BYD: Risky Now, Value Later

Warren Buffet made the first purchase outside the US in BYD Co (BYDDF.PK). Buffet purchased $232 million in the company. In addition, Volkswagen AG (VLKAY.PK) is planning to partner with BYD to produce hybrid and battery-powered vehicles. Volkswagen recognized that hybrids and electric vehicles are the future in the auto industry, especially when foreign automakers want to enter into Chinese market. Wang Chuanfu, Chairman of BYD confirmed that he has hold talks with Europe and US carmakers about supplying batteries.

Background

BYD was established in 1995 and is based in Shenzhen, China. The company is also listed in Hong Kong (HK: 1211). The company started out manufacturing batteries several years ago. Now, the company has become the world’s largest producer of rechargeable batteries for cellular phones. BYD has seven production facilities throughout China.

Buffett

The company became known to the world last fall when Warren Buffet (BRK.A) invested $230 million for about 10% ownership in the company. The main asset of the company is the development of green automotive technologies, including lithium-ion batteries and the related hybrid and all-electric vehicles. The most interesting is that the BYD electric car technology has not been proven yet, and Warren Buffet is taking an unusual risk investing in the company without a track record.

The company is planning to introduce its first green cars in China before the end of this year, and plan to get into the U.S. and European markets in 2010. Furthermore, BYD is getting into notebook batteries beyond the cell phone markets.

Risks

What is the risk? Of course, as mentioned above, the all-electric vehicle technologies have not been proven yet. Both the batteries and the vehicles have not been in mass production before. So, no one knows what kind of barriers BYD will encounter. This is the reason the investment community is surprised by Warren Buffet’s investment in the company with such high risk even the company has huge growth potential. We still don’t know whether BYD can actually manufacture vehicles that can meet the safety and reliability standard of the developed countries.

Today BYD is trading around $4 with double the average volume of around 320,000 shares (Yahoo finance). There is no doubt the endorsement by Warren Buffet has attracted many investors. The stock has a 52-week range from $1.70 to $5.25. If you decide to invest in the stock, make sure to use limited order since the trading volume is low.

Future value

I am not providing BYD’s past earnings and revenue figures since they are basically irrelevant to its future potential. Some investors may argue that the news already reflected in BYD stock price, especially at the current $4 per share, which is substantially higher than its 52-week low of $1.70. I am not totally convinced that all the potential growth has been incorporated in the stock price. Remember, if you are buying stocks in BYD, you are investing in the hybrid and all-electric vehicles growth story with substantial risk in unproven technologies. So, many more conservative investors would not buy the stock now until the growth story is proven. Thus, I believe the stock has substantial more upside when the vehicle has proven sales and has good review by the auto industry.

Until then, I believe the current investors are risk-takers and will reap higher rewards in the future. Obviously, Warren Buffet has considered all the risks involved before making such investment. Some investors argued that Warren Buffet is small relative to his portfolio so the loss is not significant affected his performance. However, I don’t agree. Investors don’t buy stocks planning to loss money no matter they can afford to loss or not. You always want to invest in companies with large potential and high probability to succeed.

Disclosure: Long position

Comments

[Old Rick:]

If this interests you, there is a great article in a recent issue of Fortune magazine that details Warren's investment in BYD. (online at money.cnn.com/2009/04/...) Apparently BRK wanted to buy a 25% stake, but the CEO would not let go of that much. Buffet sent David Sokol (MidAmerica) to China to look BYD over and he was thoroughly impressed. The story is a good read.

Jun 10 08:54 AM

[John Petersen:]

I recently pulled BYD’s annual report and was able to calculate the following valuation metrics for the Buffet purchase:

Price/Earnings – 12.3
Price/Book – 1.18
Price/Sales – 0.6

Buffet's effective price per share was in the $1.12 range. Since BYD is now trading north of $4.00 (presumably from the Buffet halo effect) the market valuation metrics for investors are nowhere near as attractive as they were for Warren.

Jun 10 09:14 AM

[James Kar:]

Old Rick: thank you for the reference. It is a good article.

John Petersen, as you know, BYD stock price goes up so much because of the exposure brought by Warren Buffet. He got in before others so Buffet deserved higher return. Furthermore, the earlier you get in, the more risk you are taking. So, I am not surprised to me that Buffet got in at a lower price with higher return potentially. My philosophy is this: since I cannot buy stocks at the bottom, I just evaluate the risk/reward based on the current price. Just like the current stock market situation, if you use the March low as a reference point, a lot of stocks have gone up over 100%. But it does not mean they won't go higher. But of course, we have to evaluate the risk/reward more carefully, and every investor should evaluate each investment according to their own risk/reward profile.

Jun 10 11:25 AM

[Wesley tryi...:]

From what I've gathered in their annual report Buffet bought 225 million shares for 230 million dollars. Thats a $1.02 a share. From what I understand over the last 5 years they have averaged .51 RMB (Chinese Yuan) EPS. Thats about 6.5 cents per share a year. At 4 bucks a share thats a little high for me. The most they have made in the past 5 years was about 10 cents a share in 2007. I actually bought about a $1000 worth at $1.85 and wished I would have put a lot more in at that time. I am waiting for the shares to come down to the 2-3 dollar range, but given their growth potential and their seemingly high popularity I may or may not get that. The shares were as high as $9 in late 07 which is just ridiculous and so is $4 and $5 right now i think. If you have 5 or 6 years to wait it out, you'll probably do well at this price. Buffet bought this for his MidAmerican Energy company so that they can test their batteries for backup power on their Solar and Wind Energy projects and because Wang Chuanfu is just an amazing CEO. I want to be more like Buffet and invest in well run businesses with plenty of growth potential, but I don't want to over pay for that.

Jun 10 12:52 PM

[RogerScott:]

BYD is not the first foreign purchase. There is POSCO, Tesco and Iscar. BRK use to own a large share of Petro China.

Jun 10 03:05 PM

[owlafaye:]

BYD's lithium ion battery technology is already outdated. Getting the car out pronto is a good move because it will be followed shortly by dozens of others. That is when BYD will need improved battery technology to offer. More expense down the road, much much more.

Jun 10 07:18 PM

[buddhabill:]

Well, as Tesla is finding out there is a lot more to manufacturing automobiles than first meets the eye. The bar for quality has been set very high by the Japanese, and now Korean and of course the new Ford for durability, and BYD as well as Tata will need to convince the buying public of their quality as a durable good. Well, maybe not Tata with a $3000 car.

That all said, BYD seems like one to keep an eye on, buy on dips. And believe me there will be a huge freakin' dip in Japanese, American and European auto makers as new sales continue to drop as consumer credit (or the willingness of consumers to take on more debt) gets more challenged.

A long BYD/short TM (Toyota) pair would be interesting...

Jun 29 03:59 PM

[Stockpirate:]

After reading about BYD in various articles via magazines and websites...my intuition told me to invest in this company so I purchased about $40,000 in stock in May and more in June. I really believe BYD has huge growth potential in the future! To me it is one of those Microsoft, Walmart or MacDonald stories. Ya know...."if only I had bought shares in that company many years ago..."

Jul 16 11:15 AM