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Lukewarm Reaction To GM Europe PSA Merger Possibility

Lukewarm Reaction To GM Europe PSA Merger Possibility.

“And why would GM want to get rid of it?”

France’s PSA Peugeot-Citroen (PSA) is discussing taking over General Motor’s European operations, but analysts and academics can’t raise much enthusiasm for the deal.

The two companies tried once before to merge, but that failed in 2014, not least because both companies were in a fragile financial condition at the time. Since then, GM Europe’s Opel and Vauxhall subsidiaries have struggled to get close to breaking even, while PSA has seen an impressive turnaround and posted strong profit margins for the past couple of years.

When the merger was first mooted in 2012, Garel Rhys, emeritus professor of Motor Industry Economics and director for Automotive Industry Research at Cardiff Business School dismissed the deal as being doomed to fail because “two drowning men don’t make a swimmer.” GM held a 7% stake in Peugeot before the talks began about a more formal merger, but sold it in 2013, when GM decided there was no longer a strategic reason for maintaining it and the discussions ended.

This time he is a little more enthusiastic, but not much.

“Peugeot is much stronger than it was, and Opel Vauxhall is not as unprofitable as it was but it still has difficulties. And why would GM want to get rid of it? Probably because it is too much of a drain on its resources,” Rhys said.

Vauxhall is the British based subsidiary of GM Europe which sells the same cars made by Opel. Opel-Vauxhall had lost more than $18 billion since 1999.

Rhys said Peugeot, despite its impressive financial turnaround, needs to gain scale to compete with the world’s biggest manufacturers like Volkswagen, Toyota and GM. It has been criticised for being too concentrated on Europe, so acquiring Opel-Vauxhall would give it scale, but the trouble is the GM subsidiary operates only in Europe.

Only game in town?
“Peugeot is much smaller (than the market leaders) but competes in the same markets, and maybe thinks a merger with Opel-Vauxhall is the only game in town. If it stays on its own it will be crushed eventually,” Rhys said.

In 2016, Opel Vauxhall had a western Europe market share of 6.6%, while Peugeot, Citroen and its DS upmarket subsidiary had just over 10 percent in second place, according to Automotive Industry Data.  VW was number one with 23.5%. The overall market was just under 14 million.   

For Opel-Vauxhall, 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.

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.

Peugeot 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%.

GM shareholders have been wondering for years while it carried on bailing out loss-making Opel-Vauxhall. The justification was that eventually it would make money, but meanwhile it contributed to GM’s need to develop small cars and diesel engines.

Investment researcher Evercore ISI analyst George Galliers said small cars and diesels are in structural decline.

Big question
“The bigger question for us is not why GM might be willing to sell (Opel-Vauxhall) but why PSA might be interested in acquiring it. PSA is an about 6% auto margin business. Therefore Opel-Vauxhall would likely immediately prove dilutive,” Galliers said.

Galliers also pointed to PSA’s big market share in Europe, which shows it doesn’t lack scale.

Citi Research said a merger wouldn’t be a panacea, and it didn’t understand why markets were getting so excited. It wanted to see more details before commenting.

“GME (General Motors Europe) is more productive, but less profitable – perhaps that’s the opportunity,” said Citi Research analyst Michael Tyndall. He pointed out that in terms of productivity 36,000 GME workers produce an average 35 cars a year, while PSA needs 88,000 workers in Europe for 25 cars.

“It looks like both companies could help each other in relation to productivity and profitability,” Tyndall said.

Berenberg Bank said it wasn’t clear how the deal would create value.

“While we understand the rationale for such a transaction – scale, cost savings, platform rationalisation – the big question mark remains the potential purchase price and how quickly PSA can achieve potential savings and reduce GMW’s cash burn,” Berenberg Bank analyst Alexander Haissl said.

Haisll said it was unclear how Opel-Vauxhall costs were allocated, and  this might mean its underlying financial performance was better than the published data showed.

Tough combination
Morgan Stanley analyst Harald Hendrikse wasn’t enthusiastic either, saying historical brand and earnings performance suggested a tough combination, adding that even with a deal, PSA’s earnings expectations have peaked.

Cardiff Business School’s Rhys pointed out huge mergers like this are seldom successful, pointing to famous clunkers like Chrysler Mercedes and BMW Rover.

“Peugeot has been looking for easy ways to increase its size, but unless everything is right, putting a merger together and making it work is very difficult. You have to rationalize and merge engines, gearboxes, factories to get more economies of scale to compete. That’s why so few succeed,” Rhys said.

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