China goes car crazy

Geely's Li Shufu hopes the Emgrand will help the company break into Western markets. Photo / Bloomberg

In a sprawling factory south of Shanghai, Li Shufu, the self-made Chinese billionaire who is poised to buy Volvo from Ford, is presiding over a new-model launch party. If he has any concerns that his Geely Automobile Holdings' rising sales and surging stock price could falter, he's not showing them.

Geely, the publicly traded carmaker that Goldman Sachs is backing to the tune of US$334 million ($473 million), is unveiling its first homegrown model specifically designed for Western markets.

The gleaming white four-door compact, which retails for US$11,700 to US$17,600 in China, is called the Emgrand, a name made up to conjure grandeur.

To the strains of the company song, willowy models in split-to-the-thigh cheongsams pin bouquets on pudgy Communist Party VIPs. Policemen salute as the first Emgrands leave this plant in the port city of Ningbo through clouds of theatrical smoke.

Li, Geely's chairman, already has an international car business. Since 2006 Geely Automobile has been a 23 per cent shareholder in the company that's the biggest maker of London's iconic black cabs. In October Ford named Geely Holding Group, Geely Automobile's parent, as the preferred bidder for Volvo. In December Ford said the companies had agreed on most terms of the sale, which is expected to be completed soon. As Li, 46, answers questions at the factory, a reporter asks whether he wants to emulate Japan's Toyota. Toyota, the biggest carmaker in the world, lost 437 billion yen ($6.8 billion) in the year that ended on March 31, 2009.

"Why should I want to be Toyota?" Li deadpans. "They're losing billions."

If any product illustrates China's place in the new economic order, it's the automobile. The country has averaged 10 per cent annual increases in gross domestic product since 1978 - growth that has helped turn a nation of bicyclists into a land of car-craving consumers.

China, with its 1.37 billion people, last year overtook the US to become the world's largest vehicle market by sales. The Government projected that car sales for the full year would soar 39 per cent to more than 13 million vehicles. In November alone, they shot up 96 per cent.

This year sales may rise more than 10 per cent to about 15 million units, according to the country's Ministry of Commerce.

While US manufacturers shrink, China had 117 carmakers at the end of 2008, according to the China Association of Automobile Manufacturers.

Amid a global recession, the collapse of Detroit and trouble at Toyota, investors are wild about China's prospects. Geely, in which a Goldman-managed fund holds bonds and warrants that can be converted into 15 per cent of the company, saw its shares jump 573 per cent on the Hong Kong stock exchange last year - more than 10 times the rise in the benchmark Hang Seng Index.

Another Chinese carmaker, BYD, has attracted investor Warren Buffett. In September 2008 he paid US$232 million for a 10 per cent stake in BYD, maker of the world's first commercially available plug-in hybrid, an electric-powered car with a small petrol engine for backup. BYD shares surged more than fivefold last year. Shares of six other Chinese car companies, including SAIC, China's biggest domestic manufacturer, have at least tripled. Goldman's September 2009 investment in Geely increased in value by 50 per cent in the first two months.

"Geely's track record of growth, profitability and innovation has impressed us," says Andrew Wolff, Hong Kong-based head of Goldman's merchant-banking division in Asia outside Japan.

Charles Munger, vice-chairman of Buffett's Berkshire Hathaway, is equally bullish on Berkshire's investment.

"BYD is one of the most interesting small companies in the world," Munger told Bloomberg Television in May.

Now, spurred by the Government, Chinese automobile companies are challenging Western, Japanese and Korean rivals on the global stage. By 2015 China is aiming for 10 per cent, or an US$85 billion share, of the world's vehicle and car parts sales, the Ministry of Commerce said in November.

"There's no doubt that 2009 marked the year that China became king of the automotive hill," says Michael Dunne, president of Beijing-based Dunne & Co, which advises fund managers on buying shares in Chinese carmakers.

There may be roadblocks ahead. The most immediate threat would be if China's Government winds down its US$586 billion stimulus at the end of this year. The incentive package has given tax breaks and subsidies to more than 700 million rural residents, enabling them to buy minivans and light trucks for as little as US$3800.

Already, in December, China said it would raise the sales tax on cars with engines of 1.6 litres or smaller, although not to pre-financial crisis levels.

And a bid for General Motors' Saab operation, backed by another Chinese carmaker, Beijing Automotive Industry or BAIC, came unstuck. BAIC ended up paying US$200 million for some of Saab's technology, according to a December statement.

Chinese carmakers, including Geely, have yet to make inroads into developed markets partly because quality, safety and brand recognition still lag behind rivals.

At home the car frenzy has sparked traffic jams and worsened air quality in some of the world's most polluted cities. Profit margins in China can be fractions of what they are in the West. And the torrid growth that's luring investors may slow to 10-15 per cent in 2010, according to SAIC and Volkswagen, which sells more cars in China than in its home country of Germany.

"This is a crucial time for Chinese carmakers," Dunne said in December. "What happens in the next six months will have a major impact on whether they will succeed or struggle."

The US shows how the top car market can stumble. Sales last year fell to about 10.3 million vehicles from 13.2 million, said research firm J.D. Power & Associates.

GM amassed US$88 billion of losses from 2004 through the first quarter of last year before it was forced into bankruptcy on June 1. After emerging on July 10, GM lost another US$1.15 billion in the third quarter. Chrysler sought bankruptcy protection on April 30, after losing US$8 billion in 2008. It emerged, slimmed down, as Chrysler Group last June.

Khiem Do, who oversees US$7 billion at Baring Asset Management (Asia) in Hong Kong, says some Chinese companies have risen too far. He's sold car holdings that he declines to name.

In December he still liked Dongfeng Motor Group, China's fourth-biggest carmaker, which has joint ventures with Honda, Nissan and PSA Peugeot Citroen. Its sales leapt 91 per cent in November from a year earlier and its shares rocketed more than fourfold last year, reaching a price-earnings ratio of 22.

"We still don't think it is outrageously expensive," Do says.

China's growth has spawned a class of super-rich, who are snapping up luxury models. Last year the country had 130 billionaires and 825,000 people with a net Continued from page 13

ICONS ACQUIRED: London's black cabs are already Chinese-made, and Yang Yi, of Sichuan Tengzhong Heavy Industrial, with Jim Taylor of GM's Hummer operation, has a deal to buy the US brand. Pictures / Bloomberg

worth of at least US$1.5 million, according to research firm Hurun Report.

This year China will overtake Britain to become the third-biggest market for Mercedes-Benz vehicles, after Germany and the US, says Klaus Maier, who heads the Chinese operations of the division of Daimler AG. He estimates that Mercedes sales in China rose by 65 per cent last year. And BMW, the world's biggest luxury-car maker, announced in November that it would build a US$732 million factory in China. Sales of BMW's vehicles, including the Mini, jumped more than 37 per cent in China in the first 11 months of last year. BMW makes cars in a venture with Brilliance China Automotive Holdings, a Hong Kong-listed company whose shares soared more than fivefold last year.

The Chinese are fast-tracking their global strategies by acquiring Western brands, sometimes at bargain prices. In 2006 Geely acquired 23 per cent of Manganese Bronze Holdings, the Coventry, England-based maker of London cabs. The £55 million ($124 million) deal enables Geely and Manganese Bronze to manufacture the taxis in Shanghai, where some workers earn one-30th of the average salary of their British counterparts, says Geely executive director Lawrence Ang.

In March Geely purchased the assets of Australian gearbox maker Drivetrain Systems International, which was operating under a receiver and in the process of liquidating, for A$47.4 million ($59 million). Buying the world's No 2 independent maker of automatic gearboxes gives Geely more advanced technology for its automatic transmissions.

Other Chinese carmakers aren't standing still. In September state-owned BAIC joined a bid to buy GM's Saab for an undisclosed price in a partnership led by Swedish sportscar maker Koenigsegg. After Koenigsegg pulled out in November, BAIC said it had reached an agreement with GM to buy some Saab assets, including vehicle platforms and turbo-engine and gearbox technology. The company said it would use the technology to develop as many as four car models and three turbo engines.

In October Chinese heavy-equipment maker Sichuan Tengzhong Heavy Industrial Machinery struck a US$150 million deal to acquire GM's Hummer brand.

Li says the acquisition of international names will help Geely gain customers at home, where only 38 Chinese in 1000 own a car. That compares with 985 per 1000 in the US driving population, according to J.D. Power.

China is still dominated by joint ventures of foreign carmakers and state-owned enterprises such as SAIC, which between them have about 55 per cent of the car market, excluding SUVs, minivans and multipurpose vehicles, according to Bloomberg calculations. BYD, founded by entrepreneur Wang Chuanfu, and Geely have less than 7 per cent apiece.

"We need to show domestic consumers that foreign customers like the Geely brand," Li says. "We can become stronger and stronger by getting into European and American markets."

China's modern car industry began to take shape in 1978 when there were barely 1 million cars - or 2 per cent of today's total - and hardly any in private hands. The world's most populous nation was emerging from 30 years of doctrinaire communism. Reformist leader Deng Xiaoping was desperate for technology and allowed Western carmakers to build and sell in China - if they took a Chinese partner.

The first such venture - between the old American Motors, later taken over by Chrysler, and Beijing Auto Works, a predecessor of BAIC - began disastrously. AMC was making the Jeep Cherokee, while the Chinese company was manufacturing a military vehicle based on a Soviet design in a primitive factory called The East Is Red.

In 1983 the two companies agreed to produce what would become the Beijing Jeep. Cultural differences proved almost insurmountable, according to Jim Mann, author of the book Beijing Jeep. The Chinese were shocked by a dealer gathering in Las Vegas that featured bikini-wearing showgirls and a performance by the Beach Boys. The Americans were horrified that Chinese workers kept beds in their offices for afternoon naps. In 1985, on a trial run of the assembly line, the first Chinese-built Jeep had to be pushed out of the factory because it wasn't drivable, Mann wrote.

By then, however, China's economic boom was creating consumers and entrepreneurs. Among them were Geely's Li and BYD's Wang.

Li made his first yuan photographing tourists. In 1986 he began manufacturing compressors for refrigerators. He switched to motorcycles three years later and produced his first car, a subcompact, in 1997. In 2005 he listed Geely Automobile on the Hong Kong exchange. Today his 50 per cent stake is valued at almost US$2 billion.

Financially, Wang has done even better. Orphaned in his teens, he started making batteries for mobile phones before launching petrol-powered and plug-in hybrid versions of a compact car called the F3. Since Buffett's investment, BYD's market value soared to US$19.6 billion at the end of last year, making Wang's 25 per cent stake worth US$4.9 billion.

Last year the petrol-powered F3 was China's biggest seller, ahead of the Hyundai Elantra Yuedong and GM's Buick Excelle.

China's car lust is propping up some of carmaking's biggest names. GM's sales in China soared 63 per cent in the first 11 months of last year, while they fell 32 per cent in the US.

"I firmly believe that China saved GM," says Klaus Paur, Shanghai-based North Asia director for TNS Research International in London. "Without the good performance of the General Motors joint venture in China, it would have been much more difficult for GM to emerge from bankruptcy."

Half of the Chinese sales were of Sunshine minivans, which start at US$3800.

"Our China business has been profitable from Day One," Fritz Henderson, GM's former chief executive, said in November. "That business is throwing off cash."

Volkswagen, Europe's biggest carmaker, reported an 86 per cent profit plunge in the third quarter last year. Again, the bright spot was China, where it plans to invest €4 billion ($7.9 billion).

"This is probably the most competitive market in the world," says Joerg Mull, Beijing-based executive vice-president of Volkswagen Group China.

China's growth lured Ford CEO Alan Mulally to Chongqing, a smog-shrouded megalopolis of 32 million people 2250km up the Yangtze River from Shanghai.

On a grey September morning, Mulally and executives leave their downtown hotel in a convoy of Ford Mondeos to break ground in a muddy field for a US$490 million, 1 million-square-metre factory - Ford's third in China.

Ford makes the Focus and other models with Chongqing Changan Automobile, a former weapons manufacturer that graduated to clocks and other consumer products before going into the car business in 1983.

Mulally, 64, is in an ebullient mood despite the drab surroundings as he's greeted by an all-female brass band whose musicians wear bright blue uniforms, scarlet lipstick and high heels that are sinking slowly into the mud.

"We have got to get a picture of that all-woman band," he whispers to an aide. Mulally is even more impressed by the business opportunity. Unlike its two biggest US rivals, Ford wasn't forced into bankruptcy despite losing a record US$14.7 billion in 2008. Last year it made a US$2.7 billion profit.

Still, since Mulally took the helm in 2006, Ford has closed more factories than it has opened. And Ford's sales of cars and light trucks in the US were little changed in November while they more than doubled in China.

"We are very gratified at how dynamic the Chinese market is," Mulally says.

Chinese car companies are benefiting from a brain drain in Detroit. In a northern suburb beyond Beijing's 2008 Olympic village, BAIC is celebrating the 1 millionth vehicle to roll off its lines in 2009.

At first glance, the carmaker exudes the air of an unreconstructed communist behemoth as the event begins with the socialist anthem Internationale. Then the company president starts talking about his global ambitions in American-accented English.

Wang Dazong, 55, who has a PhD in mechanical engineering from Cornell University in Ithaca, New York, worked for GM for 22 years. He rose to director of engineering and even acquired a US passport. In 2007 he left GM to return to China. He worked as vice-president of SAIC before being appointed president of BAIC in 2008. Today Wang has about 30 former US car executives on his team.

"In Detroit I was always downsizing, downsizing, downsizing," he says. "Here, it's nothing but growth, growth, growth."

Wang's car empire is China's second fastest growing by virtue of its joint venture with South Korea's Hyundai that makes two-thirds of Beijing's taxis. BAIC also has ties with Daimler. That venture makes Mercedes-Benz cars. BAIC also owns publicly traded Beiqi Foton Motor, the world's second-biggest truckmaker. Beiqi shares almost quadrupled on the Shanghai stock exchange last year. Geely's Li has also been headhunting Detroit talent. His research chief, Frank Zhao, formerly a research director at Chrysler, returned to China in 2006 after 18 years in Japan, Britain and the US.

While Dunne & Co's Dunne says Chinese carmakers are at least three years behind foreign rivals, Zhao says Geely's technology is sound enough to compete internationally.

"We are at least as good as the Koreans," he says.

Speaking at the launch party last summer, Li reflects on Geely's new Emgrand.

"It's the best yet for a homegrown model, but I am still far away from realising my dream," he says. Then he escapes a pack of Chinese reporters by leaping into one of the London-style taxis he manufactures in China.

If he's successful in closing his next big deal, he'll be able to use a more luxurious getaway vehicle - a Volvo.

- BLOOMBERG