Will Europe Turmoil Spur Merger Frenzy?
“From PSA’s perspective, we believe it is better to wait for the U.S. cycle to roll, potential U.S./EU trade uncertainties to clear, and on top of this for FCA’s North American inventories issues and upcoming EU emission headwinds to play out”
The global auto industry is currently having a panic fit, and a new wave of merger mania has been triggered.
Profitability is under pressure as sales weaken, the cost of the electric revolution advances as the payback date recedes, and European fuel economy rules threaten huge fines.
Investors are demanding action and the first port of call is traditionally a merger, to cut costs, remove unproductive deadwood and hone production efficiencies.
But dissenters say these old methods no longer work.
PSA Group of France, which has now become a great profit-maker after flirting with bankruptcy 5 years ago, is seen as the most likely instigator of a new round of takeovers. After all, it successfully consolidated the hitherto hopelessly unprofitable General Motors (GM) European subsidiaries Opel and Vauxhall.
First it was said Fiat Chrysler Automobiles (FCA) was in PSA’s sights. Earlier this year the two companies admitted having talked about combining, but the discussions were inconclusive. Then it was Renault of France and its Nissan alliance, but that soon petered out. Media reports also suggested that PSA CEO Carlos Tavares had expressed interest in buying Jeep from FCA, and Jaguar Land Rover from Tata Motors of India. After buying Opel and Vauxhall, PSA is also said to be eying all of GM.
A merger of PSA and FCA has now returned to the spotlight. Investment researcher Evercore ISI likes the idea, but wants PSA to wait a while longer when it could pick up FCA a bit cheaper after it faces down a few crises.
Better to wait
“From PSA’s perspective, we believe it is better to wait for the U.S. cycle to roll, potential U.S./EU trade uncertainties to clear, and on top of this for FCA’s North American inventories issues and upcoming EU emission headwinds to play out,” Evercore ISI analyst Arndt Ellinghorst said.
PSA has long been criticised for its over concentration on Europe, made worse by the Opel/Vauxhall action, and Ellinghorst points out that a merger with FCA would provide much needed regional diversification into the U.S.
EU regulations on fuel economy tighten significantly in 2020/2021 and FCA is seen as the biggest laggard, facing huge fines. Earlier this month FCA announced a deal with electric car maker Tesla to share its European carbon dioxide (CO2) emissions credits. This deal is seen as effective but short-term, and FCA will eventually have to cough up the investment to modernize its fleet.
Not everybody thinks mergers are a cure-all.
Max Warburton, analyst at Bernstein Research says the old formula of combining forces to seek scale won’t work anymore.
“We’re in the grip of M&A fever. Strategy teams are being reinforced. McKinsey is busy everywhere. Bankers are circling. Ideas are being thrown around. Industry leaders are preaching the need for scale. Everyone is talking to everyone. But is M&A the answer? While a sub-1 million unit a year manufacturer is clearly ‘sub-scale’ and even 2 million units is questionable, beyond that it gets more complex,” Warburton said.
Scale doesn’t always work
Combining PSA and FCA would add up to almost 9 million vehicles a year. Jaguar Land Rover sells just under 600,000 vehicles a year but wants to hit 1 million, while for example BMW hits just under 2.5 million.
The trouble is, scale is not an advantage when making electric vehicles.
“EVs (electric vehicles) will see far more of the car sourced from outside. Thanks to batteries, over 70% of the car’s value could be bought in. This lowers breakeven points and reduces asset intensity. That’s why new start-ups are trying to enter the industry – they believe they can sale more easily,” Warburton said.
Scale might help companies like Volvo and JLR, Warburton said, while the Renault Nissan alliance, which sold 10.8 million vehicles in 2018, never really worked, he said.
“PSA already has exceptional regional scale – going global will not necessarily deliver scale benefits. FCA’s issue is not scale – but rather low price points and excessive complexity,” Warburton said.
Fitch Ratings points to the middle ground for success, saying in a report that what it called selective alliances are preferred rather than full-scale mergers.
“Consolidation of the global auto industry is a theoretically logical answer to the challenges car manufacturers are facing. However, constraints remain, which will make the next round of large M&A very uncertain and likely to be replaced by various smaller and more focussed agreements,” Fitch Ratings said.
Nevertheless, Evercore ISI believes PSA should wait before going for FCA, although it sees another option – instead of acquiring FCA it could form a partnership similar to the one Ford and VW announced last month which concentrated on niche areas of cooperation including vans and electric cars.
In 2013 PSA was on the brink of bankruptcy and was saved by a $3.6 billion state-backed rescue plan after racking up more than $8.3 billion in losses over a couple of years. France and Chinese carmaker Dongfeng each bought 14% of the company. The Peugeot family stake was reduced to 14%.
When Tavares took the helm at PSA the company was reeling from the financial crisis and losing huge amounts of money. Tavares stopped the “pile’m high/sell’um cheap” mentality and limited production to keep prices and margins safe. He stopped worrying about market share and concentrated on selling models with intact profit margins. Tavares slashed capital spending budgets, and used limited funds to give new SUVs brash, superficial, good looks inside and out.
In 2018, PSA Group reported record sales and earnings, buoyed by the success of its Peugeot 3008 and 5008 SUV models. PSA’s recurring operating income jumped 43% to $6.46 billion for a 7.7% profit margin.
Last year PSA brands Peugeot, Citroen, DS, Opel and Vauxhall sold 2.3 million vehicles in Western Europe for a market share of 16.%, behind market leader VW’s 23.3%.