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Why BYD won't Rust (at least Buffett Thinks so)

For the fifth year running, Fortune China has published its “25 Most Influential Business Leaders in China 2008” list, the feature article in the April issue. As in the past, selection was based on “leading executives influential within their corporation and industry, and capable of changing things on a wide scale,” both in China and internationally, said the syndicate.

A sign of the times, the 2008 list pays notice to executives promoting an environmental, social, and governance (NASDAQ:ESG) corporate culture in China more than in years past. Chief among the leaders in this category was publicly traded solar panel manufacturer Suntech’s (STP) SHI Zhengrong and rechargeable battery-cum-electric automaker BYD’s (HKSE:1211) Chairman WANG Chuanfu.

UK daily Times Online likewise included WANG Chuanfu and his cousin and co-founder, LU Xiangyang, as top "eco-barons lead[ing] the way" on their published Green Rich List. Known for his gumption and leadership of a company with big green ambitions, it is no great surprise that Fortune and the Times have singled Wang out as an executive to watch. But does his company, BYD, exhibit equal promise from an investment point of view?

Focus on BYD

With a CEO who likes to carve out an egde in the market, BYD is a company with big ambitions. Until recently, BYD was known as a battery maker. It supplies the big cell phone companies – Nokia (NOK), Motorola (MOT), Samsung, and Sony Ericsson – with more batteries than any of its competitors; and has scooped up contracts to supply iPod and iPhone batteries, rising to the top of its class. In January of this year, BYD entered a new league, stepping up its proposition substantially by unveiling a Chinese contender in the electric vehicle market: the F3DM (DM stands for “dual mode”).

BYD’s story begins like most tales of Asian ingenuity. The company’s founder, Wang Chuanfu, set out in 1995 to build a cheaper alternative to Japanese and South Korean batteries. He spent a decade engineering a better battery (and succesfully fighting off copyright infringement suits from his competitors) to emerge as the world's second-biggest producer of lithium-ion batteries.

In 2003, Wang bought a bankrupt Chinese state-owned car company. Though he knew little about cars, he set out to be the best in his field and – as with batteries – succeeded. Last year, the BYD F3 sedan was the bestselling sedan in China, beating out previous cars of the people: Volkswagon Jetta and Toyota Corolla.
Over the past years, Wang has grown revenues by roughly 45% annually. 2008 revenues reached $4 billion in 2008.

Each of BYD's business units - batteries, mobile-phone components, and autos - was profitable in 2008, though not immensely so. Overall, net profits reached roughly US$187 million. BYD, which is traded on the Hong Kong exchange, has a market value of about US$3.8 billion. Though that number is below Ford’s (F) market value – which stood at US$7 billion in early April – it’s higher than General Motors (GM) US$1.3 billion.

So far this year, BYD has had record sales - selling 32,087 vehicles in March (a 35% increase from February sales), which made it the best-selling domestic automaker in China. That same month, BYD enjoyed 231% year-on-year growth.

A Look at F3DM

BYD’s electric hybrid model, F3DM, has most of the whistles and bells needed to make it a major contender in the EV market. Equipped with a 1-liter back-up gasoline engine, the F3DM is capable of being charged using a simple home electrical outlet. It can last 62 miles on a single battery charge, or 360 miles in hybrid mode, which compares favorably with the all-electric 40 mile range of the Chevrolet Volt.

The car uses a proprietary lithium-iron-phosphate battery (liFePO4) that has a 600,000 km, or roughly 10 year, lifespan. Wang says the battery is safer than the lithium-ion models, which have not penetrated the market considerably on account of their relatively high price, limited durability and safety concerns.

Finally, the F3DM comes in much cheaper than its competitors. Whereas a Prius will set you back at least US$36,500, Wang expects to price the F3DM at around US$22,000. The Chevrolet Volt is likely to be priced at around US$40,000 when it hits the market in late 2010.

How does BYD's Wang do it?

Cost Advantage
 
Unlike most automakers, Mr. Wang is not ashamed of his labor-intensive carmaking style. He has publicly stated that BYD’s advantage stems from his choice to replace some of the automated steps of the manufacturing process with inexpensive Chinese labor. Today BYD’s 11 factories (eight are in China, and the other three in India, Hungary, and Romania) employ a workforce of 130,000 people.

 

Every BYD Battery Has a Green Lining

BYD is beginning to emerge as a leader in sustainability, one of few Chinese companies to seriously consider how to integrate environmental best practices into their supply chain. One case in point is Wang’s quest to produce a battery that is 100% recyclable. So far, BYD has developed a nontoxic electroyle fluid, which Wang has proven safe by personally drinking it.

While other manufacturers in China have seized environmental opportunities without embracing the principles of corporate responsibility – reports found last year that a polysilicon supplier to China’s top PV panel maker, Suntech, was dumping toxic biproduct directly into Chinese waterways – Wang is clear in his determination to avoid making environmental technologies that create new environmental problems.

Warren Buffett is Convinced

Last September, Warren Buffett bought a 10% share of BYD to the tune of US$230 million. He had tried to obtain 25% stock in the company, but was denied by Wang, who saw the Berkshire Hathaway association as a way to build the brand and get a foot in the door in US markets, but did not want to let go of too much of his own company. Buffett has said it “was a good sign” that Wang “didn't want to sell his company."

Buffett and his partners have been practically oozing with admiration for Wang and BYD. Berkshire Hathaway (BRKB) partner Charlie Munger told Fortune that Wang “is a combination of Thomas Edison and Jack Welch - something like Edison in solving technical problems, and something like Welch in getting done what he needs to do. I have never seen anything like it." Believing that BYD has a shot of becoming the world’s largest electric automaker demonstrates an investor confidence in BYD that cannot be shaken.

Barriers to Growth

Despite BYD’s promising position, the company still faces considerable hurdles in domestic and foreign markets. First, China’s lacking battery-charging network is a market barrier for individual car buyers. That may soon change, however, as Beijing has already ordered the state electricity grid to build charging station infrastructure in Beijing, Shanghai, and Tianjin. Second, while F3DM’s sticker price is below its competitors, it’s still well above what even middle class Chinese can afford. 

Finally, China’s car industry – with BYD as no exception – has heretofore captured only a limited slice of foreign markets on account of lacking quality. So far, BYD’s vehicles have been exported primarily to Latin American and Southeast Asia, whose fuel emissions and safety standards are less stringent than the EU and the US. However, Wang signed an agreement in 2008 with Dutch dealer Autobinck, to distribute its cars in the Netherlands and Eastern Europe.

Diversified Revenue Stream

Wang remains undeterred by these obstacles, perhaps because he is confident that BYD can remain competitive even if it’s hybrid electric model cannot. His contingency plan centers around maximizing sales of what he knows best: batteries.

On March 31, WSJ reported that BYD is in talks to supply its batteries to car companies in Europe and the US. Wang revealed that the discussants include one US and two EU automakers, but refused to identify the companies by name.

Market Advantage

China has surpassed Germany and Japan to become the world’s second largest car market. But with over 100 domestic carmakers, BYD faces steep competition. That could soon change, as new policies (both already in place and in the works) aimed at increasing EV market penetration create a market advantage for producers like BYD.

Beijing hopes to raise annual hybrid and all-electric vehicle production to 500,000 by 2011. In order help EV manufacturers more competitive, the Chinese government has earmarked US$1.5 billion in funding for development and deployment of EV technologies, much of which will be given directly to automakers like BYD.

On the consumer side, the government has pledged nearly US$9,000 in subsidies for hybrid or all-electric vehicle purchases by fleet owners, such as taxi companies and government agencies, in 13 major cities, in order to create a domestic market for EVs.
 

 

While Wang is not the only luminary capturing the media's attention, as Fortune China's "25 Most Business Leaders in China 2008", listed in full, below, illustrates, BYD's success so far proves he is doing something right, and will likely continue to impress onlookers.

 

  NAME                
COMPANY CODE      
TITLE AGE INDUSTRY OWNERSHIP
1 REN Zhengfei Huawei -- Founder 65 Telecom Private
2 YU Liang Vanke
 
SZ:000002 CEO 44 Real Estate Private
3 DONG Mingzhu Gree SZ:000651 General Manager 55 Home Appliance SOE
4 YANG Yuanqing Lenovo SEHK:0992 CEO 45 Computing Public
5 MA Weihua China Merchants Bank SEHK:3968 President 59 Banking Public
6 HOU Weigui ZTE SEHK:0763 Chairman 67 Telecom Public
7 WANG Jianzhou China Mobile NYSE:CHL, SEHK:0941 Chairman & CEO 60 Telecom SOE
8 ZHANG Jindong Suning SZ:002024 Chairman 46

Electrical appliance retailer

Private
9 MA Huateng Tencent SEHK:700 Chairman 38 Online service provider Private
10 WANG Chuanfu BYD SEHK:1211 Chairman 42 Rechargable Batteries / Auto Manufacturing Public
11 HE Xiangjian Midea SZ:000527 Chairman 67 Electrical appliance Private
12 YU Minhong New Oriental NYSE:EDU Principle 47 Education Public
13 FU Chengyu CNOOC NYSE:CEO, SEHK:0883 Chairman & CEO 58 Oil & Gas SOE
14 SHI Yuzhu Giant NYSE:GA Chairman & CEO 48 Online Gaming Public
15 LIN Shaoyong China Eastern Airlines NYSE:CEA SEHK:0670 Director 50 Airline SOE
16 WANG Linxiang Erdos -- Chairman 58 Cashmere Private
17 REN Jianxin Chem China -- General Manager 51 Chemicals SOE
18 NING Gaoning COFCO HKSE:506,
HKSE:606
Chairman 51 Food processing & trading SOE
19 CAO Guowei Sina NASDAQ:SINA Director & CEO 44 Internet Private
20 Jack MA Yun Alibaba HKSE:1688 Founder 45  Internet Public
21 LI Ning Li Ning HKSE:2331 Founder & Chairman 56 Sportswear & Sporting goods Private
22 SHI Zhengrong Suntech Power NYSE:STP Founder & Chairman  46 Photovoltaics Public
23 HAN Sanping China Film -- Chairman 56 Chinese cinema SOE
24 CHENG Baijiao Belle HKSE:1880 CEO 57 Footwear Public
25 ZHOU Chengjian Metersbonwe  SZ:002269  Chairman 44 Clothing retailer Private
Click to enlarge

 Disclosure: No Positions