BYD has now become the largest manufacturer of electric vehicles in the world, in addition to having built one of the largest electronics companies on the planet. This phenomenal entrepreneurial story at the crossroads of genius and opportunity could not be better described than by Li Lu himself in 2013:
“BYD’s story is relatively simple. Wang Chuanfu, the founder and CEO of BYD, who is a really great engineer, started the company from a simple $300,000 loan, with no extra money until the IPO. He created an $8 billion company that employs 170,000 people and has tens of thousands of engineers. It solved a whole bunch of different problems. The results are therefore impressive. They happen to be in the right sector and in the right environment, and that they have the right support from the authorities.“
The company now has a big electric car company, a small gasoline car company, a huge battery company and a lithium mine near Tibet. It is also in talks to buy six lithium mines in Africa.
“We have an interesting venture capital type business, and BYD has got into a business that it has never done before, which is monorails. And they sell monorails like you can’t believe (…) And they also sell these big electric buses and so on. Wang Chuanfu is a combination of Thomas Edison and Jack Welch – something like Edison to solve technical problems, and something like Welch to do what needs to be done. I have never seen anything like it“, explained Charlie Munger in 2018.
Originally batteries
It all started in 2001 when Shenzhen-based lithium-ion (“li-ion”) and nickel rechargeable battery maker BYD (“Build Your Dreams”) enjoyed a huge tailwind from the booming use of mobiles, electrical and electronic devices. The company is already the world’s third largest manufacturer of li-ion batteries.
The dramatic increase in demand for this type of battery, due to the mass adoption of mobile phones, laptops and other devices, is driving the company’s revenue and profit. It made several acquisitions, including a 15% stake in BYD Auto in 2004. The objective is already to use this structure as a platform to develop battery-powered vehicles.
By 2010, BYD was already selling 500,000 vehicles a year and had entered into a memorandum of cooperation with Daimler to develop passenger vehicles powered by electric motors. In the mobile phone components business, management says betting on a vertically integrated model has created a lasting price advantage – a claim backed up by impressive results.
Revenues have jumped in recent years
Revenue has doubled over the past five years, from $18 billion to $36 billion. Which means that over the last fifteen years, revenues have increased thirty-six times. But that epic run has also been accompanied by perpetual margin compression, with BYD’s operating profits following a sideways curve for several years.
Growth in the electronics business has slowed and China’s electric vehicle producers were overly dependent on government subsidies, which are being cut or redirected elsewhere. No one knows how BYD’s sales will evolve in an environment without subsidies. There is no visibility on BYD’s real ability to generate cash profits, as growth consumes all resources.
From a free cash flow perspective, the last two earnings reports have been impressive, but benefited from an unusual release of stocks due to the pandemic, which freed up massive amounts of working capital. Other than that, capital expenditures are higher than ever and are expected to consume all cash for the foreseeable future.
Not for just any investor
Market cap and enterprise value are roughly equal, at $130 billion. Apart from all the usual caveats about investing in China, it’s safe to say that at the end of the day, it’s still a story for Believers. A big part of the appeal is that Berkshire Hathaway still owns one-fifth of the equity. But this investment by Warren Buffett is not the easiest to understand, because BYD’s business is moving at breakneck speed and involving large masses.
Still, it’s worth pointing out that BYD’s integrated, wholly-owned supply chain, from the lithium mines in Tibet to its vast battery manufacturing base, is a huge plus. Other automakers depend on external suppliers for batteries and raw materials. BYD’s vertical integration model should provide it with the same type of cost advantage as its electronics business.
Either way, conservative investors are likely to move on. After all, Warren Buffett, Charlie Munger and Li Lu invested when BYD stock was trading at very low valuations. To quote Munger: “She was manhandled so much it was a Graham-type action. A Graham share in a start-up.“
To learn more about the Chinese automotive market, especially the electric segment, it’s here.