Peugeot charts route to recovery after surprise sale
General Motors called up Goldman Sachs one dark afternoon in mid-December and asked it to sell its entire stake in PSA Peugeot Citroën, at the time worth about €270m and the second-largest after the Peugeot family.
The surprise sale, which tanked the share price, came in a week that marked a rough end to the year for the French carmaker.
In the same seven days Peugeot admitted its alliance with GM would save less money than expected and it was forced to write down €1.1bn on its foreign operations, Peugeot also finally announced what everyone knew: The proudly French company was in talks with state-owned Chinese carmaker Dongfeng for a financial lifeline.
A tumultuous 2013 follows five years of troubles for Peugeot. It relies too much on the shrinking European car market, and its market share in that region has fallen from 19 per cent in 2007 to about 13 per cent. Brazilian and Russian operations have struggled. The group bleeds cash. Its price to book ratio is the worst in the entire global automotive industry.
But the hope is that 2014 will mark a turning point. The deal on the table with Dongfeng is set to result in a cash injection of €3bn-€4bn – more than its €3.3bn market capitalisation – and involve the deep pockets of the French state.
Industrial partnership
Part of that deal would be an industrial partnership with Dongfeng to produce low-costs cars for the southeast Asian markets, helping Peugeot to reduce its reliance on Europe for two-thirds of its revenue, according to two people briefed on the talks.
There will also be a new chief executive, Carlos Tavares, the former number two at Renault with years of experience dealing with international alliances, including Dongfeng.
But the mountain to climb is steep. Peugeot has not produced positive free cash flow since 2010 and net debt is estimated to reach about €4.5bn by the end of 2013, with a cash burn for the year of €1.3bn, followed by about €700m this year.
The company has done what it can to cut back spending, trimming investment into new models and research. But as rivals such as Volkswagen continue to pump money into future growth, Peugeot risks entering a downward spiral of a smaller product pipeline producing smaller returns.
Cash position
Peugeot executives declined to be interviewed by the Financial Times, but company officials repeatedly stress that the group has enough cash to keep on going in the short term.
The house is not burning. But if it does not get some repairs soon, it could collapse
- Person with knowledge of company’s internal thinking
Its cash position with €9.8bn of cash and cash equivalents at the midpoint of this year is healthy, on paper, thanks in part to guarantees from the French state such as a €7bn safety net for its banking arm. But with another year of negative cash flow this year and rising debt, something has to give.
Peugeot is the fifth most shorted stock in Europe, with 14 per cent of its shares out on loan, according to Markit, meaning that large wagers have been placed by hedge funds on the stock falling. The majority of GM’s stake was snapped up by hedge funds with short positions, according to two people with knowledge of the sale.
Those sceptical that any Dongfeng deal would solve Peugeot’s woes point to three issues.
First, in the short term, there is concern that – regardless of the discount or number of subscription rights – it will be so dilutive it will severely hurt the value of current shareholdings.
“The deal may be good for the future of the company long term, but shareholders do not own the future of the company,” says Philip Watkins, director of automotive research at Citi. “It looks like it will be a really very significant dilution.”
Governance
Second, the thought of Peugeot being jointly governed by the French government, the Chinese state and the Peugeot family – itself internally divided – has the investment community fearing the worst.
“The big thing to worry about is governance. It will be a three-headed monster,” says a senior investment banker in London.
This is the one get out of jail card that they have
- Senior investment banker in London
The most fundamental critique is that while Dongfeng’s cheque keeps the wolf from the door for a while, and the extra sales in southeast Asia over the coming years would be welcome, it does not go to the core of the problems at Peugeot: its lossmaking European operations and lack of scale.
For these challenges, Dongfeng has little to bring to the table in terms of volumes outside of China. In any case, alliances typically take the best part of a decade to mature and show tangible financial benefits.
“This is the one get out of jail card that they have,” says the banker of Peugeot’s alliance with Dongfeng. “But [Dongfeng] will not do anything for the company industrially for at least five years. There’s no scale or expertise. It’s just money.”
Production levels
Peugeot produces just 3m cars a year, compared with 10m for Toyota, 9m for both GM and Volkswagen and 8m for Renault-Nissan, giving it less purchasing power than rivals. Even if Peugeot could capture 10 per cent of this 5.5m a year southeast Asian market – twice Renault-Nissan – that is still only half a million cars a year.
Despite efforts to reduce its cost base, Peugeot still produces at higher costs than many of its competitors
That lack of output has exacerbated the company’s high cost base and overcapacity in France. While the top five Volkswagen group plants in Europe have about a 90 per cent utilisation rate, the top five Peugeot ones have about a 77 per cent utilisation, according to Société Générale research. And that figure does not include other big PSA plants such as Rennes at 35 per cent and Villaverde at 20 per cent.
The company has been bending over backwards to bring this cost base down over the past three years under chief executive Phillipe Varin, who announced 11,200 job cuts, froze wages and closed the first large factory in France for 30 years.
But it still produces at higher costs than many of its competitors. Half of all 200,000 Peugeot employees are in France, compared with about 40 per cent of Renault’s 130,000 employees.
Market share
On top of this the company is losing market share in Europe. Its cars are well reviewed, but have found themselves in the squeezed middle between low-cost brands such as Kia and Dacia and premium players downsizing to meet emission norms.
I hate the tentative Dongfeng deal because it will not improve the productivity of Peugeot in France and probably destroys employment
- Philippe Villin, prominent French investment banker
“This deal does not help with the core problems in Europe,” says Rabih Freiha, analyst at Exane BNP Paribas. “Over the next three years Peugeot are still going to have to restructure operations and cut capacity in Europe.”
“I hate the tentative Dongfeng deal because it will not improve the productivity of Peugeot in France and probably destroys employment,” says Philippe Villin, a prominent French investment banker, reflecting the concern locally about Chinese involvement.
“And ultimately it’s a crazy cost of capital because the company will be giving over its brands and technology to a Chinese player,” he says.
But it is the cash injection that is making some optimistic that the Dongfeng deal will be a good one. The bulk of the French unions, for example, far from being fearful of Chinese ownership, are optimistic.
“If Dongfeng wants to recapitalise Peugeot, that is basically great,” says Christian Lafaye of Force Ouvriere union. “Peugeot cannot live alone. Today we need more capital because we need cash to develop new cars and products.”
New capital
The new money raised from the capital increase will probably go to paying down debt as well as providing capital for the restructuring of the group, be it cutting capacity in Europe or developing emerging market operations.
“Peugeot has no immediate problem funding the business, but there are product investment decisions that need to be made very soon for vehicles that will be launched around 2017,” says Stephen Reitman, analyst at Société Générale, adding that restructuring will also cost money.
The Dongfeng deal is therefore still just the beginning of a long and dangerous road for Peugeot, a move to give breathing room for the group to address its European problems as well as to turn around fortunes in Brazil and Russia.
For that it will be the new chief executive Mr Tavares, in a potentially crowded boardroom with the Chinese, the French government and the Peugeot family, who has to arrest the decline, hopefully helped by an improving European market.
“It’s important that they continue to grow outside of Europe, but there is no getting away from the fact that they really have to tackle the domestic business,” says Mr Reitman. “That is a longer and more uncertain road.”