Tesla’s China ‘Recall’ Isn’t About Safety. It’s a Turf War.

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Tesla’s rising dominance in China intensifies the cold war between two tech superpowers

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Tesla (NASDAQ:TSLA) stock has been facing a steady drip of bad press in China. The electric vehicle (EV) leader has been hit with everything from security concerns, perceived quality issues and even protests over its handling of customer complaints in the country. The weekend news won’t ease investor concerns or bolster consumer confidence. Tesla has started to “recall” (I’ll explain the quotes in a minute) more than 285,000 vehicles in the country — most of which were made locally — over a safety risk with the vehicles’ cruise control feature.

The recall is the first of its kind for Tesla. China is the world’s biggest market for electric vehicles. Chinese EV growth, market share and competition are always high on Telsa investors’ minds. In fact, about 30% of Tesla’s sales are to China.

I’m not going to sugarcoat it for you. The news may give TSLA stock a pause, particularly amid noise from other EV startups and the stock’s strong recent run into the company’s Q2 earnings report. But, it’s important that investors not overreact.

Looking closer, this safety “recall” isn’t really a recall. It’s also not really about safety. It’s a simple software patch. And this China regulator dust-up could be part of a bigger issue. The skirmish sets the stage for an intensifying battle between China and the EV maker for market dominance.

Here’s a closer look at the potential ramifications for Tesla and TSLA stock.

TSLA Stock: The ‘Terrifying’ Recall Is Just a Software Update

Tesla’s China news is pretty simple on the surface. According to China’s State Administration for Market Regulation, the cruise control system in certain Tesla models can be inadvertently activated when drivers try to shift gears or accidentally touch the gear selector. This glitch causes the vehicle to speed up unexpectedly.

Tesla filed the so-called recall plan with the regulator, which includes 35,665 imported Model 3 vehicles and 249,855 Model 3 and Model Y vehicles made in Tesla’s Gigafactory in Shanghai. All of these vehicles were produced between December 2019 and June 2021. The recall involves remote software updates which began Saturday.

Headlines aside, it’s important to look at the Tesla China news in context. At a high level, recalls are pretty common in the auto industry. Earlier this month, Tesla announced a recall of roughly 6,000 cars for loose brake caliper bolts. The news shaved about $20 billion off the valuation of TSLA stock on the day of the announcement.

But this news isn’t a recall in the truest definition of the word. None of these vehicles will have to go into a service center to be repaired. The vehicles will automatically and remotely update via software, just like any other Tesla software update. In contrast, most auto recalls relate to faulty hardware or other components and require customers to return the vehicles to the manufacturer. Some can be costly to fix, like the 2008 Takata air bag recall, which ultimately bankrupted the Japanese auto parts supplier. That recall, however, involved more than 42 million vehicles.

Let me be clear here. The news isn’t what Tesla bulls want to hear. But, the truth is, the issue is minor and it will be resolved very quickly.

A Digital Iron Curtain?

Given the innocuous nature of the issue and its update, investors should be looking deeper. Here’s an interesting fact: the recall only relates to China. That’s despite the fact that these are the same Model 3 and Y vehicles sold in the U.S. Several online forums have also questioned how meaningful an issue this is and whether it’s even possible for a driver to engage the cruise control feature by accident. The driver has to deliberately click the button. A visual and audible indicator ensues.

So, the real question is what’s really going on between Tesla and China? More importantly, the China recall sets the stage for an intensifying battle between China and Tesla for EV market dominance.

Tesla has historically been seen as a prestigious brand in China, bolstered by the popularity of Elon Musk, who has said that China’s fast-growing market will become the company’s largest. China is the site of Tesla’s only operational plant outside the U.S. And Tesla is the first foreign auto maker to operate a wholly owned plant in the country. The vehicle maker won approval for its Shanghai factory in 2018 despite the deterioration of U.S.-China trade relations under former President Donald Trump.

Tesla’s Icy Relationship With China

But despite the positive “feels,” Tesla’s relationship with China has been fraught with tension from the start. In May, Tesla announced it would not buy land next to its Shanghai plant for possible future expansion. The company has had five Chinese regulatory agencies questioning the quality of its Shanghai-made Model 3 cars. In February, Tesla was summoned by Chinese authorities citing consumer complaints about quality issues in a rare rebuke for the company (less rare now).

In March, Elon Musk had to reassure Chinese officials and consumers that Tesla cars couldn’t be used to spy on China. Sounds like the pot calling the kettle black? Tech investors might recall recent drama surrounding China’s own network equipment supplier Huawei. U.S. telecom networks banned the 5G supplier due to espionage concerns and ties with the CCP. It’s entirely possible that China’s security concerns are simply a retaliation for the Biden Administration imposing further restrictions on Huawei products being sold in the U.S.

The Bottom Line on TSLA stock

Tesla sales in China more than doubled in 2020 to nearly $6.6 billion, accounting for 21% of the company’s worldwide total. But more recently, Tesla’s challenges in China have taken a toll. Sales in China declined 27% (less than 26,000 cars) in April. The decline came as Chinese electric vehicle manufacturers such as Nio (NYSE:NIO), Xpeng (NYSE:XPEV) and Li Auto (NASDAQ:LI), have all reported improved domestic sales.

While TSLA stock has rebounded from recent lows of $550, it is still down from January highs of over $880. More recently, however, Tesla’s stock is gaining momentum. The shares are up nearly 10% in the past month, mostly on investor anticipation of strong delivery numbers. If delivery numbers outperform this quarter, the stock could see a return to early 2021 levels very easily. I continue to expect a strong Q2 for Tesla and would buy on any near-term weakness.

This news is literally a bump in a very long, $5 trillion road.

Your comments and feedback are always welcome. Let’s continue the discussion. Email me at [email protected].

On the date of publication, Joanna Makris did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Joanna Makris is a Market Analyst at InvestorPlace.com. A strategic thinker and fundamental public equity investor, Joanna leverages over 20 years of experience on Wall Street covering various segments of the Technology, Media, and Telecom sectors at several global investment banks, including Mizuho Securities and Canaccord Genuity.

Article By Joanna Makris, InvestorPlace