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SuDa Electric Vehicle Company Private Equity Investment In China Case Solution
Suda Electrical Vehicle Company is a well-recognized electric bike manufacturer in China with a market share of 3.2%. It has 3 product lines multipurpose electric vehicles, traditional lead-acid electrical bikes and scooters, and lithium-ion electrical vehicles and scooters. The company is considering its business strategy to expand aggressively and grow the business in an attempt to capture the market share. Shipston Group a family office led by Michael D Dingman is looking for a suitable investment in China with a longer-term view subsequently finding an opportune time to exit after exploring investment’s potential future growth and value. For Shipston Group investment in Suda Electrical seems suitable for multiple reasons.
Following questions are answered in this case study solution
Investment Hypothesis, with appropriate risk analysis/mitigation
Market Review of the sector, and investment within it 300
Exit and Return
Case Analysis for SuDa Electric Vehicle Company Private Equity Investment In China
The Chinese Electrical bike industry had seen substantial growth in the last few years and had been a target industry for Winston Wang (Investment manager at Shipston Group). The Suda Electric Vehicle Company is a suitable target to buy an equity stake in the e-bike industry. Suda intends to increase its capacity from 1.2 million units to 2.0 million units per year. The company offers products for both middle-income and higher-income individuals. The investment in the company would allow Shipston Group to benefit from the continued expansion of the Chinese middle class. The company has already taken exposure against various sectors including health care, transportation, biotech, clean energy real estate, manufacturing, and natural resources. Although, the e-bike industry is relatively new and only accounts for a small fraction of all the options available for transportation, however, the demand for the bikes are rapidly growing on account of rising fuel cost, concerns for environmental pollution and better transportation for growing world population.
The investment in Suda Electrical can be categorized with lower risk on the back of the company’s ability to generate internal cash flows. The company is profitable with a focus on organic growth with internally generated cash flows of the company. The company has negligible debtor days whereas the suppliers allow the company 2 months of credit period thereby generating a very favorable cash cycle for the company. Moreover, Sudo has developed various internal strengths which contribute to its various competitive advantages. The dealership network of the company is spread across the country. With more than 1000 dealers nationwide, the company is committed to adding 300 dealers every year. The company has developed intangible assets for various patents on the back of its advance research and development expertise. The commitment to creativity and innovation allows the company to provide premium products while improving the performance and life cycle of e-bikes.
Lastly, Sudo has employed many business optimization techniques to efficiently manage the cost and develop a lean manufacturing system. The use of enterprise resource planning to manage inventory on a just-in-time basis cut several expenses including storage cost. The senior management of the company is highly capable and has a proven track record of success in this business. Therefore, Shipston Group can obtain comfort from the time-tested caliber of the Sudo’s management. Hence, equity investment in Sudo Capital is recommended for Shipston Group to attain a 10% share in the company.
2. Market Review of the sector, and investment within it 300
The industry for an e-bike is relatively new but growing at a rapid speed since China is committed to rationalizing its reliance on foreign oil on account of serious international pressure about environmental concerns. According to an estimate, e-bikes can reduce the oil demand by 188 million barrels a year. The demand for e-bikes is expected to be augmented from CNY31 billion (revenue) to CNY99 billion (revenue) in 2015 with a major share from the urban areas where the population growth rate is relatively higher. Although, the industry has shown many promises for growth however investors were concerned about some inherent risk posed by the industry.
Firstly, the competition in the e-bike industry of China is extremely fierce whereby the market is fragmented among many manufacturers each having a marginal market share. Currently, the e-bikes are not subject to any regulations with respect to any requirement for license, taxes, or lane. However, with the increasing popularity of e-bikes among the masses, the other transportation industry i.e. motorbikes are concerned about the unregulated status of the e-bikes wherein road safety, pollution, and difficulty to manage traffic are major concerns. The rising demand for enforcing stricter standards and regulations for e-bikes may negatively impact the industry and sales growth may take a hit.
The lower barriers to entry is another concern for the investors. The manufacturing process for assembling of e-bikes is less complicated and even manual assembly lines are able to produce hundreds of bikes in a day. Although, there are requirements for excessive capital and management capabilities to set up an assembly unit however the overall barriers are low due to collective industrial efforts in an attempt to capture international investment. The lower barriers and fierce completion has put extreme price pressures on the manufacturers whereby very thin profit margins can be observed.
3. Enterprise Value
The enterprise value is calculated from the discounted cash flows model. The projection made by Winston Chang was used to calculate the free cash flows to equity. In order to calculate the total value of equity, the terminal value was estimated using two methods 1) revenue multiple approaches 2) EBITDA multiple approaches. The average and mean of both multiples across different industries including battery producers, Chinese bike manufacturers, and international manufacturers were reviewed. The lower average or mean for each multiple was used for both approaches. Since there is limited information on multiples related to the e-bike industry, therefore comparable multiple across different industries seem appropriate. The cost of equity was assumed to be 15% based on a prudent approach to account for excessive risk. The value of equity with respect to revenue multiple and EBITDA multiple came out to be CNY982 million and CNY1,039 million respectively. Exhibit 1 provides the details of EV estimation.
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