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Hang On, Maybe GM Europe/PSA Merger Could Work?

Hang On, Maybe GM Europe/PSA Merger Could Work?

Fiddling With Accountancy Rules Makes Opel-Vauxhall Look Good.

Putting Lipstick On A Pig?

“Perhaps GM wants to bow out now and avoid potential election trouble?”

Investment banks couldn’t raise much initial enthusiasm for a merger between France’s PSA and GM’s Opel-Vauxhall, but some are having second thoughts.

Investment researcher Evercore ISI wondered Tuesday why solidly profitable PSA would want to taint its balance sheet by buying chronic loss-maker Opel-Vauxhall. On Wednesday Evercore ISI analyst Arndt Ellinghorst said that with some slick accounting changes, Opel-Vauxhall could be made to look much more attractive.

“We believe GME’s (General Motors Europe) reported loss could be transformed into a profit within 12 months simply by a change in U.S. GAAP vs European IFRS accounting treatment,” said Evercore ISI analyst Arndt Ellinghorst.

Opel-Vauxhall has lost more than $18 billion since 1999. It has never made a profit since then. 2016 was to be a year of break-even, but it lost $257 million, blaming Britain’s Brexit vote for $500 million in foreign exchange losses.  GM shareholders have been wondering for years while it carried on bailing out this loss-maker. The justification was that eventually it would make money, but meanwhile it contributed to GM’s need to develop small cars and diesel engines.

Ellinghorst said that if PSA acquired Opel-Vauxhall, by capitalizing some of its R&D expenditure, it would swing into the black.

“By simply capitalizing some of GME’s R&D, GME’s reported profit/loss could swing into the black. Adopting the same capitalization rate as that used by PSA today, GME’s 2016 reported earnings would have been $505 million higher and positive to the tune of $248 million resulting in an about 1.3% EBIT adjusted margin,” Ellinghorst said.

Of course, this juggling would diminish over time, however GME would appear to have gone from loss making to profitable overnight.

“We can already envisage the potential news headlines referring to Tavares’ rapid GME turnaround,” Ellinghorst said.

Ellinghorst also pointed to ways of reducing Opel-Vauxhall’s cash burn

PSA CEO Carlos Tavares, who took over the job in 2014, is already being lauded by the media for his apparent success with turning the company from a financial basket case to a marauding takeover titan.

PSA hasn’t reported its results for 2016. In 2015, it made a net profit of 1.2 billion euros ($1.3 billion), its first profit in three years, and compared with a loss of 555 million euros ($589 million) the previous year. Automotive operating profit was five per cent. PSA was on the brink of bankruptcy and was saved by a 3 billion euro ($3.2 billion) state-backed rescue plan after racking up more than 7 billion euros ($7.4 billion) in losses over a couple of years. France and Chinese carmaker Dongfeng each bought 14% of the company in 2014. The Peugeot family stake was reduced to 14%.

The combined PSA-Opel-Vauxhall would create a company with the second biggest market share in Western Europe – around 16% – and bring it closer to the leader Volkswagen at 23.4%. 

Barclays Equity Research also likes some of what it sees about the possible deal.

“We believe it could make sense for both companies. Although in very early stages, we believe a potential combination of PSA and Opel (Vauxhall) would offer (Tavares) an exciting challenge. Following the sharp recovery of PSA, turning around Opel could prove at least as challenging as it had no positive operating profit over the last 15 years,” Barclays analyst Alexis Albert said.

“Synergies could range from 1.1 to 1.9 billion euros ($1.2 to $2.0 billion) according to our estimates on 2018 auto revenues of 57 billion euros ($60 billion) versus 40 billion euros ($42 billion) for PSA Auto alone – and could come quicker than in previous mergers since they have been working together since 2012 with two shared cars,” Albert said.

The Opel Meriva and Zafira SUV and minivan are built using PSA technology.

If simply changing accounting systems could make Opel-Vauxhall look much better, investors might wonder why GM couldn’t do something similar. Perhaps GM management is feeling a bit exposed too because Ford Europe, a similar chronic loss maker over the years like Opel-Vauxhall, has turned itself around.

According to Professor Ferdinand Dudenhoeffer in 2015 and 2016 Ford Europe made $1.5 billion profit in Europe, while Opel-Vauxhall had a $1 billion loss.

“$2.5 billion profit difference in two years are the difference in results of Opel (Vauxhall) and Ford (Europe),” Dudenhoeffer said.

Dudenhoeffer also said the news PSA may buy Opel-Vauxhall can’t be good for sales.

“The sales negotiations signal Opel has not solved its problems and therefore GM wants to get out. Who wants to buy a brand that has problems? If the future of the brand is uncertain, potential buyers will be put off. This will mean even higher price discounts,” Dudenhoeffer said.

Election turmoil
Meanwhile GM CEO Mary Barra was visiting Germany Wednesday, where reaction from politicians and unions to the deal has been negative. Vauxhall, which sells Opel cars in Britain under its own brand name, is a big employer there and unions are also making predictable noises because of the danger of job losses.

Some cynics are also wondering about the timing of the proposed deal. Europe is about to be rocked by potentially damaging elections. The turmoil will be kicked off by an election in the Netherlands March 15. The first serious test will come in April and early May when France holds its two-rounds of presidential elections. Front National candidate Marine Le Pen has pledged to withdraw France from the euro single currency if she wins. That could lead to the demise of the euro, force Germany to revert to the high priced deutschemark and torpedo the bottom line at Opel. Perhaps GM wants to bow out now and avoid potential trouble. Germany holds federal elections on September 24 which will decide the fate of Chancellor Angela Merkel.

But that’s the horror scenario.

Evercore ISI’s Ellinghorst said the accounting changes he suggested don’t of course mean any fundamental improvement in Opel-Vauxhall’s business.

“However, they are potentially easy wins for PSA and Tavares which if actioned well give the impression of an immediate and impactful turnaround. Importantly, in our view, such improvements even if “optical” would likely give Tavares goodwill with politicians, labor and investors as PSA looks to negotiate and subsequently implement long-term opportunities to streamline capacity and investments of a combined entity,” Ellinghorst said. 

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