Days Are Numbered for BYD After a Tough October (10-23-11)

A poor October for China's auto market and a growing appetite for domestic 

M&A may spell the end for Warren Buffett favorite BYD Autos.

Hard Times

The October numbers are in and they don’t look good. Last week, the China Association of Automobile Manufacturers (CAAM) released the auto sale and production figures for the month of October. China’s auto sales are down 7.37% relative to September 2011 and are showing a 1.07% drop YoY. Production, too, has fallen 1.99% relative to September figures. This is a first for China and a major shock for the industry. Since China’s State Information Center started recording the statistic in 2000, China has never before reported negative growth in October auto sales.

In April 2010, Chinese consulting firm AlixPartners released a survey in which 50 auto industry executives stated their expectation that China’s auto sales would continue to grow by 20% per annum over the next five years. This may have been a safe statement to make in 2010 when auto sales for January-October were up 35.03% relative to the same period in the previous year, but 2011 has shown only 3.47% growth over this period.

These plummeting figures are a shock for a number of China’s small domestic auto manufacturers, many of which have already been struggling to stay alive in an overcrowded and highly competitive industrial landscape. China’s auto industry is renowned as being the most dispersed in the world. According to the October figures reported by CAAM, China’s top 5 sedan manufacturers represented less than 44% of the month’s sedan sales. Not a single one of these five firms are indigenous to China. Indeed, in the list of China’s top ten firms ranked according to sedan sales for October, only two names (Chery and Geely) are domestic. The other eight companies are made up of joint enterprises in which Chinese members own a mere 51% stake.

Recognizing the need for stronger domestic players in the industry, the Chinese government has chummed the waters with a series of policies encouraging domestic mergers and acquisitions. The party has publically stated its goal to reduce major market players from 14 in 2010 to less than 10 by next year. When the music stops, a number of firms are going to loose their seats for good, and investors are lining up to make bets on who’s going to get the chop.

Warren Buffett’s Big Bet

In 2008, Chinese automaker Build Your Dreams (BYD) looked like a sound investment. Despite its obvious theft of auto designs from Hyundai and Toyota, BYD claimed a level of technological maturity that other Chinese firms had yet to achieve. Originally the world’s largest manufacturer of cell phone batteries, BYD has since set its sights on leading the world to a future of plug-in hybrids fueled by lithium-ion batteries. The proposition was so exciting, in fact, that Warren Buffett put USD 232 million into purchasing a 9.9% stake in the company.  

Electric plug-ins may have been a hot promise in 2008, but since this transaction took place, the company has yet to sell even 500 units of plug-in autos. The Joint Research Center of the European Commission reported in a document released in June 2010 that pure electric cars will “remain very limited until at least 2020” and that major barriers for large-scale market development will remain in place up to 2030.

Despite this lukewarm outlook for new energy autos in the short term, BYD has initiated a series of long-term investments in industrial parks all over China aimed at increasing its stake in solar cells, electric cars and recharging stations. This expansion is a big risk, and BYD is relying on auto revenues and government support to keep the company afloat until the investments mature. This aggressive expansion into new energy led to a spike in fixed asset investment, boosting the value of its fixed assets and plants under construction by nearly RMB 10 billion in 2010 – an increase of 51.32% YoY.

Build Your Nightmare

Many investors now fear that BYD chairman Chuanfu Wang has grown reckless after years of gorging himself on the government punch. In 2008, 2009 and 2010, government subsidies paid 12%, 10% and 28%, respectively, of the company’s reported annual net profits. Additional revenues came from government contracts placing orders for hundreds of e-buses and electric taxis for Chinese cities.

Even with the government boosting BYD’s books, the fact remains that recent investments were made under the presupposition that sales and profits would continue to trend upwards for years to come. On August 22, BYD released a report stating that auto sales for H1 2011 only reached 225,800 units, down 22% from H1 2010. Profits over the same period took a nosedive to the tune of 88.6%. Paired with this report was an announcement that BYD would be significantly reducing its auto sales staff from 2,600 employees to just 800. Employees pushed back, and 50 days later management was forced to enter labor negotiations under threat of government intervention.

With sales and profits sharply dropping and capital tied up in long-term investments in new energy, BYD’s liquidity and quick ratios have dropped far below those of industry competitors to values of just 0.63 and 0.4, respectively. New reports say that the company is paying off its mature bank loans with borrowed money. With the People’s Bank trending towards tighter monetary policies, BYD has been having an increasingly more difficult time getting access to new loans to pay off old debts.

BYD’s existing capital is tied up with local governments in unbreakable industrial park development contracts. Its profits are tanking as auto sales plummet. The company is also losing access to new loans to pay off its old debts. China has stated that at least three of its major auto firms will not survive past 2012. Somewhere, Warren Buffett is starting to sweat.

 "If I have seen a little further it is by standing on the shoulders of Giants."

- Isaac Newton

Chris Lowder is the Director of Marketing Services at China Monitor. For more insights from China Monitor and the China Economic Information Network (中国经济信息网), please visit our website at www.chinamonitorisg.com