Warren Buffett to purchase 10% of BYD

The Sage from Omaha spends $230 million on a stake in the world's second largest rechargeable battery producer as the company nears completion of its first electric car.
MidAmerican Energy Holdings, a subsidiary of Warren Buffett's Berkshire Hathaway, has agreed to purchase HK$1.8 billion ($230 million) of shares in Hong Kong-listed BYD Company, the world's second largest producer of rechargeable batteries. MidAmerican will subscribe to 225 million new H-shares at a price of HK$8 per share, representing a discount of 4.8% to the closing price last Friday.

The shares represent approximately 9.9% of BYDÆs enlarged share capital, and 28.4% of its enlarged H-share capital.

The deal gave BYD's shares a massive boost. Trading in the stock was suspended yesterday morning at the company's request, but resumed after lunch at which point investors jumped in to get a share of what Buffett supposedly regards as an undervalued stock. By the end of the session, the share price had gained 41.7% to HK$11.90, having opened as high as HK$16.

BYDÆs major products include computer components û such as rechargeable batteries, liquid crystal displays and plastic casings û but MidAmerican is most attracted to the electric cars that it is currently developing. BYD expects to have its first car to be fully powered by electricity out by the end of the year.

The Shenzhen-based battery maker was established in 1995 and listed in Hong Kong in 2002. It has 10 million square metres of production space spread across seven facilities û in Guangdong, Beijing, Shanghai and Xi'an. It also has branches elsewhere in Asia and in the US and Europe.

Wang Chuanfu, president of BYD, welcomed the deal as a "confirmation of our strategic insight". He said the investment by Warren Buffett will be a strong endorsement, especially if BYD tries to further break into the US market where it has little recognition.

In a research report J.P. Morgan described the investment as "a huge vote of confidence for BYD: we believe this endorsement should boost confidence for investor and existing companies of BYD, which has suffered poor publicity from legal lawsuits with [Foxconn International Holdings]".

In addition to the public relations boost, the report says MidAmerican will assist BYD with its funding needs. As of the end of 2008's first half, the Chinese company had net debt of Rmb4.8 billion ($615 million) and growing capital expenditure needs over the next year as it expands the division focusing on automobiles. After the investment, the gearing is expected to fall to 32% from 50% before the deal.

David Sokol, chairman of MidAmerican, cited BYD's management and the quality of its research as incentives to go ahead with the deal. He maintained that MidAmerican would be a long-term investor, in keeping with Buffett's investment philosophy. Sokol will take a seat on the company's board as a non-executive director.

BYDÆs earnings in the six months ending June 30 were mostly positive. Turnover was up by 44% to Rmb12.39 billion ($1.8 billion), and gross profit rose by 31% to Rmb2.3 billion. Basic earnings per share were down by 7%, however.

This investment is somewhat atypical for the world's most famous value investor, since BYD looks somewhat like a growth story, with much expectation pinned on the electric cars, which are yet to prove themselves as a mass market product. It is also unusual in that Buffett normally favours companies which have a simple business model, with strong brand recognition, usually in the consumer goods sector. Again, a Chinese company focusing on batteries doesn't seem to fit into the mould. It does however meet his demand for a return-on-equity of at least 15% as BYD is returning about 20%.

But it should not be forgotten that Buffett became the world's second richest person due to his exceptional prescience û maybe once again by stepping outside of his own scheme he has been able to spot an opportunity that the rest of the market has failed to notice.
¬ Haymarket Media Limited. All rights reserved.
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