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TheStreet Open House

Tesla's Reputation Is On the Line (Update 2)

Updated from 10:16 a.m. EST to provide analyst comments in the fifth paragraph.

NEW YORK (TheStreet) -- The ride in Tesla Motors (TSLA - Get Report) has been pretty bumpy over the past few months but as news hit of a probe and potential recall of the Model S, that ride, unlike driving the car itself, is about to get a lot bumpier.

The National Highway Traffic Administration (NHTSA) is opening a probe into two fires that have happened on American soil as concerns about the safety of the Model S have crept up in recent weeks.  Shares were hit on the news of the probe, which Tesla and CEO Elon Musk asked for, falling 1.4% to $119.90.

Bloomberg reported the NHTSA administrator was unaware of a request from Tesla requesting the investigation. Tesla spokeswoman Liz Jarvis-Shean noted that Jim Chen, Tesla's vice president of regulatory affairs, requested the probe while having a call with the staff of the NHTSA, the same day the agency ordered the inquiry.

"The resulting impact damage to the propulsion battery tray (baseplate) initiated thermal runaway," the NHTSA wrote in its investigation letter. "In each incident, the vehicle's battery monitoring system provided escalating visible and audible warnings, allowing the driver to execute a controlled stop and exit the vehicle before the battery emitted smoke and fire. Based on these incidents, NHTSA is opening this preliminary evaluation to examine the potential risks associated with undercarriage strikes on model year 2013 Tesla Model S vehicles."

Jack R. Nerad, executive editor and market analyst at Kelley Blue Book, noted it could be a huge blow if there's a recall for the Model S. "An official inquiry into Tesla Model S fires is a blow to Tesla Motors, which has touted the vehicle as the safest car in the world," Nerad said in an email. "This inquiry doesn't mean there will be a safety recall, but if there were a recall, it would be an even larger blow to the innovative automaker."

In late October, the NHTSA had said it was investigating the fires but no decision was made on a probe.

Tesla has received incredible amounts of positive press because of the Model S, which has sold more than 20,000 units around the world. Consumer Reports gave it its highest ever rating, while Motor Trend awarded the Model S its 2013 car of the year.  Even the NHTSA awarded the Model S its highest ever safety rating.

Earlier this year, I reviewed the Model S, noting that although "the car is incredibly quick, hitting full torque instantly, it's built like a tank. The Model S feels very safe and well-built."

Tesla is taking several actions to prove the safety of its Model S.  In a blog post to the company's Web site, Musk said Tesla has "rolled out an over-the-air update to the air suspension that will result in greater ground clearance at highway speeds." He noted this is about reducing the chances of underbody impact damage, not improving safety, as Musk, and others have repeatedly said the Model S is the safest car on the road. "Another software update expected in January will give the driver direct control of the air suspension ride height transitions," Musk said.

In the post, Musk said, "It is literally impossible for another car to have a better safety track record, as it would have to possess mystical powers of healing."

In addition to the update to the air suspension, and the probe which Tesla has asked for, Tesla said that if anything is found during the probe that would "would result in a material improvement in occupant fire safety, we will immediately apply that change to new cars and offer it as a free retrofit to all existing cars."

Musk noted that the probe is largely being done to help perception about the safety of electric cars, despite the fact there are an average of 152,000 vehicle fires per year from internal combustion engines (ICE) every year, according to the NHTSA.

Lastly, Tesla said it would amend its warranty policy to cover damage due to fire, even if caused by driver error, which previously was not available. "Either our belief in the safety of our car is correct and this is a minor cost or we are wrong, in which case the right thing is for Tesla to bear the cost rather than the car buyer," Musk wrote in the blog post.

The fires, although limited to just three, have done more to affect the company's stock price than the perception surrounding the car, with the latest owner, Dr. Juris Shibayama, saying he "would buy another one in a heartbeat." Since the stock hit a high of $194.50 on Sept. 30, shares have lost approximately 40% since but are still up more than 200% year to date.

Some of that loss stems from a sharp sell-off in the stock following Tesla's third-quarter earnings, as the company noted it is supply constrained, not demand constrained, as it expects to deliver only slightly under 6,000 Model S units during the fourth quarter. For the third quarter, Tesla earned 12 cents a share on $603 million in revenue; the company delivered 5,500 Model S units during the quarter.

The second fire resulted in a downgrade from Merrill Lynch analyst John Lovallo, who noted "meaningful execution challenges remain," including the company's ability to handle the bad public relations surrounding the fires.

Shares of Tesla have certainly been on a wild ride in the past few months, with Musk even saying the share price was "more than we have any right to deserve." News of the probe and the uncertainty surrounding are likely to continue to weigh on the stock until a decision is made, or not made, to recall the Model S.

Earlier this year, I raised the idea that it was time to take profits on the name, with comments from Musk being a red flag.

With the recent drop in shares, the probe and a potential recall of the Model S, negative sentiment surrounding Tesla may shift as great as the positive sentiment surrounding the stock and the company was before it.

The probe will continue to weigh on shares of Tesla over the coming weeks, until a decision is made, which may not happen for months.  So far, Tesla has been able to weather the storm of bad public relations for the Model S fires, but a probe and potential recall of the Model S is different. It's putting the company's reputation on the line, given how confident and persistent Musk and his team have been on the safety of the car, and electric vehicles in general.

Musk made a rather curious tweet, concerning the supersized media coverage of the fires.

I noted to him there were three reasons for that:

Musk's bravado, showmanship and sense of aura about him have helped the stock, while the Model S has sold itself. If a recall ultimately does happen, shares of Tesla may have to lighten up on the accelerator.

--Written by Chris Ciaccia in New York

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