Will WikiLeaks Sink Buffett's Chinese Investment?

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Careful Buffett-watchers have known for a while that Berkshire Hathaway's (NYSE: BRK-A  ) (NYSE: BRK-B  ) much-touted investment in Chinese battery and auto maker BYD wasn't quite up to the master's usual standards. In fact, BYD is exactly the kind of company he has carefully avoided in the past: a hard-to-understand technology firm angling for explosive global growth.

But Berkshire invested anyway, making a bet on the talents of CEO Wang Chuan-Fu, who Charlie Munger called "a combination of Thomas Edison and Jack Welch." And while the value of that investment has risen handsomely, questions about the company have continued to surface.

And now that investment is likely to come under heavy pressure, thanks to WikiLeaks.

WikiLeaks strikes again
The WikiLeaks website has been in the news since it published a trove of formerly secret U.S. diplomatic cables late last year. Among those cables are several from the U.S. consulate in Guangzhou that express serious concerns about BYD's quality and operations. These cables were provided to Reuters, which used them as a starting point for an in-depth report on the company.

That report was published late on Thursday, and it doesn't look good for BYD. Among the problems noted by Reuters:

  • Copied designs. China's intellectual property laws are famously lax, and the copying of global companies' designs is hardly a problem limited to BYD, or even the auto industry. But even by Chinese standards, some of BYD's moves have been blatant. The company's F3 sedan is awfully similar to a Toyota (NYSE: TM  ) model, both visually and mechanically, and according to Reuters, dealers would actually replace the cars' BYD markings with Toyota badges for a modest fee. These are not cars (or business practices) that can be exported without facing hopeless intellectual-property challenges.
  • Low quality. BYD's cars are "nowhere near" meeting U.S. or European safety standards, according to an insider interviewed by Reuters. The consulate's report noted that the company often tended to use cut-rate materials to save weight and cost, at the expense of safety. Wang has talked at length about BYD's global ambitions, even setting up offices in the U.S. and Germany, but the products aren't yet ready for prime time.
  • Battery problems. Building shoddy, copied cars is one thing. Building a good car for a competitive price is hard, but it's not a challenge that is likely to daunt the Chinese auto industry indefinitely. But BYD's real promise, at least from Berkshire's perspective, is its battery technology. BYD's electric E6 sedan, now said to be arriving in the U.S. in 2012 after several delays, is said (by BYD) to charge faster and have a greater range than cars such as General Motors' (NYSE: GM  ) Chevy Volt and Nissan's Leaf. Range is the electric-car battleground at the moment, but Reuters notes that there are reasons to think BYD's battery technology isn't performing as advertised, at least not yet.
  • Minuscule sales of the cars that matter. In an earlier look at problems at BYD, I noted that the company had sold all of 18 examples of its much-touted F3DM plug-in hybrid in the first half of 2010. That number rose to a whopping 480 by year end, according to Reuters, despite a Chinese government subsidy that covers almost half of the car's purchase price. By contrast, GM has already sold more than 600 Volts in the U.S. this year, and production is still ramping up. The New York Times recently road-tested an F3DM and pronounced it "impressive, though imperfect," but so far, buyers seem to be looking elsewhere.
  • Sales in free-fall. BYD's total Chinese-market sales were down 15% in January, despite a nearly 14% year-over-year gain in the overall market. Bad as January's numbers were, the company sold half as many cars in February, despite heavy price cuts midmonth. If BYD can't hold on to its market share at home, is there any reason to believe it can credibly expand into the U.S. or Europe?

Some of this can be written off to growing pains, and some of it is probably part and parcel of the chaotic Chinese market. But taken together, the report raises serious doubt about BYD's ability to become an export power, and that is (or was) the key to the company's hoped-for growth.

Serious reasons for skepticism
Despite BYD's troubles, Berkshire's stake, which was bought for $232 million and valued at $1.18 billion at the end of 2010, is still comfortably in the black. But it's worth noting that Berkshire's 2009 letter valued the stake at just under $2 billion, a near 40% loss in what was otherwise a pretty good year for the markets.

Of course, BYD's awful third-quarter numbers -- in which the company reported a 99% decline in profits -- had a lot to do with that. But things haven't improved much since. BYD's shares have dropped another 15% so far this year, threatening to drive the value of Berkshire's investment under $1 billion.

I think the stock is likely to fall further, and not just because of the Reuters report. The case for BYD as an investment was based on its battery technology, and on its plans to become a global mass-marketer of affordable, viable electric cars. The problem is that the global window of opportunity for new electric-car makers is likely to be a narrow one, assuming consumers buy into the technology, with well-funded newcomers such as Tesla Motors (Nasdaq: TSLA  ) racing to get a foothold ahead of rapidly advancing global giants such as Toyota and Ford (NYSE: F  ) . Any new company hoping to be a long-term player in this space needs to get world-class products into the market as soon as possible.

Is there any chance BYD, with its crude products, iffy technology, and falling-by-the-day credibility, can establish itself as a serious global carmaker before the big guys' technology blows past them?

I don't think it can. I wonder if Warren Buffett still does.

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Fool contributor John Rosevear owns shares of Ford and General Motors. BYD is a Motley Fool Rule Breakers pick. Berkshire Hathaway and General Motors are Motley Fool Inside Value selections. Berkshire Hathaway and Ford are Motley Fool Stock Advisor recommendations. The Fool owns shares of Berkshire Hathaway and Ford. You can try these or any of our other Foolish newsletter services free for 30 days, with no obligation. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (8) | Recommend This Article (16)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 11, 2011, at 10:25 PM, jomueller1 wrote:

    The article mentions all the merits of Chinese companies from copying designs to making shoddy products. It may sound strange but compare a German made nutcracker to a Chinese made nutcracker. If you have at least a little bit of sense for quality you rather pay the high price for the German version.

    And so it is with cars. The Chinese brought some car over to Germany and the TÜV, the German association in charge of safety for many products, had the vehicle crash tested. It crashed so badly that the vehicle had no chance of being approved in Germany. It may take the Chinese ten years or more to make some inroads into markets where quality counts.

    As far as I am concerned I avoid Chinese products wherever I can.

  • Report this Comment On March 12, 2011, at 2:55 PM, vaidybala wrote:

    THE Chinese internal market for electric cars is huge, foreign cars will have tough entry points from cost point of view and local support services plus Chinese prefer Chinese products. With this background even though western critics say impressive, but not perfect, Warren Buffett studies businesses ten years or so into future, other only see the now market. This view could make the difference between millionaires and billionaires.

  • Report this Comment On March 14, 2011, at 8:00 AM, andyzhu wrote:

    hope that buffett chokes on his new acquisition, LZ

  • Report this Comment On March 14, 2011, at 9:17 AM, TMFMarlowe wrote:

    @vaidybala: Actually, so far, the market for EVs in China is pretty tiny despite big government incentives, and the two biggest-selling car companies in China are GM (yes, *that* GM) and Volkswagen, both of which have massive dealer and service networks and huge local manufacturing operations via joint ventures.

    John Rosevear

  • Report this Comment On March 14, 2011, at 3:05 PM, TMFMarlowe wrote:

    BYD just released Q4 results... net income down 94% (90 million yuan, analyst consensus expectation was 830 million, a huge miss), sales down for 7 straight months. Q3 wasn't a fluke, apparently.

    John Rosevear

  • Report this Comment On March 14, 2011, at 4:14 PM, omt68 wrote:

    hope that buffett chokes on his new acquisition, LZ

    Now andyzhu, why would you hope anyone choke on an aquisition?

    Could it be that you are envious on Buffet because you think he is a more successful investor than you are?

    If you spend less time being envious and more time applying yourself, you might be a successful investor someday!

  • Report this Comment On March 14, 2011, at 6:33 PM, BuffettJunior1 wrote:

    Buffett wouldn't have bought BYD if it wasnt for Charlie Munger.

    I agree that BYD is pretty much a tech company which makes it very unpredictable.

    Another problem is that its a Chinese company which makes it even more risky. Chinese companies are notorious for accounting fraud.

    I wouldn't buy this stock even if it was trading under a dollar per share.

  • Report this Comment On May 04, 2011, at 12:33 PM, deepestvalue wrote:

    Buffett has made four times his money on BYD. People criticised his PTR buy and he more than tripled his money. They criticised his foreign exchange investment and he exited with a $ 2 Bil. profit.

    Let us see how much he makes on BYD, but he could exit next month and make 300% +profits. I will take that and so should you.

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