China’s BYD was hotly tipped to become a global player. But the company that promises to ‘Build Your Dreams’ is seeing its own dreams dashed. Mark Bursa asks: What next for BYD?

‘Build Your Dreams’, is the company’s advertising hook. But for Chinese automaker BYD, the building work has stopped and the dream has turned into a nightmare.

The company is being forced to issue bonds to clear mounting debts, at a time when recent hikes in interest rates makes issuing bonds a risky and unattractive proposition. Meanwhile, sales are tumbling and the company is riven with internal strife, especially in its domestic sales department.

What’s gone wrong? And can BYD pull out of its current steep financial nosedive and keep its own dreams alive? It seems extraordinary to have to ask these questions about a company that was seen as the Chinese automaker most likely to make a global breakthrough.

BYD’s advanced battery technology gives it a head start in the emerging hybrid and electric vehicle market, while its backing from US investor Warren Buffett gives it financial credibility in the West. BYD turned up regularly at foreign motor shows, even as recently as Geneva 2011, and its executives outlined a consistent, ambitious strategy to start selling in Europe and North America within the next few years, focusing on hybrid vehicles that match the performance of their established rivals.

But at Frankfurt this month, BYD was notably absent, its managers choosing instead to focus on fixing the company’s domestic woes. Those export plans appear back-burnered for the foreseeable future.

Just as well, for if BYD had approached major foreign markets in the same way as it has tackled China, problems would have surely resulted. At the root of the problem is over-ambitious expansion at the bargain-basement end of the market, building short-term market share, but not laying solid foundations for the long haul.

For all the talk about EVS and hybrids, BYD’s Chinese market share has been built on basic, small petrol-engined cars, such as the F3 hatchback and the F1, a copyright-bothering copy of the European market Toyota Aygo – a car that’s not sold in China, so is deemed to be an acceptable BYD original under China’s loose IPR rules.

The appearance of the F1 (sometimes as the F0) at Geneva a couple of years back did set the alarm bells ringing. While such copycat designs were seen as par for the course for many Chinese automakers, BYD had presented a sheen of originality, largely as a result of its EVs and hybrids.

But in reality, sales of these cars have progressed at a glacial pace. The E6 electric hatchback was originally scheduled to go on sale in 2009. But in fact the first serious order – for 250 taxis for the city of Shenzen – only materialised in August 2011, and sales to the general public have yet to start.

The smaller F3DM hybrid, which boasts the sort of plug-in hybrid technology that Toyota is about to launch on the Prius, has been on sale since late 2009. But in 2010, only 417 units were sold, while sales in 2011 are hardly steaming ahead, with only 395 sold to the end of August.

The reality is these cars are too expensive for the Chinese market, and the infrastructure to support them is not there. So really, BYD has had no choice but to sell simple, cheap petrol-engined cars. And it’s done this very successfully – in 2009, the standard non-hybrid F3 model was China’s single best-selling car with 291,000 sales, while BYD’s total sales of 448,000 pushed it up to sixth-biggest manufacturer in China. It looked like a very impressive performance for a company that had only built its first car five years earlier.

But the 2009 market was largely propped up by Chinese government incentives on small cars – exactly the sort of cars that BYD was selling. The incentives were intended to keep the Chinese market growing – but in fact they proved to be too effective, resulting in an overheated sector. This year, China has sought to put the brakes on the economy – so out went the incentives. And once the incentives stopped in mid-2010, BYD sales started to slow.

Unfortunately, BYD had been planning for growth. BYD Auto was headed by Xia Zhibing, one of BYD chairman Wang Chuanfu’s most trusted lieutenants. Xia had set about an aggressive dealer recruitment drive in a bid to secure 800,000 sales in China in 2010. But without incentives, this proved impossible – sales peaked at 520,000 in 2010, and in the first half of 2011 just 220,000 cars were sold, a decline of 23%.

As a result, Xia was forced to resign in August, amid rumours of cutbacks, redundancies and reassignment of dealer personnel to manufacturing jobs elsewhere in the BYD group. Under Xia, the number of BYD dealers had doubled to 1,200 between 2008 and 2011. But sluggish sales left dealers with lots full of unsold stock. Many have closed or quit the network.

In a humble apology – read and weep, Rupert Murdoch – Xia said: “For my own eagerness for quick success and instant benefit, I misled the company sales team. I demanded too much. Too much pressure was on the sales team. I hurt our dealer friends.”

The collapse in sales hasn’t just affected the dealer network. It’s had a devastating effect on BYD’s Hang Seng-listed share price, which has collapsed from a peak of HK$85 to around $15, leading to speculation as to whether Warren Buffett might cut his losses and sell his stake.

This does seem unlikely, despite a financial collapse that saw profits tumble 88% in the first half of 2011. Despite the slow start to EV and hybrid sales for BYD, there is every indication that China will become the global growth engine for EVs. The Chinese government has yet to define fully its policy on alternative fuel vehicles, but things are starting to happen.

General Motors has this week announced an EV alliance with its long-standing Chinese partner Shanghai Automotive, and this will help to put pressure on China to provide incentives for EVs and hybrids. BYD also has an alliance with Daimler, and its expertise in battery technology will put it in a strong position once the market starts to gather pace.

That won’t be a short-term solution. So in the meantime, BYD is being forced to offer 10-year bonds in a bid to raise up to US$1bn in cash. Not easy in the current market, where Chinese government bonds offer decent yields already. BYD will have to offer better returns – at a time when its profits are falling. The timing of the bond issues will be crucial – a business recovery would be helpful, but for that to happen, BYD would have to be selling more profitable cars through a less overheated sales structure.

Things happen quickly in China. But BYD faces a tricky couple of years. Perhaps its impressive technology will prove to its salvation. Daimler is already looking to use BYD battery technology in a China market car, and it’s possible that BYD could develop its business by supplying batteries and EV technology to foreign automakers, just as it does for makers of laptops, tablets and mobile phones.

So maybe BYD will pursue a different dream, as a dominant Tier 1 in the emerging electric-powered automotive world rather than a car brand. It might be the model that makes most sense for Chinese firms to gain a slice of the global market, focusing on technology and cost, rather than trying to build a brand – a process that has taken the Koreans 20 years or more, and would be even tougher for the Chinese to achieve today.

Mark ‘Coolbear’ Bursa