Analysis - How the Merged SpaceX-Tesla Will Address Its China Issues

Reuters, October 22 - Elon Musk plans to carry out a major merger between Tesla TSLA.O and Space Exploration Technologies SPCX.O (link), but these plans are likely to face China-related obstacles from regulators on both sides of the Pacific over national security and concerns regarding data and technology sharing.

The world’s richest man said on Tuesday that his two companies (link) have established a special committee to discuss the merger, calling it a "good idea." However, for this vision to become reality, it will be necessary to properly handle the difficult contradiction between Tesla’s heavy reliance on Chinese manufacturing and SpaceX’s defense business.

Rocket company SpaceX is increasingly dependent on sensitive US government and defense contracts, which means any merger involving Tesla’s China operations would be subject to strict scrutiny on national security grounds.

Chinese regulators also require Tesla to keep all user data collected by its autonomous driving system strictly within China, and any firewall must prevent the flow of information or technology between the two sides.

Below are some measures that Musk and his companies might take to remove obstacles set by Washington or Beijing.

Can Tesla retain its China operations?

One possible solution is for the merged company to establish a firewall around Tesla’s China business, preventing SpaceX and other business units from accessing sensitive data. Daniel Kollar, head of automotive and mobility at consulting firm Intralink Group, said such measures are not unprecedented.

He cited Airbus (AIR.PA) and Honeywell (HON.O) as examples, pointing out that many companies are able to operate in China while also running important defense businesses outside the country.

SpaceX’s defense-related business includes the "Starshield" project, which develops military and intelligence satellite systems for the Pentagon.

Analysts note that mutual firewalls are likely to be the minimum requirement for ensuring that Tesla driver data in China remains within the country. Since 2021, Tesla has abided by Beijing’s demand to keep all driver data within China’s borders.

Michael Dunne, CEO of automotive consultancy Dunne Insights, which closely tracks the Chinese auto industry, said Tesla could continue to operate in China for several more years as an independent entity with its own R&D capabilities, strictly adhering to agreements to retain all data within China.

However, Christopher Tang, professor at UCLA Anderson School of Management and global supply chain expert, pointed out that satisfying both Beijing and Washington with such a "firewall" might not be easy. He said the Chinese government is very likely to try to use any proposed merger as leverage during negotiations, attaching various conditions to approval.

"China will use this as a bargaining chip," Professor Tang said. "At the moment, they have the upper hand in negotiations."

Ioannis Kokkoris, Professor of Competition Law and Economics at Queen Mary University of London, pointed out that China may seek two main concessions: Chinese firms gaining access to strategically significant technologies, and a commitment to retain manufacturing capacity and investments within China.

However, any demand to share sensitive technologies related to SpaceX would directly run up against US security restrictions.

About divestment?

Analysts say there are three main paths to asset divestment: spinning off the China business while Tesla retains a majority economic stake, selling with a long-term brand licensing agreement, or direct sale (possibly to another automaker).

Any kind of divestment will entail a host of complicated issues, including the imminent question of "who would acquire the asset." Li Yanwei, an analyst at the China Automobile Dealers Association, said Chinese automakers don’t need extra production capacity and are unlikely to be interested.

On the other hand, many foreign automakers are currently financially constrained and therefore also unlikely to be buyers. Kollar said Musk is more likely to split off and sell the China business rather than cede control to others.

But Kollar added that unless Musk intends to signal an exit from the car business, he expects Tesla will try to retain its China business under the current ownership structure.

Tesla China and China’s State Administration for Market Regulation did not respond to requests for comment.

China remains indispensable for cash flow

Completely exiting the Chinese market may not be easy. According to Zhang Ye (phonetic), managing director of Shanghai-based consultancy AutoForesight, Chinese suppliers are deeply integrated into Musk’s business empire, and Tesla’s Shanghai plant accounts for more than 50% of its global output.

Still, some investors say these considerations are not enough to prevent a deal from going through.

Brian Mulberry, chief market strategist at Zacks Investment Management—which invests in both Tesla and SpaceX—said Tesla's manufacturing base in China is substantial, but the EV maker is already expanding its capacity in the US, especially for humanoid robots and "Cybercab" autonomous vehicles, and many investors are now more focused on Musk’s promise for the future development of these projects.

Mulberry also said he expects Tesla will argue to US regulators that its China business will not overlap with SpaceX, but if it fails to persuade, he believes Tesla might close or downsize its Chinese manufacturing operations.

"The impact in the near term is limited, and the scale is small enough to be manageable," he said.

UCLA’s Professor Tang pointed out that despite Tesla’s future prospects possibly lying outside China, its current electric vehicle business is highly dependent on the Chinese market. Most of the cash needed to fund future investments is generated from building EVs in China, he said.

"That’s exactly why China will seize this opportunity," Tang said, "because you still need them."

(To facilitate non-native English speakers, Reuters has automatically translated its report into several other languages. Because automated translation may be inaccurate or may not contain needed context, Reuters does not guarantee the accuracy of the automated translation, which is provided solely for convenience. Reuters assumes no responsibility for any harm or loss arising from the use of the automated translation feature.)