Stuttgart to Shenzhen

Investment Note #19 - 27th September 2024

Stuttgart to Shenzhen

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Synopsis

• During the 2021 equity bull run, the automotive industry was in a blissful state of electric vehicle (“EV”) euphoria. The legacy automakers churned out optimistic sales forecasts fuelled by exciting new EV developments.

• The shakeup caused by EVs is among the biggest the industry has seen in the past century, but not in the way the legacy automakers would have liked.

• To the delight of new entrants, EVs have more in common with a smartphone on wheels than an internal combustion engine (“ICE”) vehicle. The barriers that prevented countries like China from dominating the industry have swiftly fallen.

• Three years ago, as Tesla’s valuation surpassed $1 trillion, most people had assumed they would dominate the EV industry for decades to come. However, initial optimism faded thanks to a surge of Chinese EVs flooding the global market, outpacing legacy automakers and Tesla in both pricing and technological innovation.

• This investment note will explore how China quietly emerged as a leader in the EV industry.

All Quiet on the Eastern Front

• In the early 2000s, China’s car industry was struggling. While the country was a manufacturing powerhouse, it had failed to develop a successful auto industry.

• China has long aimed to transition from being the "world's factory" of low-value manufacturing to a global leader and technological powerhouse. The Chinese Communist Party (“CCP”) hoped that this transition could be done, in part, through their auto industry. But it never fully clicked.

• As South Korea and Japan showed, it takes decades of significant investment and strong leadership to develop the engineering know-how, intricate supply chains and talented labour force to make a successful auto industry possible.

• This was a level of patience China didn’t have. “You would have to invest billions of dollars for another 20 years, and maybe then we would be getting close to the Germans,” says Shen, founder of the Chinese EV company WM Motors, as he refers to the failure of ICE manufacturing in China - “It’s hopeless” (Source: The Economist, 2020).

Jammed

• This struggle was particularly evident in supply chains. Thousands of intricate and tailored parts must come together precisely to orchestrate the perfectly timed string of explosions necessary to generate torque.

• China struggled to develop the expertise to produce these components in-house, and tapping into supply chains with existing manufacturers was equally challenging.

• Unlike electronics, ICE manufacturing requires close collaboration with suppliers, who often prioritise their established relationships with legacy automakers. China was shut out.

All on Black

• After this realisation, the CCP decided to largely break away from the existing technology, and instead leapfrog to the top of a new industry.

• This strategy began as early as 2001 when EV technology was made a ‘priority science’ in the country’s 5-year plan (Source: The Guardian, 2024).

• The timing aligned perfectly with the early days of EVs, two years before Tesla was founded and seven years before Elon Musk took charge of the company.

• The real push started in 2007 when Wan Gang, a former Audi engineer, became China's minister of science and technology. Wan is credited for deciding to go all-in on EVs. Since then, developing a domestic EV industry has remained a priority in national economic planning (Source: MIT Technological Review).

How Was It Done?

• The CCP facilitated this through an array of targeted policies, investments and incentives that focused the country’s vast resources on the growth of the sector.

• Government Spending: From 2009 to 2023, the CCP invested an estimated $230 billion into EVs through subsidies, tax breaks, and infrastructure investment (Source: CSIS, 2023).

• Made in China 2025: The country’s ambitious ‘Made in China 2025’ policy further prioritised EVs and sought to reduce dependence on foreign technology.

• Local Initiatives: In major cities, initiatives were struck to boost sales to local EV manufacturers – as an example EVs were prioritised for new vehicle registration and cities like Beijing required all new taxis and buses to be electric.

• In comparison, the EU’s investment in EVs and EV infrastructure has been less effective due to China’s decade-long head start and greater public-private coordination.

Charged Up

• We mentioned EVs function more like a smartphone on wheels than an ICE vehicle – this largely comes down to the batteries and the lack of mechanical systems (i.e. moving parts).

• China is the world’s leading producer of batteries, the most expensive and technologically critical component of EVs.

• “Coincidentally”, the country also dominates the global supply chain for critical minerals like lithium, cobalt and nickel - which are essential for battery production.

• China's dominance in battery production and innovation, driven by firms like CATL and BYD, has solidified the country’s lead in the EV market. Early investment in the technology created a moat that Western automakers are struggling to cross.

• Meanwhile the Swedish company, Northvolt, that has been Europe’s hope for an alternative to Chinese batteries, is close to collapsing due to low demand and competition from China. This week alone the company cut 1,600 jobs.

Build Your Dreams Limited

• The industry's growth is exemplified by BYD, a company that started as a battery manufacturer in 1995. In 2003, the company leveraged its experience in battery technology to manufacture EVs that are not only affordable but also technologically competitive.

• This wouldn’t have been possible without the government’s support. BYD’s annual reports show $2.6 billion in government subsidies from 2008 to 2022.

• The company has established itself on the international stage. They’re currently fighting for the top spot as the world’s best-selling EV brand, a position currently held by Tesla. ‘Inside EVs’ has projected that BYD will pass Tesla by the end of the year.

Conclusion

• Historically, China has focused on the less attractive, lower-end manufacturing, while leaving the high-value consumer products to the West. China has been trying to change this and while EVs are its first major success, it may not be the last.

• The reaction has been a wave of protectionist policies in both the US and Europe as governments jump to defend their national interest.

• The Draghi report issued this month provided more colour on the future of European competitiveness. The paper demanded “a new industrial strategy for Europe” and called for investment of €800 billion a year (yes, a year!) to stop Europe from falling behind China and the US (Source: Financial Times, 2024).

• However, this is at a time when European businesses are doing the opposite. Volkswagen is considering closing its German EV plant, the company’s first closure of a domestic plant ever.

• Western automakers and governments must grapple with the reality that the future of mobility may not be driven from Detroit or Stuttgart but from Shenzhen or Shanghai.