After Initial Euphoria, Renault/FCA Merger Poses Big Questions.
“Ultimately, it will take a decade or so to judge the true success or failure of this potential tie up”
On day one, a merger between Renault of France and Italian-American Fiat Chrysler Automobiles (FCA) promised massive benefits with happy investors talking about huge cost savings and synergies, all adding up to the best thing sliced bread.
On day two though, some harsh questions have arisen about just how easy it will be to earn the promised 5 billion euros ($5.6 billion) in annual cost savings. Can this really be achieved without closing plants? How likely is it that a merged French, Italian, American, Japanese company can exist with a French government stake, albeit diluted down to 7.5% from the Renault stake of 15%? Will Italian politicians insist on taking a similar share in the venture as the French government as it seeks to protect Fiat’s future? Can the Nissan part of the alliance be happy to come on board with its stake reduced to 7.5% but with voting power, from the previous non-voting 15% in Renault?
On day one, investors were hailing the great step forward which would allow Renault and FCA to survive and thrive in an autonomous electric car world of the future, and fight off competition from rich technology companies. On day two, investors with long memories were remembering the wild claims for the proposed 1998 Daimler Chrysler marriage which was purportedly made in heaven, but which never came close to finding the promised synergies before breaking up.
Investment bank Berenberg of Hamburg, Germany wasn’t convinced the Renault/FCA deal made sense.
“Hard cost savings could be more difficult to achieve as the cost structure, particularly at FCA, is already at or close to its optimum level on most metrics. A merger in an overall slowing/declining auto market environment could prove to be much more challenging and risky, as we view the underlying cash flow generation as weak and more vulnerable than at most peers,” said Berenberg analyst Alexander Haissl.
“The combined balance sheet is not as strong as it appears at first glance, in our view. Additionally, it is unclear if a merger makes it easier or more difficult for Renault to unlock value from its alliance with Nissan, which could provide more upside for Renault shareholders than a merger with FCA,” Haissl said.
Investment researcher Evercore ISI was more enthusiastic, and reckoned the combination of these two second line companies might work in the long term, although it had reservations too.
“We applaud FCA in its effort to drive much needed consolidation within the auto industry and believe this should ignite more rational industry behaviour around allocation of capital, particularly in Europe and Latin America. Renault and FCA are amongst the lowest valued automakers globally and we believe a combined entity will result in value accretion for both sets of shareholders,” Evercore ISI analyst Arndt Ellinghorst said.
But all this will take time, and Ellinghorst pointed to the Daimler/Chrysler factor.
“Ultimately, it will take a decade or so to judge the true success or failure of this potential tie up. However we believe investors will more likely focus on the upside near term. There are clearly risks associated with this type of merger – memories of Daimler/Chrysler still linger – and we are skeptical of both parties technological leadership,” Ellinghorst said.
Ellinghorst warned about the difficult of managing cross border companies. He said Renault’s alliance with Nissan had offered great scale improvements but with limited bottom line results. He pointed out that PSA’s successful turnaround of General Motors’ Opel and Vauxhall subsidiaries was based on plant closures and workforce cuts.
Fitch Solutions Macro Research said the proposed merger of FCA and Renault would create the third biggest automaker in the world, and that it would become the biggest if Nissan and Mitsubishi alliance members came aboard. FCA had a big SUV presence in the U.S., while Renault was a major player in Europe and Latin America with its small and electric cars.
Economies of scale
“We believe that the proposed group would be able to utilize economies of scale given that both companies have manufacturing facilities across the world. We believe that by utilizing the resources of the two groups, the proposed business would be able to improve its operating expenses through cost-savings by sharing technologies,” Fitch Solutions said in a report.
But it agreed final agreement was as long way off.
“Meanwhile, the French government has also agreed in principle with the merger but highlighted that the proposed combination will have to address several concerns relating to securing jobs at current plants and the government’s stake in Renault. We believe that there are significant challenges that the companies will have to address before the merger,” Fitch Solutions said.
Investment bank UBS saw plenty of mutual advantages for the companies.
“There is a substantial product and platform overlap in Europe. Also, Renault is much more advanced in electrified cars than FCA, which would help FCA to achieve CO2 compliance in the EU at much lower cost than on a stand-alone basis. FCA brings a strong and profitable U.S. pick-up and SUV business to the table, a region in which Renault is only indirectly present through its Nissan shareholding,” UBS analyst Patrick Hummel said.
UBS had recently looked into the possible benefits of a merger between FCA and PSA Group, also of France, and estimated it would generate synergies saving between 3 billion and 6.6 billion euros ($3.4 and $7.4 billion) a year, mainly in Europe.
“We think the synergy potential with Renault would be within a similar range. However, FCA said there would not be any plant closures in the case of a merger with Renault. It remains to be seen how Renault’s key shareholders respond to the approach, particularly the French state and Nissan,” Hummel said.
Given that PSA had been expected to seek a deal with FCA, was there a chance it would step in with a counter bid of some kind?
Berenberg Bank’s Haissl didn’t think there was enough value in FCA to prompt a counter bid, and even thought an attempt to sell off FCA’s subsidiaries like Jeep, Maserati and Alfa Romeo wasn’t likely.
“We would consider any upside from taking over FCA to be rather limited, unless the acquirer broke up the company entirely, which could face multiple hurdles. FCA is not a restructuring case, as the business is already run efficiently with most cost ratios at or close to optimum levels. FCA’s balance sheet has strengthened in the past few years, but is still among the weakest in the industry,” Haissl said.