China's First Foreign-Controlled Automaker Is Coming, and Brilliance Has Lived Through Every Turning Point in China's Auto Industry | QDaily Business History

China traded market access for money more than for technology.

BMW Brilliance is about to become China's first foreign-controlled automaker.

On October 11, the BMW Group announced it would buy another 25% of BMW Brilliance for €3.6 billion. The deal closes in 2022, at which point BMW will hold 75% of the joint venture with Brilliance and control it outright.

That breaks a protective rule for the auto industry written into law 24 years earlier: foreign investors could not set up wholly owned automakers in China and could enter only as joint ventures, in which the Chinese partner had to hold at least 50% of the equity and the chairman had to be appointed by the Chinese side.

BMW Brilliance's change of status arrives in the middle of a larger shift. On one side, China's car sales are heading for their first annual decline since 1990; on the other, trade tensions have dimmed the global market.

The move has thrown Brilliance China, the Chinese partner in BMW Brilliance, into turmoil once again. Brilliance's stock fell 28% the day the news broke, mainly because the profit it takes from the joint venture will be cut in half. In the first half of this year, BMW Brilliance handed Brilliance China 3.67 billion yuan in net profit. And like almost every joint-venture automaker, Brilliance has no profit source of its own on anything like that scale. Strip out the money BMW passes over and it has been losing money for years.

Twenty years ago Brilliance was one of the best-performing automakers in China. Its 1998 revenue reached 3.227 billion yuan, on a par with FAW Hongqi. In 2002, the year before the BMW deal, Brilliance China's revenue passed 7 billion yuan.

After 15 years as BMW's joint-venture partner, importing technology and management practices, Brilliance's revenue last year — excluding sales of BMW-badged cars — was just 5.3 billion yuan.

This company, which went from state-owned to private and back to state-owned, rode along as China's auto industry grew from nothing into something, from small to large, from closed to gradually open. It has lived through every turning point in that transformation.

Even State Firms Were Short of Cash at First, So Brilliance Became the First Chinese Automaker to Raise Money in the US

Brilliance Auto's official account of its own history starts in 2002, when it became "a state-holding company established under a central government decision and approved by the Liaoning provincial government." In fact its roots reach back to the Shenyang Automobile Manufacturing Plant of the Great Leap Forward era. After reform and opening-up began, the Shenyang Industrial Bureau led the formation of the Shenyang Automotive Industry Corporation, which restructured its shares in 1988 and in the process set up Shenyang Jinbei Auto — the real predecessor of Brilliance Auto.

Jinbei was a standard state enterprise then, run by Zhao Xiyou, former head of the Shenyang Automotive Industry Bureau. It was also a machine for producing big Chinese business news abroad: the first automaker to convert to a joint-stock company, the first state enterprise to run a leasing business, the first Chinese company to list shares in the US.

In 1988, Jinbei signed a commercial-vehicle technical-support agreement with Toyota, which brought its third-generation HiAce into China for Shenyang Jinbei to build. Toyota first gave Jinbei body-stamping and welding technology; in 1992 the agreement widened to painting and assembly, and Toyota Auto Body joined in. Arrangements like this were common at the time between Japanese automakers and local state enterprises.

That model was the white Jinbei van seen in streets and alleys across China from the 1990s on — you can still often find a fruit seller parked beside the road in a Jinbei, calling out to customers. Because Toyota and Jinbei had no joint venture, all these vehicles were sold at home under the Jinbei badge.

Under the auto-industry strategy China had set at the time, first-tier automakers such as FAW and SAIC got the state-brokered deals with Germany and the US, which landed in China as joint ventures.

Japanese automakers missed that first wave. Toyota negotiated a joint venture with Tianjin Auto and FAW while entering the Chinese market a step earlier through technology transfer and technical support. The approach was nothing new for Toyota — Japanese automakers had gone through a similar opening in the 1950s.

With Toyota's HiAce manufacturing technology in hand, Jinbei was building about 35,000 vans a year after 1992 and clearing more than 100 million yuan in profit. At one point it supplied a quarter of China's pickup market and half of its minibus market.

But cars are a capital-hungry business — a single production line easily costs hundreds of millions or even billions of yuan. China's auto industry, just out of the planned economy, was short of technology and short of money — even a big state enterprise like SAIC.

In 1980, China's gold and foreign-exchange reserves fell to a balance of -US$1.296 billion. According to the recollections of former SAIC chairman Jiang Tao, SAIC, then preparing its joint venture with Germany's Volkswagen, nearly had to give the plan up.

Jinbei, a local state enterprise of far less strategic weight, was even shorter of cash. Zhao Xiyou, then Jinbei Auto's general manager, pushed through a shareholding restructuring to raise money on the Shanghai market. But the A-share market, itself only recently established, was short of capital too: when Jinbei went public on the Shanghai Stock Exchange in 1991, only 51 million of the 100 million shares it planned to issue were sold, not enough to fund its growth.

That was when the turn came.

Around 1990, Yang Rong — a Hong Kong businessman whose background was never much publicized — and Hainan Huayin Trust, which had state capital behind it, were hunting for a company they could package for a US listing. Jinbei, a state-enterprise platform with a simple ownership structure, was their target.

In 1991, Yang Rong, through Bermuda-registered Brilliance Holdings and Hong Kong Huabo Finance, first subscribed to 46 million shares of Shenyang Jinbei Auto at 1 yuan a share. Hong Kong Huabo then joined Hainan Huayin Trust and Jinbei Auto to set up Shenyang Jinbei Passenger Vehicles — the asset at the center of all the capital maneuvering that would later be known as "the Brilliance group," with the three parties holding 25%, 15%, and 60%.

No rule was yet written down, but every joint-venture automaker had state capital holding at least 50%. That created a problem: the US Securities and Exchange Commission required a single-purpose US-listed company to hold at least 51% of its core asset.

Yang Rong's side, holding only 40% of Jinbei Passenger Vehicles, then joined Hong Kong Brilliance, the Education Department of the People's Bank of China, the China Finance Institute, and Hainan Huayin to set up the China Financial Education Development Foundation. The foundation took over the 40% of Jinbei Passenger Vehicles that Yang Rong had held, plus another 11% injected by Jinbei Auto, giving it the 51% controlling stake the NYSE required.

But having handed over its shares, Shenyang Jinbei Auto had in effect lost control of Shenyang Jinbei Passenger Vehicles, which by its ownership structure was no longer a state enterprise either.

Those rounds of share shuffling also planted the ownership dispute that would later engulf Brilliance.

As for Yang Rong's background, a later investigation by Southern Weekly found that he graduated from Southwestern University of Finance and Economics with a doctorate in economics, once headed the Shenzhen office of Henan's No. 4 Cotton Mill, and later moved to the US and Hong Kong.

In October 1992, Brilliance listed on the NYSE, becoming the first "China state-enterprise concept stock," a full year ahead of Sinopec Shanghai Petrochemical. It raised US$80 million, US$74.4 million after issuance costs. At that point Geely's Li Shufu was still making refrigerator compressors while helping his second brother in the aluminum-magnesium curved-panel business, saving up the capital for the car business he would start later.

Not long after the listing, Jinbei Passenger Vehicles, the Brilliance group's core asset, slipped, hurt by its products and by a slowing economy. Revenue for 1993, 1994, and 1995 came to 1.31 billion, 1.246 billion, and 1.056 billion yuan, and net profit fell from 104 million yuan to 29 million yuan.

But the listing money carried Brilliance through the lean years. After going public in the US it kept working the capital markets, issuing more shares in 1994 and 1998, and after 1998 began arranging a second listing for CBA in Hong Kong. In October 1999 Brilliance listed in Hong Kong, raising HK$650 million, and left the NYSE six months later.

After 1995 the Chinese economy picked up. Private business owners met clients in a Santana or an Audi 100 and hauled goods and passengers in a Jinbei or a Wuling; the combination became standard kit.

From 1995 to 2000, Jinbei's revenue grew 43% a year. In the financial report Brilliance China filed with the NYSE in 2000, Jinbei Passenger Vehicles' sales revenue reached 6.3 billion yuan, with 60% of the light-bus market and after-tax profit of 1.8 billion yuan — second in the industry only to SAIC Volkswagen and FAW-Volkswagen, the two big state enterprises the government had singled out for support.

Profit, production lines, dealer channels, and a private-sector identity made Brilliance BMW's ideal partner. According to International Finance News, Günter Schiemann, then BMW's Greater China president and a participant in the joint-venture talks, said in an interview that BMW chose Brilliance mainly for its management system, its private-enterprise structure, and "Yang Rong's personal charisma."

Then in 2002 everything turned 180 degrees.

While Negotiating with BMW, Brilliance Was Taken Back Into State Ownership

According to reports by International Finance News and Southern Weekly, on March 11, 2002, the Ministry of Finance issued a directive ordering that Hong Kong Brilliance China Automotive Holdings Ltd, Hong Kong Yuantong Technology Holdings Ltd, Zhuhai Brilliance Holdings Co., Shanghai Brilliance Group Co., Shanghai Brilliance Industrial Co., all their derivative companies, and companies registered by management in their own names or their relatives' names be transferred to the Liaoning provincial government, liabilities included. It also ordered an audit without delay to prevent the loss of state assets.

Three days later Liaoning province set up a "Working Group to Receive Brilliance Assets" and began a full inventory, verification, and takeover of Brilliance's assets, with CBA as the core. What followed came fast: in May Yang Rong left for the US; in June he was removed as chairman of the board; in October Hong Kong Huabo, which he controlled, sued the China Financial Education Foundation; on October 14 the Beijing Higher People's Court took the case; six days after that the Liaoning Provincial Public Security Department approved Yang Rong's arrest.

The dispute turned on how much capital the China Financial Education Foundation, Brilliance's largest shareholder, had actually put in.

In an interview with International Finance News, Yang Rong and his lawyer said he had personally supplied most of the foundation's registered capital, that they had already given the court proof of the payment, and that the foundation merely held Brilliance's shares on his behalf. The report added that Yang Rong's account largely matched what Wang Kangmao told other outlets — one of Brilliance Auto's founders, a director and executive vice president who left the company in 1995 and later became a professor at Zhejiang University's School of Management.

Wang Kangmao said Yang Rong had at first planned to register the listing under his own name, but investment banks advised showing up in the US with a state-owned identity, because overseas investors then knew Chinese companies only as state-owned and would not believe a private Chinese entrepreneur could have that much money and build a business that big. Registering under an individual's name would certainly have invited a laborious investigation.

The government, though, said that when Brilliance Auto was first set up, the foundation had received a letter from the State Assets Bureau, which read:

In order to explore models for managing state-owned assets overseas, our bureau hereby formally entrusts your foundation to invest on our behalf in Brilliance China Automotive Holdings Ltd, in the amount of US$15.3 million. The funds are provided by our bureau; your foundation, acting as agent, bears none of the risk of this investment and holds none of its rights and benefits — all equity in Brilliance and all proceeds from its shares belong to our bureau. As compensation, our bureau agrees to sponsor and support your foundation, including funding your foundation's Outstanding Teacher Award, Outstanding Student Award, and Outstanding Science and Technology Worker Award, totaling 3 million yuan.

This was one of the pieces of evidence they used to argue that Brilliance belonged to the state.

Yang Rong, by then in the US, said the bureau's letter left room for interpretation. He said he did not care who officially owned the company; what mattered was that the state had not put up a single yuan. "After all, I'm the one who built this company. It's now worth more than 20 billion yuan in market value. I took a company on the brink of collapse and turned it into one with 3.2 billion yuan in net assets, generating nearly 1 billion yuan a year in taxes and profit."

On the tangle among the parties, Economic Observer once commented that even with the state-owned foundation as a major shareholder, Brilliance had been run in Hong Kong and on the mainland from 1990 to 2000 as a private company. Under the early property-rights rule of whoever puts up the money owns it, Brilliance had never before been treated as a state enterprise — no industry regulator had ever handled its personnel appointments or given it administrative direction as if it were state-owned.

Because of historical baggage, a good many Chinese companies had murky property rights, which fed conflicts between business owners and governments over who controlled them.

Li Jingwei, the former chairman of Jianlibao Group, took over the state-owned beverage factory in Sanshui, Guangdong, in 1984 and within a decade turned it into a giant with annual revenue of nearly 2 billion yuan. But when he tried to push through a shareholding restructuring, buy shares, and move the headquarters out of his hometown, the Sanshui government stepped in and refused to approve his decisions. It ended with Zhejiang Guotou taking 75% of Jianlibao's shares and Li Jingwei pushed out.

Haier, Chunlan, Midea, and TCL ran into much the same problem, with different endings. Haier's shareholding restructuring was never carried through, and the question of whether it is really private or state-owned keeps coming up; founder Zhang Ruimin was luckier than Jianlibao's Li Jingwei in that he was never pushed out. Chunlan Group, one of the top sellers in China's air-conditioner business in the 2000s, planned to split its shares and break the company up, was ordered to stop, and today its brand is barely heard of. Midea and TCL came out better: Midea became a company controlled by the He Xiangjian family, while TCL grew with state capital in the mix and let management share in the profits along the way.

Sheltered by the 50% Rule for Decades, and in the End the Market Bought Money More Than Technology

Even after Brilliance reverted to state ownership, BMW carried on with the talks and signed a deal in March 2003 to set up a joint venture split 50:50. Locally built BMW 3 Series and 5 Series sedans went into production that October. Today BMW Brilliance's Tiexi and Dadong plants are among the largest BMW production bases in the world.

A 50-50 split between Chinese and foreign capital was the standard joint-venture form for state-owned automakers.

Last year the BMW Group delivered about 560,000 BMW-branded vehicles to Chinese customers, two-thirds of them built by BMW Brilliance. Since 2009 the joint venture has invested more than 52 billion yuan in Shenyang, and its supplier network has grown to 350 companies, more than 80 of which have set up offices in Liaoning province. It also provides 18,000 local jobs and hands the Shenyang government several hundred million yuan or more a year in taxes and profit.

BMW has held its own against Audi and Mercedes-Benz. After the Brilliance joint venture opened the Chinese market to it, BMW's share here climbed quickly, second among luxury brands only to Audi.

Brilliance's own profits grew too: its 50% stake entitled it to half the joint venture's earnings. From 2004 through the first half of 2018, the joint venture passed more than 30 billion yuan in net profit to Brilliance.

The other joint-venture automakers grew well too. SAIC collected 7.46 billion yuan between 1988 and 1994 from the localization fund alone, charged on every Santana sold. In the National Bureau of Statistics' ranking of China's highest-revenue companies in 2000, FAW came ninth, with revenue above 50 billion yuan.

But the impressive numbers hid a real problem: on the Chinese side of these joint-venture brands, product development was weak and manufacturing know-how accumulated slowly. Inside the joint ventures, the heads of engineering and technical departments were usually staff appointed by the foreign partner, while the Chinese side ran the support functions — finance, administration.

Joint ventures took China's car market from small to enormous. China became the world's largest car producer in 2009, and by 2013 the auto manufacturing industry's revenue equaled more than 10% of GDP, making it a genuine pillar of the economy.

But that made the industry big, not strong. The 34-year-old rule capping foreign ownership of joint-venture automakers at 50% turned "trading market access for technology" into trading market access for money. Take Brilliance: strip out the profit from the BMW brand and its own brand lost more than 7.8 billion yuan in total between 2004 and the first half of this year. The other joint-venture partners were no better off — their joint-venture models outsold their own models by a wide margin.

In 2017, FAW-Volkswagen and FAW-Toyota together sold 2.65 million vehicles, while FAW's own brand sold 220,000. GAC Toyota and GAC Honda together sold 1.13 million, while GAC Trumpchi sold 510,000.

Bringing in foreign capital to form joint-venture automakers with fixed ownership ratios, trading market access for technology, was not a Chinese invention. Japan, South Korea, and India had all done it.

The difference is how long it lasted. South Korea took 20 years from its first joint venture in 1972 to scrapping the ownership cap. India brought in joint-venture automakers in 1982 and lifted the cap nine years later. China has kept its cap for 34 years, since the 1984 approval of SAIC Volkswagen.

When China joined the WTO in 2002, it carried out only part of its tariff-reduction promises; tariffs overall stayed high, especially on luxury sedans, where domestic prices ran far above prices abroad. A report from the Evergrande Research Institute showed an Audi A8 selling for roughly 500,000 to 630,000 yuan in the US against 880,000 to 1.225 million yuan in China. Foreign brands therefore could not simply enter China with imported cars; they had to form joint ventures with Chinese companies.

Long protection left the state firms holding the joint-venture brands weak in the market, inefficient, and short on new ideas. The scale advantages that normally come with the car business never turned into competitiveness or profit for them. From 2014 to 2017, the return on assets of listed state-owned automakers trailed that of private automakers by a clear margin.

According to the China Passenger Car Association, the top five automakers by 2017 sales were all joint ventures; the home-grown brands Geely, Changan, and Great Wall Motor took sixth through eighth.

But private brands like Geely, Chery, and BYD had almost no resources to draw on. Short of money and short of technology, they had to build cars on their own. Their early models might have had no air conditioning and hand-cranked windows, but they were cheap enough to put most people behind a wheel. According to the China Association of Automobile Manufacturers, China's car market grew 30% in the first half of 2007, fastest in the 1.0-1.6-liter segment. There, the private brands beat state-owned home-grown brands that had better equipment and performance but initially cost twice as much, simply by costing less.

Then they poured money into research and acquisitions to raise quality and technical standards. In the first half of this year Geely's R&D spending passed 4.2 billion yuan, close to 10% of revenue; BYD's ratio was 3%. SAIC Group, with twice Geely's revenue, spent 1.2%.

The National Development and Reform Commission this year mapped out plans to lift the ownership cap on all joint-venture automakers by 2022, and for new-energy vehicles the cap is already gone. In theory, then, Tesla — which has already set up a wholly owned company in China — should be the first foreign-owned automaker here. But with trade tensions in the picture, even Tesla's claim to being first is no longer certain. And now it is a German company breaking the 50% cap.

As for Brilliance, the first company to give up control of its joint venture, the effects of the protective policy are already plain: BMW's profit has for years accounted for more than 100% of its operating results. So although the share sale is expected to bring a one-time gain of about 16.7 billion yuan, analysts at GF Securities and Industrial Securities International still cut their rating on Brilliance China.

After 15 years of operating under the shelter of the 50% rule, this company never traded its market for technology that could carry its own development — only for money.

Jinping Xie contributed reporting.

Cover image/TheMaker, Sichuan News Television