M&A, Talking Point

Batteries are included

Why Samsung has decided that it needs to invest in carmaker BYD

BYD Co. Chairman Wang Chuanfu Presents Annual Earnings Results

Founder Wang Chuanfu partnered first with Warren Buffett and now with Samsung Electronics

After Warren Buffett splashed $230 million on a 10% stake in BYD in 2008, the wily Nebraskan looked to have struck a rapport with the Chinese carmaker’s chairman, Wang Chuanfu.

The world’s most famous investor subsequently showcased BYD’s electric vehicles at Berkshire Hathaway’s annual shareholder meetings, even giving Bill Gates a lift in one to convince onlookers that the car was cool. When Buffett and Gates visited China in 2010, Wang returned the favour by taking the billionaire duo to a slew of BYD functions that included factory visits, company dinners and even a lottery draw.

Buffett’s endorsement added invaluable credibility to BYD’s investment story. Its car sales and share price both spiked, making Wang one of China’s richest men. Investors were hopeful that the Buffett connection would even help BYD market its electric vehicles (EVs) to American drivers, as well as aid the sale of more of its solar panels to Berkshire units such as KB Home. Li Lu, the Chinese hedge fund manager responsible for introducing BYD to Buffett, was even tipped by the Wall Street Journal as one of Buffett’s potential successors at the helm of Berkshire Hathaway.

Nevertheless, Berkshire and BYD haven’t developed a strategic partnership. The former has not had a representative on BYD’s board since early 2011. And BYD’s sales to the United States accounted for just 4% of BYD’s revenues by the end of last year.

But BYD found itself back in the headlines last week as Samsung Electronics revealed that it was in talks to invest in the Chinese company. Apart from adding another big name shareholder, investors now wonder whether BYD will be able to extract more strategic value from its tie-up with the world’s biggest maker of mobile phones and memory chips. Executives from companies like Apple and Tesla will also be questioning how this unexpected new alliance might reshape the landscape for electric vehicles.

How big is Samsung’s bet?

The Korea Economic Daily first reported last week that Samsung is planning to acquire a 4% stake in BYD for roughly $440 million. That would value the Chinese firm at roughly $11 billion – the company’s market capitalisation stands at $16 billion as of this week – and makes Samsung the second largest foreign shareholder in BYD behind Berkshire Hathaway.

In a regulatory filing in Hong Kong – one of the two places BYD is listed, the other being Shenzhen – the Chinese firm confirmed the news, although it also said that it wouldn’t guarantee that Samsung would end up owning a 4% stake.

The overture from the South Koreans was spurred by a fundraising plan that BYD flagged a year ago. Last July it obtained approval from Chinese regulators to raise up to Rmb15 billion ($2.2 billion) by issuing new shares in Shenzhen. The placement is still going ahead and BYD said last week that Samsung is in talks to take part.

One reason the share sale has taken so long is the price gap between BYD’s shares in Shenzhen and Hong Kong, which were trading last week at Rmb64 (or HK$74.24) and HK$50 respectively. That raises the question of why an institutional investor would bother to take part in BYD’s A-share placement, when its Hong Kong shares come at a price 50% cheaper (after foreign exchange adjustments). But Samsung is looking at more than an equity investment: the Korean giant is also keen to develop a strategic relationship with BYD. “Going forward, the parties will jointly seize opportunities in the rapid development of the global electric vehicles industry,” BYD said.

Details, including the size of the investment and the nature of Samsung’s relationship with BYD, will be disclosed on confirmation of the investment, Samsung announced.

How has BYD been doing lately?

Regular WiC readers should be familiar with BYD’s stellar rise after Berkshire’s investment in 2008, which gave it global prominence (see WiC25). However, they will also be aware that BYD has struggled since Buffett made his bet (see WiC159). That said, the company seems to have finally found its stride in the past 18 months (see WiC316) and BYD’s net profit climbed to Rmb2.8 billion last year from Rmb433 million a year earlier.

The improvement was largely driven by BYD’s new energy vehicles (a category that includes hybrids, which have gasoline engines as well as electric power). In fact, its sales of EVs and plug-in hybrids more than doubled last year to 58,000 units, ranking BYD as the world’s largest manufacturer of new energy vehicles in terms of revenues.

BYD has benefited from plenty of government support. The Shenzhen-based firm has been one of the biggest beneficiaries of state subsidies in the automotive sector. In 2015, for instance, it received Rmb581 million in “government grants and subsidies”, compared with Rmb798 million a year earlier. These direct subsidies don’t include other forms of government support such as tax breaks, cheaper land and State Grid’s helpful construction of a growing network of charging facilities (which are friendlier to domestic-made EVs than foreign imports such as Tesla cars). And BYD has also been winning bigger contracts from local government and state firms, as Beijing wants more EVs on the roads in order to fight pollution. For example, the car firm said earlier this month that it had secured a procurement contract from a bus firm owned by the Shenzhen government. The initial deal was for almost 3,000 electric buses worth Rmb1.8 billion ($269.8 million), although a week after the original announcement BYD conceded the contract had been scaled back to 691 electric-powered vehicles.

The Economic Observer thought this could be a signal that local governments want to reduce the subsidies that are paid out when state firms make EV purchases. (Last week, one of WiC’s readers reported that buyers of one model of electric bus – costing Rmb1.2 million – were receiving almost Rmb500,000 from the central government and a similar amount from the local government; see WiC333).

All the same, the Economic Observer said that the switch to EVs remains a key plank of China’s national energy strategy.

What does Samsung want from BYD?

Wang Chuanfu hinted at his new Korean partner’s possible motives earlier this year. “We are very lucky that the Chinese government has been offering strong support to the NEV market,” he told CBN newspaper in an interview. “This makes a lot of foreign entrepreneurs salivate, especially companies from South Korea.”

Samsung and LG control about a third of the world’s EV battery market and the Korean firms opened factories in Xi’an and Nanjing respectively last year. But the Chinese market has proven difficult to crack, in part because the Ministry of Industry and Information Technology (MIIT) has been pushing for stricter rules to govern the EV market. One key measure: only the EVs equipped with batteries from an MIIT-approved vendor are qualified to receive government subsidies.

Both the Samsung affiliate Samsung SDI and LG hoped to get on the vendor list but they were told last month that they were being excluded from the latest certification round. In fact, the 60 or so companies approved by the MIIT so far are almost entirely Chinese. Hence Samsung’s decision to acquire a BYD stake, the Korea Times has reported, may prove “a key factor in Samsung SDI obtaining battery certification in the fifth certification round in August”.

For the time being, the different state subsidies account for a substantial share of the selling price of an EV. 21CN Business Herald says the subsidies can also amount to 40% of the production cost of an EV. “It is obviously unreasonable to subsidise foreign firms with Chinese taxpayers’ money,” an industry insider told the newspaper.

So it seems that Samsung has come to the view that the addition of Chinese partners could help it negotiate protectionist sentiment. Besides its potential deal with BYD, the Korean giant also held a signing ceremony last week for a $170 million joint venture with Chinese solar firm Sungrow to produce storage systems that help households retain surplus electricity generated from rooftop solar panels.

Is it a strategic alliance then?

As WiC reader Francois Perrin, a portfolio manager with East Capital, suggested in his essay in our last issue, local producers such as BYD will be key beneficiaries of the capacity expansion in the EV battery business (see WiC333).

Until recently BYD had focused on developing lithium-iron-phosphate (LFP) batteries – technology which the company has described as safer and more environmentally friendly (Wang Chuanfu famously poured the fluid from one such battery into a glass and drank it in front of Buffett’s representatives), even though LFP technology generates less energy

Wang seems to have been preparing for a change in strategy. In BYD’s annual report he told shareholders that it will continue to improve the energy density of LFP batteries but that it was also working on new types of batteries that “increase the mileage and overall competitive advantage of its new energy vehicles”.

As Perrin noted last week, nickel manganese cobalt (NMC) batteries are an advance on LFP technology and may become the long-term standard for the EV industry in China. The MIIT’s partial controls on foreign imports, Perrin has suggested, is designed to buy time for the likes of BYD to catch up with Japanese and Korean competitors (aka Samsung and LG) in NMC technology.

Hence Samsung and BYD could become strategic partners. “The investment will help BYD develop its next-generation battery technology and also be beneficial for Samsung to expand its electric vehicle component business in China without policy risks,” a Samsung official told Korea Times.

Cars of the future?

The corporate histories of Samsung and BYD have at least one achievement in common: both have seen off competition from much bigger Japanese rivals in securing their current market positions. While Samsung is a case study for how Japanese electronics firms such as Sharp lost their crown to their Korean neighbours, BYD also overcame the likes of Sanyo to become the world’s largest producer of mobile phone batteries.

Now the pair may lock horns with familiar Japanese foes again. “Another interesting point is that Samsung wants to supply its batteries exclusively to BYD, just like Tesla’s reliance on Japan’s Panasonic,” Korea Times has noted, adding that Samsung needs to find new demand for its manufacturing capability as growth in the smartphone sector starts to slow.

The Samsung-BYD alliance illustrates another trend: tech firms and automakers collaborating – and sometimes competing – as each industry does its best to shape the future of the automobile market.

Google has plans to produce next-generation vehicles – and many suspect the same to be true of Apple. All the major Chinese internet firms (including the BAT trio, plus Xiaomi and LeEco) have entered the frame too.

Taiwan’s Foxconn has also teamed up with Tencent (one of the BAT trio, along with Alibaba and Baidu) to back Future Mobility, a Chinese automaker which poached a team of senior managers from BMW earlier this year. Future Mobility plans to launch its own EVs by 2020.

The jostling for position between the major players has been intense. Taiwanese media reports that Foxconn has been supplying parts for Tesla’s EVs, for instance. A longtime rival of BYD in the mobile phone battery market, Foxconn even took its competitor to court after allegations that it was stealing its commercial secrets (BYD had poached hundreds of executives from Foxconn).

More intriguingly, Foxconn also paid $3.5 billion in March for a controlling stake in Sharp, whose business was failing largely because of competition from Samsung. Last but not least, Sanyo, which BYD had earlier defeated, is now part of Panasonic, which is a major battery supplier of Tesla.

Of course, making the investment in BYD will be the easy part for Samsung. The challenge will be to forge a functioning alliance from two very different corporate cultures and to collaborate effectively around the different battery technologies.

But it will also be a moment to savour for senior Samsung executives. Korea’s biggest conglomerate was forced to cede control of its carmaking unit to Renault during the Asian financial crisis of the late 1990s. It did so with reluctance (to put it mildly), compelled by its then weak balance sheet to surrender the field to its local rival Hyundai, which has dominated the Korean car market ever since. With its BYD investment Samsung is resurrecting its ambitions to be a major player in the global auto industry – albeit this time with a big bet on EVs and the China market.

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