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VW, Fiat Deny Deal But Investors See Possibilities

Peugeot Then Cited As Fiat Chrysler Candidate.
Denials All Round As Rumours Swirl.

Fiat Chrysler Automobiles (FAC) and Volkswagen quickly denied reports they were about to get together, then a rumour Peugeot was a FAC merger candidate was squashed, but that didn’t stop investors musing about the possibilities.

The fact that most of Europe’s non-German mass car makers are in big financial trouble makes these reports sound as though they might have some credibility.

If Volkswagen did buy FAC it would instantly achieve its storied leader Ferdinand Piech’s ambition to leap-frog over General Motors and Toyota to become the biggest car company in the world. And the family owners of FAC would cash-in an instant profit, rather than wait years for CEO Sergio Marchionne’s controversial long-term plan to work.

Volkswagen, Europe’s biggest vehicle maker, has been an enthusiastic acquirer of brands and now has 12 car, truck and motorcycle companies as Piech pushes the company towards its goal of world leadership by 2018. Don’t expect Piech to be daunted by going for unlucky thirteen, not least because buying FAC would bring a bunch of new brands including Jeep, Dodge, Lancia, Ferrari and Maserati.

Bernstein Research analyst Max Warburton acknowledged the denials but thinks there would be some advantages to a deal.

“We believe a deal has a degree of industrial log – and perhaps more importantly, a load of emotional logic,” Warburton said, adding that it would also upset VW shareholders because of its costs and dilution of their power, and they would worry about what he called a “Teutonic” company integrating and running an Italian-U.S. business.

For VW, the deal would create instant scale in the U.S., where it has struggled to make an impact, offering up a market share of 15 per cent. Dodge and Jeep would give it an entry into the profitable pickups and boost its SUV lineup, Warburton said. For Fiat, although the merger with Chrysler has been a partial success it still has a massive debt load, and huge investment needs. Its operations in Europe are in trouble.

“Long-term, surely, the plan (for the Agnelli-Elkann family owners) is to exit the automotive industry? So perhaps it would not be insane to sell now. There have been some reported public spats between (FCA CEO) Marchionne and VW. Would he enjoy selling his life’s work to Piech. That depends on whether he thinks he’s selling him a gem… or a hand grenade,” Warburton said.

Marchionne was annoyed by a Piech remark coveting his Alfa Romeo subsidiary at the Paris Car Show in 2012, and invited him to a showdown at dawn. Marchionne also accused VW of predatory pricing in Europe.

Barclays Equity Research doesn’t expect VW to act soon to buy all or parts of FAC, “at least right now”.

Barclays analyst Michael Tyndall said the fit between the companies makes sense, at least at a superficial level. But VW is not as flush with cash as some investors believe because of unfunded pensions, while recent acquisitions will preoccupy management.

“Never say never, but the timing looks off to us in terms of funding and management bandwidth,” Tyndall said.

International Strategy and Investment analyst Arndt Ellinghorst is less enthusiastic for a deal.

“We would be very concerned if VW would indeed buy all of FCA. The risks from integrating Italian plants and managing a U.S. business are material and we do not believe that the potential benefits justify the risks. Chrysler remains a subscale U.S. player and Fiat brands lose money in all regions except Latin America, which VW would unlikely be allowed to keep (for anti-trust reasons). Indeed if VW does truly want to buy an incremental business, we see a better argument for expanding its position in trucks,” Ellinghorst said.

Other worries
Ellinghorst said there are other worries for investors in VW which need to be addressed, citing reports about efficiency problems, and a possible split in management about the likelihood of more take-overs.

As investors wonder exactly what VW might do, Bernstein’s Warburton has a theory.

“One little known but important thing about Piech – he tends to buy the product before he buys the company. He reportedly took a heavy goods vehicle license before buying Scania (Trucks) …. and could be seen roaring around on a Ducati Monster (motorbike) before buying Ducati. Want an indication of what’s next? Well he’s been seen driving a Ferrari F12 and recently bought his wife a LaFerrari,” Warburton said.

As for the Peugeot-FAC possibilities, floated in the Financial Times of London citing “four, unnamed people with knowledge of the discussions”, this was dismissed by ISI’s Ellinghorst.

“We do not believe a deal is likely. Too much overlap and political hurdles,” Ellinghorst said.

“Arguably, Europe’s autos industry is suffering from overcapacity and both nameplates are at the centre of the malaise. A merger, as suggested by the FT, would unlikely solve that problem as we would question which party would make the necessary plant concessions. Volume/scale is not the problem in our view. We prefer to recommend Renault/Nissan where product momentum and execution are driving earnings and margins growth, Ellinghorst said.

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