Car Maker BYD's Health Faces Skeptics

The Wall Street Journal, September 26, 2012

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By COLUM MURPHY in Shanghai and JOANNE CHIU in Hong Kong

Chinese auto maker BYD Co. —investor Warren Buffett's highest-profile China investment—is facing renewed questions about its future as investors grow increasingly skeptical of its core businesses' prospects.

BYD shares traded in Hong Kong have fallen 13% over the past two days after brokerage CLSA slashed its target price for the stock, citing weakness in the company's mobile-phone-component, rechargeable-battery and "new energy" businesses. "BYD is likely in worse shape than we thought," analysts Scott Laprise and George Yang wrote in a research note.

CLSA's target price is 41 Hong Kong cents (13 U.S. cents), compared with the eight Hong Kong dollars (US$1.03 ) a share that MidAmerican Energy Holdings Co., a unit of Mr. Buffett's Berkshire Hathaway Inc., paid for its close to 10% stake in BYD in 2008. On Wednesday, BYD's shares closed at HK$13.26.

At the heart of BYD's problems is the company's weak performance in China's increasingly competitive market for conventional cars, a core revenue source. BYD also hasn't delivered on its mission to ride an intended Chinese push into electric vehicles, which is taking longer than expected to materialize as the government's implementation plan falls behind schedule.

The company eked out a profit of 16.27 million yuan ($2.58 million) in the first half of this year, down 94% from the same period a year earlier.

"BYD has been and continues to be profitable. Now it's not the same profit levels we have all been all accustomed to, but we are on track to get back to that spot," said company spokesman Micheal Austin.

BYD will re-emphasize quality in its vehicles as well as focus on new electric vehicles it is designing along with Daimler AG of Germany, he said. "We got ahead of ourselves," Mr. Austin said. "It's time to slow down and redirect to the principles we were founded upon."

Bill Russo, founder and president of auto consulting firm Synergistics Ltd. and a former Chrysler executive, said he believes BYD needs to be restructured. "As a maker of conventionally powered vehicles, BYD does not have what appears to be a very strong case for its continuation," he said.

The company's debt totaled 18.04 billion yuan as of June, slightly less than the 18.42 billion yuan at the end of 2011. Its cash and cash equivalents totaled 4.83 billion yuan at the end of June. Of total debt, about half is repayable in one year.

Industry officials said BYD is at little risk of insolvency because Chinese officials and banks often prop up major companies, and it enjoys the backing of major state-run banks. But its finance costs nearly tripled last year, and its weakened share price gives it less room to go to equity markets for the money it might need to overhaul its operations.

BYD's first-half vehicle sales fell 9% compared with a year earlier, to just under 199,700 vehicles. Electric cars, including electric taxis, accounted for only a few hundred.

China's auto industry has been plagued by high inventories, overcapacity and fierce price competition. The economic slowdown and higher oil prices also contribute to a much tougher environment for car makers. Still, revenue from BYD's auto division was up modestly, suggesting that the company has managed to increase sales of higher-priced models.

BYD is also striving to rebuild its distribution network after an exodus of dealers. According to Macquarie Securities, 308 dealers left the network last year, representing about 20% of BYD's total dealerships.

One of the company's major weaknesses is a lack of a foreign partner, analysts say. Chinese auto makers allied with big global car makers such as General Motors Co. and Volkswagen AG have posted stronger sales results than many of their unaligned rivals. "The better foreign auto makers are already dancing with someone. It's kind of hard to get married up now," Mr. Russo said.

BYD points to its new joint venture with Daimler, in which it is providing battery and other electric-vehicle technology. "The JV with Daimler has completely changed the way BYD thinks about the design process," Mr. Austin said.

A spokesman for Daimler said the joint venture was for the sole purpose of developing an electric passenger vehicle in China. "We are currently focused on the Chinese market only," he said.

Electric cars won't be a quick fix. In 2011, only 6,000 electric vehicles were sold in China, well behind the official target of half a million, according to a report by consulting firm McKinsey & Co. China has failed to build a support network as quickly as planned. More than 400,000 charging piles were to be in place in 2015, yet only 16,000—or under 5%—had been built as of last year, McKinsey said.