BYD's Lessons from Peak to Hardship: Subsidies Bring Only Illusions of Profit

BYD's pure electric model E6. Mark Blinch/REUTERS

BYD Lessons

What should Chinese companies learn from BYD’s rise from peak to decline?

Wang Chuanfu sat upright, ready to "open his mind".

It was 3 p.m. on October 14. The 45-year-old BYD chairman and president held a rare media conference. Not long ago, he had just appointed BYD's first full-time public relations director. And a few hours ago, he publicly demonstrated BYD's "core technology" for the first time - the fully automatic production line of lithium iron phosphate batteries in Huizhou.

In half a month, BYD will release its third quarter report for 2011. According to the semi-annual report, the company's operating decline since 2010 will continue, and its profits will drop sharply by 85% to 95%.

Wang Chuanfu is facing another difficult period in the 16 years since he founded BYD, and this time it is more dangerous than before: none of the three main businesses, IT, traditional automobiles and new energy, are doing well; the capital expenditure of 20 billion in two years has been over-expanded, while cash flow is stretched; the loan burden has to be dealt with by "borrowing new to repay old". Since entering the A-share market in June this year, except for the initial surge in the listing, the stock price has been falling step by step. The H-share price has fallen from the highest level of more than 80 Hong Kong dollars to the current level of less than 14 Hong Kong dollars, approaching the level when Buffett announced his investment in 2008.

Wang Chuanfu now defines the three years from 2010 to 2012 as BYD's "adjustment period", which can be said to be "learning from the pain". Many people who are familiar with and have worked with Wang Chuanfu know that as the absolute helmsman of BYD, he is adventurous, focused, persistent, flexible, and does not easily admit failure or mistakes.

These determined BYD's basic trajectory: from battery and IT OEM to automobiles, to new energy leapfrogging industry layout, and the domineering way of intervening in the entire industry chain, no one in the industry can match it. And the low-cost automobile manufacturing by imitating "micro-innovation" and mold + hand-made methods is also like its brand label, which is lingering. Before 2009, all of this was a success: cars sold well, Buffett bought shares, and the stock price soared.

In the leap from traditional industries to new energy, BYD's leap is clearly different from its previous foray into the automotive industry: it is not only a leap in industry, but also a leap from the ability to compete in the market to the ability to grasp and operate external corporate resources, and a leap from relying on the market to relying on the government.

The magnitude of this leap can be seen in its E6 Pioneer pure electric vehicle, which will be launched on October 26: Just to calculate the commercialization of this car, BYD has spent nine years, and the cultivation of the pure electric vehicle market is only in the initial stage, so it can almost be concluded that it will be difficult to see benefits in the short term.

Blessings and disasters go hand in hand. BYD underestimated the difficulty of this leap. BYD has made a large-scale leap into the new energy field, which has a low degree of marketization and is influenced by the government and policies. It has transformed itself into a large enterprise doing government business. Billions of bank credit and capital expenditures have started from this. In addition to supplying production capacity for the booming automobile sales, most of the industrial parks in various places are related to new energy business. And the one who copes with all this is a private enterprise that describes itself as "first-class strategy, second-class R&D, and third-class management."

Therefore, BYD relied on the explosion of the new energy industry for its subsequent growth. In the traditional automobile field, where it was still a "newcomer", it acted rashly and doubled its sales plan for traditional automobiles in 2010 without sufficient product updates. It calculated cash inflows based on this as the basis for aggressive capital expenditures.

Unfortunately, with the policy swings, BYD's new energy business lacks a market-oriented framework and has no way to go. It can only explore and wait patiently. The competitiveness of its traditional automobiles has been damaged by its imprudent expansion strategy, and its quality and R&D capabilities have been questioned, and its brand image has been damaged. The resignation of Xia Zhibing, general manager of automobile sales, is an unprecedented executive personnel shake-up for BYD. The company's cash flow is also becoming increasingly tight.

Under the pressure of survival, Wang Chuanfu tightened the reins. At this time, this company listed in Shenzhen and Hong Kong with total assets exceeding 60 billion yuan and 180,000 employees, and a star enterprise in the eyes of the government, was struggling.

Hou Yan, who succeeded Xia Zhibing, told Caixin New Century, "Now is BYD's reform and opening up!" On the one hand, it made up for the management failure, adjusted the organization and personnel, alleviated the financial difficulties, and reversed the brand crisis; on the other hand, Wang Chuanfu also told Caixin New Century reporters that he would still stick to the new energy layout, but the most realistic and feasible path would be to choose the electrification of public transportation as the priority. BYD's focus in the next few years will obviously return to the traditional electronics and automobile industries, and return to market competitiveness under the slogan of consolidating technology and quality.

Phantom of Profit

"The good profits are actually caused by government subsidies"

In just a few years, BYD has been on a roller coaster, with ups and downs. In 2009, the monthly sales of F3 reached 30,000, establishing its position as a new upstart in the auto industry. In 2010, a crisis suddenly emerged, car sales fell sharply, dealers withdrew from the network, and the decline continued into 2011.

In the first half of 2011, BYD's operating income was 22.5 billion yuan, a decrease of 10.77% from the same period last year, and its profit was only 275 million yuan, a year-on-year decline of 88.63%. The profitability of its three main businesses classified in the financial report - automobiles, mobile phone parts and assembly, and secondary rechargeable batteries - were all negligible.

In the first half of the year, BYD's mobile phone parts and assembly revenue was 9.7 billion yuan, up only 4% year-on-year, with limited growth. In addition to the single largest customer Nokia (Weibo) reducing orders due to its declining market position, the market is also worried that BYD's OEM business will miss opportunities in the growth of smartphones.

The revenue of secondary rechargeable batteries in the first half of the year was 2.5 billion yuan, a year-on-year increase of 17.31%. This business also includes lithium iron phosphate batteries and solar cell products used in new energy vehicles, energy storage power stations and photovoltaic power stations. However, most of this new energy business is still in a state of continuous investment.

Several interviewees familiar with BYD pointed out to Caixin's "New Century" reporter that BYD's traditional businesses such as OEM and batteries have very limited profit margins, with gross profit margins of only 12% and 13%. "At most, it can only sustain itself, and can no longer support its cars." For a period of time after BYD entered the automotive industry in 2003, traditional electronics and consumer battery businesses were the main source of support for BYD's capital expenditures in new fields.

Now, BYD's biggest hope is its automobile business. However, in the first half of the year, the sales revenue of this business was about 10.2 billion yuan, a quarter lower than the same period last year. The above BYD executive told Caixin's "New Century" reporter that the gross profit margin of the automobile business is about 18%, which has dropped significantly from 26%-29% in 2009.

A careful study of the financial report reveals that BYD's profitability is even more discounted.

First, in China's automobile industry, manufacturers often put goods on dealers in advance. After receiving the goods, dealers must pay the manufacturer. The payment methods include: paying in cash, providing a loan, and signing a three-party agreement with the bank and the manufacturer. Among them, when signing a three-party agreement, the car certificate is mortgaged to the bank, and the dealer can pay 70% of the payment through the bank, and the dealer pays 30% of the payment himself.

Since the payment made by the bank is secured by the car certificate, if the dealer has problems with repayment, the bank has the right to claim against the manufacturer. Therefore, the manufacturer cannot immediately recognize this payment as sales revenue. Generally, large automobile manufacturers will not recognize it as revenue.

Tang Jun, an analyst at GF Securities, told Caixin New Century that whether it is recognized as revenue depends on how the bank signed the agreement. In fact, BYD did sign a relevant agreement with the bank, and the bank will not pursue the money. BYD can recognize this income as revenue. But this accounting method is undoubtedly radical. According to rough estimates, this part of the adjustment may increase operating income by hundreds of millions of yuan.

Secondly, in terms of costs and expenses, BYD's main expenses are operating costs of 1.8 billion yuan and management expenses of about 1.6 billion yuan. Operating costs are generally unavoidable expenses, but there is room for maneuver in management expenses.

According to the "Condensed Consolidated Income Statement" disclosed in BYD's H-share financial statements, its R&D and development costs are 600 million yuan, plus administrative expenses of 1 billion yuan, the sum of the two is the above-mentioned management expenses. Compared with the "Balance Sheet" disclosed in the A-share financial statements, its development expenditure is 1 billion yuan, which is a non-current asset.