Aug 4 (Reuters) - Tesla's electric vehicle business in China looms as a key hurdle to a potential merger between Elon Musk's automaker and SpaceX because of complications it could pose for the space firm's business with the U.S. government.
The prospect of a merger between the companies, each valued at more than $1 trillion, has tantalized investors and analysts in recent months, particularly during SpaceX's record $75 billion initial public offering process in June.
Musk fanned the flames on Tesla's
earnings call last month when he cited growing overlap between the companies. The Wall Street Journal last week reported the automaker's executives had been told to prepare for a separation of its China business ahead of a potential merger.
The billionaire denied the report, saying such a separation had "never even come up in a discussion."
Still, analysts and investors say Tesla's China business could complicate any deal by uniting a company that depends heavily on China for manufacturing and sales with another increasingly reliant on sensitive U.S. government and defense contracts.
SpaceX drew about a fifth of its 2025 revenue from U.S. federal agencies, according to its IPO filing. That reliance on government work could subject any merger involving Tesla's China operations to intense national security scrutiny.
Musk may face more questions about a possible merger when SpaceX holds an earnings call on Tuesday.
POSSIBLE PATHS
Morningstar analyst Seth Goldstein said he sees three broad paths if Tesla were to separate its China business: a spinoff in which Tesla retains a majority economic interest, a sale paired with long-term brand licensing agreements, or an outright sale, possibly to another automaker.
Any of them, he said, could ease the regulatory scrutiny a merger would face in both Washington and Beijing.
Cleaving off Tesla's operations in China could "clear the way for a cleaner merger domestically" in the U.S., said Brian Mulberry, chief market strategist at Zacks Investment Management, a Tesla investor.
But that could pose governance challenges in China, where Tesla's Shanghai Gigafactory is the automaker's largest and most productive plant, serving as a main export hub for Europe, Canada and the Asia-Pacific region and historically accounting for more than half of its global deliveries.
China has previously granted Tesla preferential treatment, including a reduced corporate tax rate between 2019 and 2023, underscoring leverage the government could have over any restructuring.
A standalone Chinese entity would need buy-in from Chinese Communist Party leaders, who Mulberry said are "more than likely to require" a seat on the board of directors and would potentially install allies in executive positions.
The mechanics of a spinoff also carry other complications, said Shawn Campbell, a Tesla investor and adviser at Camelthorn Investments — starting with where the stock would be listed.
A Hong Kong listing would probably be palatable to most investors, he said, but a mainland China listing would raise ownership and governance concerns for foreign shareholders. "I would immediately sell any Chinese shares in the event of a spinoff," Campbell said.
UNTANGLING TIES
On paper, Tesla's China operations may look easier to separate than its businesses elsewhere because much of the manufacturing infrastructure is already self-contained.
But the real challenge, said Bill Russo, founder of Shanghai consultancy Automobility, would be untangling more complex ties such as shared software, intellectual property, AI systems, data governance and supply chains. A newly formed China entity could enter into long-term licensing agreements to use Tesla's brand and technology, Russo said, but that could make it difficult to maintain product consistency across markets.
A licensing deal could carry regulatory risk of its own: ongoing technology transfers, such as software upgrades for self-driving, to a Chinese entity could run afoul of U.S. rules, said Christopher Tang, a professor at UCLA's Anderson School of Management who specializes in global supply chains.
The stakes go beyond compliance. Most investors value Tesla for Musk's promises in self-driving and robotics, but the core auto business still funds those ventures — and China remains central to vehicle sales.
One investor in both Tesla and SpaceX, who declined to be identified, said separating China would leave Tesla without manufacturing capacity at comparable scale elsewhere. "Where are they going to make the cars?"
Others do not see that as a strategic problem.
Steve Greenfield, founder of U.S. venture capital firm Automotive Ventures, said Tesla could still choose to separate from its China business because it is not central to Musk's vision of the company as a robotics and autonomous-driving juggernaut.
"Tesla isn't really valued on the auto business anyway," Greenfield said. "If their ultimate goal is to be acquired by SpaceX and, within five or 10 years, move from vehicles to humanoid robotics, they may care less about the short-term brand implications" of exiting China, he said.
(Reporting by Chris Kirkham in Los Angeles and Ju-min Park in Beijing; Additional reporting by Akash Sriram in Bengaluru and Echo Wang in New York; Editing by Mike Colias, Peter Henderson and Jamie Freed)
