The brilliance of Brilliance

Captial at risk.

The joint venture of Brilliance and BMW

Brilliance China Automotive is a state-owned automotive manufacturer, perhaps known more for being the first Chinese company to list on the New York Stock Exchange in 1992 than for its automotive products in those early days. It was first bought for Emerging Markets portfolios in 2015. The core investment case was built around a key asset: a 50-50 joint venture with BMW in China, which began in 2003 and has since been renewed till 2040. It made sense to own the fastest growing part of one of the most respected luxury car makers in a market with huge potential.

However, in March 2021, Brilliance’s shares were suspended. Legal proceedings surrounding unauthorised guarantees by a subsidiary to its parent prevented the company from publishing annual accounts. A resultant lack of disclosure, the limited visibility as to a resolution and the possibility that the company could be delisted made for a challenging period. That suspension lasted over 18 months, during which the holding was valued at a 75 per cent discount to its last traded price. The large discount was reflective of governance concerns, the real risk that Brilliance would choose to waste its newfound wealth rather than return it to shareholders, and the possibility that the shares would be delisted. ESG ratings were definitely not complimentary.  

While the shares were suspended, a change in foreign ownership regulations in China allowed BMW to raise its stake in the joint venture to 75 per cent by paying $4.1bn to Brilliance. At our valuation price, the company was being valued at a significant discount to the value of the cash received for its 25 per cent stake in the JV, let alone reflecting the value of the continuing operations of their remaining 25 per cent.

Laying the groundwork for recovery

Through the lengthy period of suspension, we wrote to the Company and its Board several times seeking clarification of the type and scale of the issues, what investigations were being undertaken and what remedial steps were being proposed. After some delay, the company began to address the issues raised but remained suspended on the Hong Kong Stock Exchange. Aiming to ward off the risk of Brilliance being delisted, we contacted the Exchange and queried why it remained suspended, given the company’s corrective actions. This seemingly played a small part in allowing Brilliance to relist in October 2022 with a reconstituted Board, half of which is now independent. As a result, Brilliance is now paying out the proceeds of its sale of 25 per cent of the BMW joint venture to shareholders in a series of special dividends. The share price has responded very positively.

It would have been easy to have sold the company as soon as possible upon its relisting, with much relief. With the shares bouncing back from the 75 per cent haircut we’d used when suspended, it would have been easier to move on from the holding, leaving behind the need to justify the challenging governance history. But, the financial possibilities pointed to an asymmetry of returns. Management and governance had changed. The auditors and stock exchange would be watching like hawks and the company was being valued at a fraction of its cash, let alone any future earnings from the joint venture, which continues to perform well.

Despite the Chairman saying they would distribute most of its current cash if it couldn’t find suitable investments related to the auto business, previous governance challenges led to a degree of scepticism in management’s capital discipline. As such, the recent special dividend announcement is a strong signal of the company’s focus on returning excess capital to shareholders. That question has now been answered and, in doing so, strengthens the argument that the company will continue to pay special dividends from its recurring investment income from the Brilliance-BMW automotive JV.

Having been somewhat of a ‘special situation’ in recent years, fundamentals should now drive returns from here, with the focus turning to the value of their 25 per cent stake in the BMW-Brilliance joint venture. At the time of writing, our pens were out to reassess the case for doubling from here. After distributing the planned special dividends, the company will still have approximately HK$1.1/share in cash, with the joint venture expected to distribute an additional €4bn dividends to its two shareholders in 2024 (based on 2023 earnings), which would translate into another HK$1.5/share for Brilliance based on the 25 per cent holding. The company is currently valued at $5.5bn market cap and is expected to have 30 per cent of that in cash by the year end. The case then rests on how BMW is likely to do in China in the coming years. The jury is currently deliberating.

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This communication was produced and approved in August 2024 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

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