China Play May Buffet Buffett

By ASSIF SHAMEEN | MORE ARTICLES BY AUTHOR

A wager on auto and battery maker BYD could go south on the Oracle of Omaha.

• Article
• Comments

Berkshire Hathaway CEO Warren Buffett's stellar reputation as an investor has been burnished by some lucrative bets in China. In late 2007, for example, Berkshire got $4 billion for a stake in Chinese oil major PetroChina (ticker: 857.Hong Kong) that had cost it $488 million―producing a 700% return over five years. But not all of Buffett's China ventures have worked out.

In September 2008, MidAmerican Energy Holdings, a Berkshire Hathaway (BRKA) unit, swooped in on Chinese battery and auto company BYD (1211.Hong Kong) days after Lehman Brothers collapsed. The deal was hailed as classic Buffett―buying a 9.9% stake in an undervalued firm at the market's bottom. By early last year, BYD had surged from eight Hong Kong dollars (US$1.03) when Buffett bought it to HK$88―turning a US$230 million investment into a US$2.3 billion paper profit in 15 months.

Buffett's bet was on electric cars. On magazine covers and on TV, the Oracle of Omaha was plugging a $35,000 Chinese-made model dubbed the BYD E6. Three years on, BYD shares are down 72% from their peak, and the company, controlled by entrepreneur Wang Chuan Fu―described by Buffett's colleague Charlie Munger as "a combination of Thomas Edison and Jack Welch"―isn't looking so good. Buffett's paper profit is down to $430 million, and analysts have been cutting estimates for BYD, which could plunge another 20% to 25%. "I have been bearish on BYD for over a year now, because I just don't buy their electric-car story," says Scott Laprise, an analyst for CLSA in Beijing. He has a HK$16.68 price target, the lowest of any analyst.

Last week, BYD raised US$219 million in a secondary offering in China of Shenzen-listed A shares (available to locals and to qualified foreign institutions) but at 35% below the original goal. "BYD needs to raise [more] cash as quickly as possible, given its mounting short-term debt," says Credit Suisse's Adrian Chan, He adds that it faces a cash shortfall exceeding US$1.3 billion for its projects. Though the company could raise this through bank borrowings, rising interest rates in China will boost financing costs.

BYD rode China's car boom by churning out conventional sedans and subcompacts as it readied a slew of hybrids and electric cars. But only a handful of E6 electric taxis have been sold, and the company hasn't had much success with its F3DM plug-in hybrids. Worse, it's been losing market share in conventional cars. This year, BYD's total car sales are down 22%, and its gross margin slid to 11% in the first quarter, from 27% a year earlier.

Last month, China's auto sales plunged 4% year over year, as Beijing withdrew subsidies for new cars. CLSA's Laprise says a bigger problem is that BYD hasn't refreshed its aging flagship F3/F6 models.

Another problem is beleaguered cellphone firm Nokia (NOK). The Finnish company's woes are weighing on BYD's 66%-owned subsidiary BYD Electronics, a contract handset maker. Nokia accounts for more than 40% of the unit's revenue.

Is it time to buy BYD stock, which is trading at 19 times this year's estimated earnings and around two times price-to-book value? Probably not. A big worry is that Buffett might decide to unload his stake before it tanks below his purchase price. The stock, analysts say, carries a 20% "Buffett premium," meaning it could lose a fifth of its value if the Oracle of Omaha decamps.

That might not happen, but the prudent―especially anyone with a profit in the shares―probably should motor away from the stock now. 

Better News

China shares leaped as Premier Wen Jiabao said inflation was under control.

ASSIF SHAMEEN covers Asian capital markets from Singapore.