Love is in the air again among the world’s car manufacturers.
The alliance of Renault, Nissan Motor and Mitsubishi Motors aims to restart merger talks in 12 months before moving on to a takeover of Fiat Chrysler Automobiles, the Financial Times reported last week.
Peugeot-owner PSA Group is also looking to build a partnership with Fiat Chrysler.
Nissan chief executive officer Hiroto Saikawa told the deposed alliance chairman Carlos Ghosn in an e-mail last year that he had been looking at bringing in a fourth manufacturer to the partnership, Bloomberg News reported earlier this week.
For all the ambition behind such mega deals, the fissiparous nationalist politics that have plagued the Renault-Nissan relationship seem more likely to win out, as my colleagues wrote last week. So why all the desperation to merge?
One under-appreciated reason is that the car industry has become dangerously competitive.
Thanks to the decline of Detroit’s giants, the rise of China’s state-owned joint-venture partners and the burgeoning success of mid-size car companies, the market share of the top four car companies has dropped precipitously over the past two decades.
At the turn of the century, those firms accounted for more than two-thirds of industry revenue (levels over 50 per cent are typically considered oligopolistic). In 2017, that had fallen to little more than one-third.
Of course, car sales are local even if companies are global. Toyota Motor may only have about 11 per cent of global revenue, but it accounts for almost half of unit sales in its home market.
Volkswagen, the biggest car-maker by worldwide deliveries, sells fewer cars under its own marque in the United States than smaller players like Kia Motors or Subaru.
A core strategy of General Motors CEO Mary Barra has been to retreat to the company’s US market by shedding less-profitable overseas units, some of which had been held for nearly a century.
At the same time, car-makers are in a global fight for supremacy – one reason that figures like Mr Ghosn have been such evangelists for a world of pooled manufacturing platforms and modular designs that can minimise the ferocious costs of developing new vehicles. That is especially crucial in the face of the triple threat from electric vehicles, autonomous driving and shared mobility.
The risks of duplicating capital and research & development (R&D) expenditure in that environment can be brutal. At BMW, Volkswagen and Tata Motors’ Jaguar Land Rover, R&D costs have risen to 6 per cent or more of sales in recent years, producing some impressive innovations but cutting dangerously deep into profitability.
As a result, investors are disenchanted with the industry’s prospects: The equity and debt of PSA, Fiat Chrysler and Volkswagen could be bought for less than two years of their forecast Ebitda (earnings before interest, tax, depreciation and amortisation). By comparison, even in its current state, Facebook could be bought for 11.5 times Ebitda.
The flip side of those valuations and the current low cost of debt is that, by traditional metrics, it is phenomenally cheap to buy a car-maker if you are prepared to pay cash.
Even before assuming synergies, Nissan could buy Renault at a 70 per cent premium and still double its earnings per share by 14 per cent in the first year, based on Bloomberg’s merger calculator. Daimler could pay a 30 per cent premium for BMW shares and get a deal that was 70 per cent accretive. Ford could buy Subaru at the same premium and watch earnings rise by 30 per cent in the first year.
Of course, companies do not take over their rivals just because they are cheap.
If investors hold a dim view of a stock’s prospects, potential acquirers may make the same calculation. What is different right now, though, is that the industry desperately needs to consolidate and reduce the current ruinous levels of competition. Getting even bigger does not seem such a bad way of bringing about that future.
It is not clear that this necessary process can easily happen. As we have seen with the Renault-Nissan saga, the US administration’s car tariff proposals and Daimler’s lukewarm response to an investment from Geely Automobile Holdings’ parent, the global car industry seems to be getting more, not less, nationalist. Things are likely to get worse before they get better.
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