Tesla stores, complain about glitches in the car's management system, and arrange to charge their cars at each other's homes. They call this "stealing electricity."

Xiao Zufu (phonetic), 44, works at a brand-name store. On a recent drive from his home in Zhejiang province to Shanghai, a distance of 380 kilometers (236 miles), he used this method. He was in an unfamiliar town, and his battery had only enough charge left for another 60 kilometers. He immediately found a Tesla owner nearby through QQ and charged up at his place.

"It's actually a bit embarrassing," he said. "If I were driving a diesel car, I'm sure that when the warning light turns yellow, I could still go at least another 50 kilometers. But with an electric car like this, I'm not so sure how much farther it can go."

Still, most Tesla owners are quite understanding of the company's difficulties, especially those who work in China's equivalents of Silicon Valley. "We are willing to be lab mice," said Chen Zhong, 32, marketing director of an online media company in Beijing, who bought a Tesla Model S last year. These buyers are fairly well off, and what they value is the high-tech culture the car represents. "The first time I drove this car, it felt like driving an iPad," Mr. Chen added, describing what it is like to own a Tesla. "It makes those of us in the IT industry feel great."

Wei Jianguo (phonetic), 40, is an angel investor in Hangzhou. He owns a Mercedes-Benz S350 and a BMW 3 Series Gran Turismo, and a Tesla on top of those. He doesn't mind at all that charging stations are hard to find, and he believes the problem will solve itself as China's electric-vehicle infrastructure improves.

"Right now it's just like when cars first appeared and horse-drawn transport began to feel the effects," he said.

Cover image: Inc