Recent articles have claimed that Kandi Technologies (NASDAQ:KNDI) has an overly complex hierarchical business model. This complaint about business structure is a consistent theme among Kandi investors and has yet to be adequately answered. There have also been claims that Kandi is warehousing vehicles that are not yet sold to the end user as a means of bolstering their revenue figures and artificially inflating their share price. In this article, I attempt answer some of these concerns and accusations while clearly and logically explaining the structure of Kandi's EV parts and production business. Beyond this, I describe how the national and local government subsidies are currently impacting EV production.
This is not meant to be an analysis to the very minutia of the company business. It is meant to clarify some of the larger points that still seem to be areas of confusion among the investing community.
The main sources of Kandi's revenue are:
- Legacy Business
- Electric Vehicles
- EV parts
1. Legacy Business:
Kandi's legacy business is its ATV and Go-Cart company. This sells its product domestically and also exports internationally. As Kandi is the manufacturer of these products, revenue from the legacy business is transmitted directly back to Kandi Technologies. Kandi's legacy business has continued to grow annually. For example, it had a 62% growth in ATV revenue from 2012 to 2013 and total legacy business revenue of over $45 million.
2. Electric Vehicles:
Kandi's electric vehicle business has overtaken its legacy business as the greatest source of revenue for the company. Their EV revenue grew 145% year-over-year between 2012 and 2013 with total annual revenue of $46.6 million on 4,694 EV units sold. The joint venture company has announced a Q2 sales figure of 4,114 units in the just the second quarter alone. Coupled with the Q1 sales figures, they have already surpassed the entire 2013 annual sales, so ongoing growth is apparent.
Much has been said recently about the complexity of Kandi's EV business structure and some have expressed concern that the company is simply selling to itself. In the following paragraphs, I will focus on this top-down structure of EV production and sales process that seems to worry everyone. This general explanation will deal with the pathway from Kandi Technologies to the end-user, also known as Zhejiang ZuoZhongYou Electric Vehicles (ZZY).
Firstly, we have to remember that Kandi Technologies (via Zhejiang Kandi Vehicles) is a vehicle parts manufacturer, outside of its legacy business, and not a licensed street-approved EV manufacturer. Kandi partnered with Geely to form the joint venture (JV) Kandi Electric Vehicles Co (it's in the name), which is the licensed operations unit for manufacturing street-approved cars. Kandi Electric Vehicles (the JV) is 50% owned by Kandi Technologies and 50% owned by Geely. It has operations in multiple provinces, which is illustrated on the 10-Q figure below. This is broken down into individual EV production plants because the different provinces have different tax codes and partitioning the various plants into the different tax codes is easier to keep track of. As you can see, however, each of those plants is really just Kandi Electric Vehicles (as evidenced by 100% ownership). This is similar to a McDonald's in Illinois and a McDonald's in Montana being a different branch of same company. The 19% owned company listed under this JV is the ZZY company, which distributes and rents cars throughout participating cities for the car-share program. In this sense, after benefiting from the sale of their vehicles, The joint venture then splits a 19% interest in continuous rental revenues from those vehicles with Geely. This net gain/loss through JV activity then trickles back to Kandi Technologies as a 50% owner of the JV, creating additional return on investment. See below:
Now that we understand Kandi Technologies is an EV parts producer that sells car kits to Kandi Electric Vehicles (the JV) for manufacturing and distribution, let's take a look at how this chain of sales might look with a hypothetical example. We will also see how the national and local government subsidies will impact these sales arrangements.
In this hypothetical example, let us assume that Kandi Technologies sells an EV parts kit for $10,000 to the JV. Let's also assume that after manufacturing this EV, the joint venture company (Kandi Electric Vehicle, whichever provincial plant it is made at) sells this car to the end user for 50% more at $15,000. The end user in our case will be the company ZZY, which is where the cars are currently going, as Kandi does not yet sell to individual private citizens. Government subsidies will be included with an example of $8,000 national PRC subsidy and a $7,000 local subsidy (local subsidies are supposed to more-or-less match the national ones).
To summarize we have these players in our little thought experiment:
- Kandi Technologies: sells EV parts kit for $10,000.
- Kandi Electric Vehicles (The Joint Venture aka 'JV'): Buys EV parts kit for $10,000 and sells completed EV for $15,000.
- ZZY Company (End User): Buys the car for use/rental project.
- National Government: Subsidizes $8,000 for produced EVs with sales agreement.
- Local Government: Subsidizes end user $7,000 on purchase of EV.
How do all of these players come together? This all begins with Kandi Technologies (through Zhejiang Kandi Vehicles), who will sell its parts directly to the JV for the up-front cost of $10,000. Therefore they gain $10,000 of revenue. This will be the predominant source of revenue for Kandi Technologies in the EV-related business. The JV then manufactures this EV through the kit it just purchased. On production and sale of the EV, the national government subsidizes $8,000, paid directly to the manufacturer (JV). (This national government subsidy is theoretically paid quarterly and in advance per Chinese briefings, with reconciliation between the manufacturer and government at the end of each fiscal year. However, the subsidies are currently being paid in a retroactive fashion, and the JV recently received its first subsidy in the amount of $31.8 million for vehicles produced in 2013 and Q1 2014). www.nasdaq.com/press-release/kandi-technologies-group-announces-jvs-receipt-of-approximately-us318-million-new-energy-vehicle-20140707-00260 The amount of the national subsidy for low-speed EVs is publicized to Chinese end-users. They know that the JV is provided $8,000 for the car, so when the JV sells the completed EV to ZZY for $15,000, this $8,000 dollars is subtracted from the sale price. Now ZZY is charged $7,000 for the completed EV as opposed to $15,000 because the national government has assumed part of the cost.
The good news for ZZY (end user) does not end here. Local subsidies are also mandated, and in this example, there is a $7,000 subsidy to reimburse the end user upon purchase of an EV. In this case, the final cost to ZZY with the local subsidy is now zero dollars for a $15,000 car and the ZZY company can begin to profit instantly from rental services on that vehicle.
This brief example illustrates how the subsidy policy allows a sequentially greater benefit to each piece of the Kandi production and sales chain. It also explains how the ZZY company and car-share program can be instantly profitable despite the need to acquire significant inventory for their operations. The national and local governments are essentially absorbing the cost to put these low-speed EVs on the road. The JV is guaranteed $8,000 reimbursement by the national government reimbursement upon completion and sale of the vehicle. The end user receives the benefit of the additional local subsidy, off-setting the markup price by the JV and allowing them to "purchase" the vehicle for next to nothing.
Take a moment to draw the above scenario out on a piece of paper to solidify your understanding.
An important detail to remember here is that Kandi Technologies is paid directly by the JV company for the EV kit. The PRC subsidies are not transmitted to Kandi, they are paid to the JV. Likewise, the local subsidies (disclaimer: these are still pending announcement in Hangzhou) are not paid to Kandi, they are paid to the end user (ZZY). In other words, Kandi does not rely on subsidies for their revenue, however, the subsidies greatly increase the demand for EVs and the magnitude of EV demand directly translates to increased EV kits sold by Kandi to the JV. Secondly, ZZY is reimbursed for cars purchased that have proof of parking space with plug in capability before receiving the subsidy. Because the subsidies over the next 2 years will allow ZZY to obtain a car at essentially no cost, this gives incentive for rapid expansion of the car-share program and charging infrastructure to maximize EV inventory and therefore, rental revenues.
As observed in the 10-Q, the majority of EV kit sales from Kandi Technologies was to the JV and its various provincial factories. Some online investors have openly accused this as "selling to oneself" to bolster sales numbers. From the above model, we can see that this sale of EV kits, that are then manufactured into street-approved vehicles by the licensed JV, and the final transfer of those cars to the ZZY end-user is a completely logical and even expected route of sales. The JV with Geely is a required intermediary, as they are the ones with the manufacturing license.
The end user in this picture is a separate company, ZZY, of which Kandi Technologies is only a 9.5% stake-holder (19% owned by the JV, which is split 50:50 between Kandi and Geely). The sale to the JV by Kandi technologies is ultimately transmitted to the ZZY company. However, as the combined subsidies cover the total cost of car purchase, the money for the vehicles is really paid by the government and the car title goes to ZZY. In other words, this is not a company "selling to itself"; Kandi is not buying EVs from itself with its own money; money is flowing into Kandi Technologies by way of national and local government subsidies at the time of EV production and purchase by an end user business (i.e. ZZY). Again: the government is bearing the cost of putting low-speed EVs on the road, allowing ZZY (and it's co-owners i.e. Kandi JV) to instantly profit from rental fees. Therefore the JV profits from both the 5,000 price hike at final EV sale and its 19% stake in ZZY rental revenue. Knowing this, if the JV owned a larger percentage of the end company ZZY, they would receive an even greater end-financial benefit! This is why the Kandi/Geely JV has been contemplating purchasing a larger stake in the ZZY company. In other words, owning part of ZZY should be considered a very good thing in a "the more the merrier" kind of way.
Why is there a difference between the number of Kandi kits sold and the number of EVs sold by the joint venture? Certainly there will be an estimated 2-6 week delay in Kandi's kit numbers and JV vehicle numbers (ZZY purchases) based simply on the turnaround time needed to complete the EV manufacturing process and finalize a sales agreement with the end user.
This should explain why Kandi's sales and the JV end-user sales are not reported with the same figure at any point in time. The car kits are still purchased from Kandi Technologies by the JV and the subsequent EVs are manufactured for sale to the end user. The manufacturing process introduces time delay between Kandi kits sold to the JV and the finalized, manufactured EV that is sold to ZZY. Therefore, Kandi's EV kit sales numbers should always be higher than the ZZY purchase numbers at any point in time, but the delayed sales figures from the JV will ultimately match the Kandi kit sales, as each kit is converted into a final EV product.
3. EV Parts Business
A description of this has been previously described at length in an online article by Arthur Porcari. It can be found here:seekingalpha.com/p/1uct3
While Q1 revealed the introduction of the parts business for Kandi vehicles and it accounted for a significant proportion of overall revenue, it should not take away from the fact that Kandi is, in reality, a pure-EV play in China. The main long term opportunity for the company lies in its EV kit sales, and return on investment from its 50% JV ownership (and therefore 9.5% interest in ZZY car rental program). As evidenced by the significant increase in EV sales from the JV this year, Kandi's EV kit sales should also be increasing (given that each final EV sold must be preceded by an EV kit sale to the JV). As such, the Q2 earnings report should continue to show significant growth in the EV portion of Kandi's business model, stimulated by the rapid EV adoption that local and national subsidy policies allow. In this sense, the recent focus on the battery sales is somewhat of a red herring when the long term potential of the company is considered. But I am in agreement with many that I anticipate further clarification with the upcoming earnings report, scheduled for August 11.
I hope this gives a fair summary of the Kandi EV production and sales model. I did not cover the additional components in Kandi Technologies' complete business structure including Yongkang Screw Electric Co etc, as my aim was to focus on the EV production component.
Kandi Technologies remains at the forefront of the urbanization of green-energy vehicles in China. As described above, they are a clear beneficiary of the rapid deployment of low-cost electric vehicles that government subsidies allow. This is exemplified by ZZY and the car-share model as I have explained. Beyond this, further incentives such as 10% tax break on Chinese domestic EVs starting in Septemberwww.bloomberg.com/news/2014-07-09/china-to-exclude-electric-cars-from-purchase-tax-amid-smog-fight.html (Tesla does not qualify) and a mandated 30% EV purchase rate for government vehicles will keep Kandi Technologies' rapid growth intact.
Best of luck in your investing decisions.
Disclosure: The author is long KNDI.