Thursday, August 25, 2011

Buffett, Berkshire, BYD and The Greater Fool Theory in Practice


 BYD, the Chinese automaker whose name stands for “Build Your Dreams,” couldn't be more aptly named.
 A Chinese rags to riches story, its shares were given the good housekeeping seal of approval several years ago when Warren Buffett bought a 10% stake after his notoriously dour, skeptical (and brilliant) business partner, Charlie Munger, convinced Buffett that the company was not just a car company, it was an engineering marvel with a shot at world domination thanks to breakthrough battery technology.
 Here’s how Munger defended the unusual investment—unusual for Buffett, who prefers low-technology to high-technology, and closer-to-home rather than halfway around the world—at the Berkshire Hathaway annual shareholder meeting two years ago:
 “BYD, while its founder is only 43 years old, it’s not some early stage venture capital company, it’s one of the world leaders of rechargeable lithium batteries…  From a standing start of zero he created the best selling model in China.  This is not some unproven, highly speculative activity—it’s a damn miracle….”
 And Munger, whose distaste for con artists and unproven business models is as well known as his dry wit (read “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett” for some fun examples, didn’t stop with encomium for BYD—he applied it to the entire country:
 “You get a remarkable aggregation of human talent, which when unfettered by the wrong kind of government, they succeed mightily—when they came to this country as coolies, slaves, they would leave and become the most important people in the town, so these are a remarkable people.”
 Of course, Munger was speaking two years before a likewise remarkable number of Chinese scams went public in the U.S., thus paying back, it might be said, some small part of the debt owed by the American railroads to their ancestors. 
 But if Munger’s na├»ve-sounding enthusiasm was premature, it was earnest, and based in large part on the chance for BYD’s supposedly revolutionary battery technology to help solve the great problem of how to store wind and solar-powered energy so it can be used when and where it is actually needed, as opposed to the Mohave Desert:
 “These lithium batteries are a remarkable technology, we need them.   I know it looks like Warren and I have gone crazy, but I don’t think we have…
 “It may be a small company but its ambitions are large, and I don’t wanna bet against 17,000 Chinese engineers led by Wang Chuanfu I would be amazed if great things don’t happen here.”
 Now, great things did indeed happen at BYD.  In this decade alone, sales grew almost 40-fold, gross profits 20-fold, and pretax income 15-fold.
 And the share price really took off after Berkshire invested a quarter-billion U.S. dollars in the company in 2008.
 Technically, of course, it was MidAmerican Energy Holdings that acquired the stock, buying 9.89% of BYD for $8HK per share.  And in what might now look like a giant red flag for Berkshire shareholders, it was MidAmerican’s CEO at the time, David Sokol, who went to China to look the company over before Buffett approved the investment (Munger recused himself—appropriately—from the decision-making, because his family had owned BYD shares for some time, a fact Sokol later tried to use, lamely, in his own defense after making undisclosed purchases in Lubrizol shortly before Berkshire announced a deal to acquire that company).
 Unfortunately, Sokol may have done Buffett no favors in encouraging the BYD investment, for while BYD shares soared immediately after the announcement, reaching $88.40HK—10 times Berkshire’s cost—they have since returned to earth ($15.40HK last sale) after a series of missteps, including missed sales forecasts in the bread-and-butter car business, an 88.6% profit drop in the most recent half-year results, and a series of missed deadlines for delivery of the company’s revolutionary electric car.
 This last is most worrisome for Munger’s optimism, which he maintained when asked about BYD’s setbacks at the most recent Berkshire shareholder meeting:
 “Any company that tries to move as fast...is going to have its glitches...I'm quite encouraged...”
 But we would not be so sure, particularly after asking an acquaintance from a large and prosperous US-based company, which has been making car batteries for almost 100 years, about BYD’s so-called revolutionary technology.
 The acquaintance shrugged.  “We don’t know much about it.”
 “You guys make batteries.  How come don’t you know?”
 “We don’t work with them.  They make everything themselves.  Everything.  We don’t know what their technology is.”
 “Well, what do you think it is?”
 Another shrug.  “Batteries hold a charge.  It’s how you put them together that makes them better or worse.  We don’t know what they do.”
 “Well, what do you think they do?”
 He speculated that part of the answer lies in the fact that the expected life of a car battery in China is shorter than in the U.S.  “They might only get five years out of it.  We build ours to last 10 years, which means they’ll last 15.  But what they’re doing in lithium, we don’t know.”

 Thus far, the “margin of safety” by which Warren Buffett lives (read “Secrets in Plain Sight” for the meaning behind this phrase), has protected Berkshire Hathaway from an embarrassing loss on its BYD investment.
 But while speculation rages that Berkshire will up its stake in the company, the speculation is dead wrong.
 Warren Buffett is no fool: he can read a balance sheet, and he can read a cash flow statement…and he could have easily bought all the new BYD shares he wanted when the company offered them recently on the Shenzhen stock exchange, supposedly for “research and development.”
 Against all odds—the weak sales, the State Department cables describing BYD’s alleged copycat cars, and the delayed electric car introduction—the BYD offering was 21-times oversubscribed.

 The greater fool theory lives.
  

Jeff Matthews
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2011)    Available now at Amazon.com


© 2011 NotMakingThisUp, LLC
                                                             
The content contained in this blog represents only the opinions of Mr. Matthews.   Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.  This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever.  Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored.  The content herein is intended solely for the entertainment of the reader, and the author.

16 comments:

Namazu said...

Jeff: I eagerly await your take on the question of whether Mr. Buffett has just made an in-kind campaign contribution in the form of an NYT editorial in exchange for material non-public information on BAC, delivered by an unimpeachable source from Martha's Vineyard.

Jeff Matthews said...

Namazu: I give it zero credibility. I've heard all kinds of conspiracy-theory stories about Buffett over the years, from all kinds of sources--unimpeachable and impeachable--and while he has a much bigger ego and cares much more about what people think of him than anyone might guess, he isn't stupid.

A. He can write editorials for the NYTimes any day of the week he wants to;
B. He knows more about BAC's financials than any unimpeachable source.

JM

Anonymous said...

Hilarious -- I was the first Anonymous commenter on your BYD post last year ( http://jeffmatthewsisnotmakingthisup.blogspot.com/2010/08/buffetts-possible-successor-it-aint.html ). Aside from the typos and bad prose, I'm glad it stood up so well. If only I had gone short.

"It's great at copying, it's great at keeping decent quality, and it's great at doing so cheaply. ... But it's not world changing."

It definitely seems like a Buffet investment -- except that everyone keeps talking about it like its revolutionary.

Anonymous said...

My memory about BYD was that Buffet et al were really excited about the CEO. If you look at all of Buffett's acquisitions, they are successful mostly because Buffett is a good judge of people. In this case I think Buffett made the investment based on the CEO with the 'technology' being a secondary feature.
So why is he such a supporter of Obama, probably the worst president the US has ever had? Even the Democrats are comparing him to Carter (who actually helped set up the conditions for the 1980's boom by deregulating transportation).

Anonymous said...

Buffet is a great investor, there is no doubt about it. Like Ed Thorp suggested he's a full Kelly bettor.
Agree with you that he knows & understands more about BAC's financial than any unimpeachable sources. But not more than the current management. It's good bet but not the way presented by buffet. It's more like the bet's tepper, paulson & gross made during 2009 understanding that the govt stood behind those banks and they'll get the all upside and little downside. All buffet did was extract an even sweeter deal then those managers. It's simple probability ( like he once said about salmon investment " It's a treasury bill with a lottery component for free", though his returns on that were not big enough to talk about). What would have happened to his stakes in BAC,WF,GE e.t.c & his networth if the govt did what Sweden did and made bond holders and equity holder hold the bag. He's talking his book in a folksy manner & clever wit, like he's archemedis and hasn't gone about the idea that struck him in the bath tub. Do no be fooled by his do as i say not as i do.(full disclosure - i've bought options & shares of C,WF,BAC in feb 2009 which netted me substantial profits that i encashed in late 2010, just by understanding that the govt is not going to do anything drastic.)

mark said...

do you know for a fact that he did not increase his BYD stack since he did not need to file with SEC , I thought. I am just curious.

Kyle said...

To the second anonymous, "So why is he such a supporter of Obama, probably the worst president the US has ever had?". This is obviously not a political blog but I can't let this one slide. Worst president ever? I think you might have had amnesia from 2000 to 08. I serve in the military and rather like presidents that don't send people into harm's way without careful consideration. You worry about your marginal tax rate, and I'll worry about my friends and family that hike in the thin air of kandahar, jerk.

Jeff Matthews said...

Regarding Mark's question on Buffett's "BYD stack," well, we don't know if he increased his "stack" or not.

Regarding the political back and forth between some readers, we're bordering on Yahoo message-board stuff here, which is not tolerated. Keep it clean and rational, and stick with the fundamentals.

And Mark, check your spelling first.

JM

bjdubbs said...

http://www.nakedcapitalism.com/2010/10/guest-post-tim-geithners-magical-mystery-tour-of-tarp-propaganda-has-little-use-for-truth.html#comment-203986

Funny and possibly true account of encounter with Munger.

Kyle said...

I would like to replace most of the anger in my first post with a brief and conciliatory explanation. I have never been to war but I've been close enough to know that it will take you places you don't want to go. Much like watching some one wipe out big wave surfing, from the shore it looks like fun and that the wipeout is probably not so much. Get out in the big waves, wipeout and get rag dolled once and you will see the ocean with a level of humility and fear that you should have had from the beginning. I like our leaders to be very wary of war. You don't like Obama? Fine, understandable but W. sent us to war with such a gunslinger cavalier attitude because no one he loved or knew had to face any danger. Sorry about the rant. I'll post only on topic from now on. I don't post often because I am painfully aware that I'm outgunned by IQ or financial experience and often times both.

Jeff Matthews said...

Kyle, well said, but don't worry about being "outgunned" by financial types here. Some of the dumbest decisions in the world are made by the smartest, most well-educated MBAs. Like HP's buy of Compaq, which they took years to admit was dumb and only recently got around to doing something about it.

JM

Rich said...

I have been following this blog for quite some time but have never been compelled to write something until I saw the comment about MBA dumd decisions - very well written, Jeff! Your straight-forward commentary and analysis is one of the reasons I keep coming back.

As an aside, is there anyway to assign a # to the Anonymous posts? It is sometimes hard to keep track of comments referring back to just "Anonymous" when there are several.

Kyle said...

If I may offer a suggestion, putting a guideline to posting on the front page of your blog might be a good idea. I know most of your limits only because I've been reading your posts and comments for a long time. No swearing, even the yosemite sam simulated symbol swearing. Politics should be civil and bare minimum. Other areas are a bit more gray to me, outright solicitation I assume is a no no but recommendation of things of interest such as blogs or books is acceptable assuming no financial interest or at least disclosure would be acceptable. Am I wrong, or missing something?

Jeff Matthews said...

Rich, I'm not sure but it's a good thought. Maybe the geniuses at Google have dealt with it somehow, and our "tech support department" only needs to find it. We'll check.

Kyle, that's an excellent suggestion. I think we'll add it below the disclaimer and right above the "Comment" button. Much thanks.

JM

deaner said...

Kyle, on other blogs people often refer to posts (particularly anonymous ones) with the time: "Anonymous 10:36 am" would refer to the first anonymous post in this thread, for example.

This seems common where there are many more anonymous comments - fortunately there are fewer here, but adoption of this convention could be at least part of a solution. I don't know whether Blogger offers post numbering, although other platforms (Word Press, perhaps?) seem to do.

deaner said...

Ooops.
My last comment was directed at Rich's suggestion.

Apologies for any confusion.