Wang’s recharged ambitions

When Wang Chuan-Fu first mooted the idea of entering the car industry, he asked his Shenzhen-based engineers to dismantle his car and see how it was put together.

But when they appeared reluctant to damage his shiny new Mercedes, Wang didn’t hesitate. He scratched the bodywork with his keys and declared: “Okay, now you can demolish my car.”

With a Mercedes playing such an embryonic role in getting Wang’s firm BYD started in carmaking there was a certain poetic logic to last week’s announcement of a new technology partnership with Daimler AG. The move saw BYD’s stock price climb more than 5%…

What’s in it for Daimler?

Daimler is hoping for wider access to the China market, just like everyone else. And it’s starting to feel the heat since it was the only German carmaker to report losses last year.

Daimler’s bet is on electric vehicle technology. None of the established manufacturers want to fall behind in the race to develop hybrid cars (which run on batteries that can be recharged either from mains electricity or via a small internal combustion engine) or pure electric ones (plug-in power only).

Daimler has already bought a 10% stake in Tesla, the Silicon Valley-based electric car manufacturer (Tesla batteries are going into Daimler’s electric Smart car brand). But their latest tie-up may prove to be a bigger deal as BYD is said to be a leader in battery know-how. China is also expected to become a key market for electric car sales. “It’s obvious that you cannot have 1.3 billion people drive their own car with a combustion engine. You just don’t have the gasoline to fuel them. So it’s a necessity for China to find a way towards emission-free driving and the electric car is the most likely answer,” Dieter Zetsche, Daimler’s chairman, told the Financial Times.

And for BYD?

The obvious reason is that it allows them to combine their expertise. BYD brings its lithium iron phosphate battery technology, and Daimler its electric vehicle design and engineering skills.

Getting the Germans on board could also be a response to rumours that test drivers have been lukewarm about the BYD experience. Take the comments made in the Wall Street Journal last year by the technology chief of a global auto maker (admitedly a rival one) who had taken BYD’s latest offering, the electric E6, round the block. His feedback: shock that BYD would consider introducing such a “half-baked car” into the marketplace.

Hardly an impartial assessment, BYD would argue. And on the face of it, the company had a solid year in 2009. But performance was driven almost entirely by the sale of 400,000 gasoline-engine cars, as well as revenue from its longstanding telecom handset parts business. No sales were reported for the rechargeable car battery business, for which BYD has garnered the most publicity.

Why are sales so low?

BYD’s first hybrid model, the F3DM, generated a halo-effect as far as early investors were concerned, and the company’s battery technology is widely believed to be ahead of its rivals.

But just a hundred or so hybrids have sold since late 2008. One issue is the lack of supporting infrastructure to charge electric vehicles in China, although efforts are being made to address this (see WiC49). The main obstacle, though, is price. At $22,000 the F3DM is just too expensive. The latest model – the E6 – will cost even more, at close to $40,000, according to press reports.

BYD knows such prices are a problem, so it hasn’t made much effort to sell directly to consumers – focusing initially on government departments and corporations. It is also lobbying for the subsidies it says are crucial for encouraging wider adoption, and there were signs at this week’s National People’s Congress (helpfully, Wang is a delegate) that official help may finally be on the way – although the subsidy amounts are unclear. The Beijing Youth Daily has reported on a pilot scheme in five cities offering subsidies of up to $8,800 per car.

Will that be enough to kick-start demand? At current price tags, electric vehicles will still be a lot more expensive than traditional ones, even after the financial support. The public clearly needs some convincing: a McKinsey survey in January revealed that even with $7,400 thrown-in, only 6.4% more people were ready to consider purchasing electric cars.

Another problem, says Caixin Online, is that BYD’s battery performance is still unproven, especially in large-scale production. There is a suspicion that the company’s labour-intensive production process makes quality problems more likely. BYD counters that its battery-making lines are now largely automated, although that’s a departure from earlier press coverage of it’s competitive advantage in manual assembly in Shenzhen.

Still, large-scale production won’t be tested while sales levels are so low. The lack of reliable vehicle data is a problem for the industry. And the Chinese government too: Miao Wei, vice minister at the Ministry of Industry and Information Technology, rebuked manufacturers for trying “to fool laymen” with questionable product information.

Any intellectual property issues?

There’s speculation of foul play here too, especially in light of rumours about BYD exporting to the US within 12 months.

Much of the debate is over the company’s reputation for reverse engineering (imitating but never direct copying, Wang says). To be fair to BYD, it has fought off patent infringement suits in the past. But any plans to export to the US would bring it into an ongoing dispute about ownership of the underlying chemical formula used in most battery design. New Century Weekly predicts BYD will “get into trouble” if it tries to gate-crash the debate.

Of course, a plausible alternative is that the export plan is just a red herring, designed to impress investors (as well as potential Chinese customers) that BYD cars are good enough to sell in America.

Back in China, BYD may find it has entered the market too soon. The first-mover advantage is of little value while prices remain so high, and there’s risk that local rivals will copy BYD’s batteries before its vehicles have been sold in serious volumes. That could make BYD a technology “martyr”, says New Century Weekly – a mantle that might bring smirks to its reverse-engineered rivals.

No sign of Wang losing confidence yet…

It looks like there are some pretty fundamental questions that still need to be resolved. Does the battery technology really work? Can it be integrated into a car that people want to drive? And can it be priced low enough to compete?

Wang’s mood seems buoyant enough (“99% of my decisions have been correct,” he told the Economic Observer at the start of the year, “because nobody knows the industry better than I do”) and he has led from the front before – by moving BYD into car manufacturing from its origins in telephone components.

Warren Buffett doesn’t often back duds either. The smart money says he’s punting on BYD’s prospects in battery technology rather than electric cars. Since he invested in September 2008 the stock has seen impressive growth, and it continues to trade at an earnings multiple well above its peers. Of course, Wang has helped that along with a savvy PR game: getting Buffett aboard, promoting BYD’s “next generation” technology wherever he can, and stoking up press interest with announcements on foreign tie-ups (Daimler being the latest).

But much of the stock price premium relates to BYD’s pretensions to “green” leadership. Lose those credentials, and its story risks losing some of its glitter. At some stage, there will need to be evidence of a sales breakthrough too. Although BYD is far from alone in struggling to get its new-generation vehicles that extra mile to commercial success, it’s also true that few others have their reputations (and stock prices) quite so hitched to getting there.

---

© ChinTell Ltd. All rights reserved.

Sponsored by HSBC.

The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.