Friday, 11 January 2008

Industry Structure - Malaysia - Profiting from Proton

Since its birth in 1983 as the national car-maker, Proton has historically been viewed with scant regard within the global auto arena. The government funding used to set-up and support the corporation - as part of the national economic development plan - did for a long period succeed in creating what was touted as a viable, growth driven entity. But as we know, that was only really made possible by a heavy-handed protectionist policy that effectively denied a level playing field for foreign competitors. Only the Daihatsu-linked state-backed Perodua was able to enter the fray. However by the end of the 90s, this was to change, so action was needed improve the car-maker's abilities and fortunes.

To do so Proton bought Group Lotus outright in 1999 (from Luxembourg's ACBN Holdings), but the consultancies acquisition has neither re-directed the fortunes of either parent or child. The expected relationship was based on mutuality of need - expertise for Proton and funding for Lotus - but political and fiscal pressures haven't generated the idealised synergies. Yes there's been good Proton product portfolio improvement in a short timeframe (including a new family of engines) but not enough to elevate the cars to US/European/Japanese standards now expected both domestically and for advanced global markets such as it's target top 3: UK, South Africa & Australia.

In the west Proton is an entry-level player, so has suffered from the rounds of heavy price discounting that has become the norm for mid-life vehicles by the large VMs and of course the crop of affordable brands such as Hyundai and Skoda. Such pressurised markets negate the competitive price advantage 'alternative brands' like Proton once enjoyed; add the disadvantage of a sporadic dealer network and poor residual values and the UK, SA and Australian export drives - although long-lasting - have been fruitless in the attempt to off-set the long expected domestic sales decline that has now come to pass.

The catalyst was the end of the AFTA agreement exclusion (providing a scaled reduction of import/CBU tariffs), opening the doors to those foreign makers that hadn't already set up assembly plants to by-pass the previous barriers. Ultimately, the momentum of globalisation yielded an influx of new car opportunities for the general public, which they seized, Proton sales suffering dramatically - down from 60% of the market in 2002 to 23% today; equalling 130k units pa.

This output figure represents only 13% of the output capacity of the firm's manufacturing capacity, dramatically raised in recent years by the creation of 'Proton City', a PPP (Private-Public-Partnership) funded modern production hub that seeks to dramatically improve Proton & Malaysia's operational capabilities. The aim to demonstrate Malaysia's advantages as an apparently world-class auto-centre for manufacture and distribution; competing with Thailand as the "Detroit of SE Asia". Under the AFTA free-trade threat Ministers recognised the need to re-shape its domestic auto-industry, essentially broadening its remit, and using Proton itself as the mechanism for industrial policy change. To develop a plan that fits Proton and Malaysia into the broader, rapidly changing, highly competitive Asian framework; transformation led by the Chinese and Indians.

The core strategy behind the Proton City plant was to provide a massive hike in regional volume capacity, much needed given economic growth forecasts of the region. The idea is that the capacity would offer one or more combined stragetic choices:
1. to entice a western auto-maker to buy a significant stake in Proton
2. to sell the capacity to a western or VM on a lease/rental basis
3. to create a sound parts and assembly supply chain to feed burgeoning inter-regional demand.
4. to produce re-badged Proton cars on behalf of 'new' Asian auto companies...leading...
5. to become a Tier 0.5 VM client-focused producer (like Magna-Steyr etc)
6. to allow Proton sell-on technology and IPR to 'new' Asian producers

To date:
1. no western VM (eg VW, GM, PSA) has taken a serious interest in buying Proton, their focus on BRIC regions that offer better direct sales opportunities.
2. The idea of selling capacity to essentially contract-in assembly work is still top of mind.
3. Efforts to do so taking time given the differing interests of high profile Malays that own much of the parts-base
4. An agreement has been struck with China's Youngman to badge-engineer cars under the Europestar brand. 30,000 Gen2 cars to be supplied, with eventual additional models (ie BLM)
5. Although negotiations have taken place, no concrete progress forward (yet).
6. This essentially puts Proton/Malaysia in the role of technology broker to needy 'new' entrants, re-emphasising the need to exploit and grow Lotus Engineering's powertrain, chassis and body R&D.

In terms of tangible progress, there have been only a few positive announcements, and a few 'leaked' but incorrect press releases that served to try and bouy shareprice. However, as stated in point 4, one success story are the first few tentative steps in a Chinese supply deal.

However this has only slightly supported company prospects and financial markets are still weary of a bad (if not worse) case scenerio as an eventual outcome if the Chinese supply strategy falters. The biggest blow came from the retraction of VW's interest in forming a JV, Proton's stock-price plummeted 20% and has hardly recovered, leaving the share-price (and MarketCap) about half of what it was a year ago. Given their stake-building the government backed Khazanah Nasional (investment fund) and Employees Provident Fund (social security arm) have been hit hard, but their purchase actions were very probably prompted to help stop a possible worse blood-letting if more stock had been held by reactionary parties.

So what next?

At present Proton as an independent car company looks very shaky, with little direct foreign investment on the horizon. The oft touted possibility of creating the exportable 'Islamic Car' is as 'idealistic', unlikely and remote as ever since plainly other Muslim countries like Iran, Morocco, Turkey, Pakistan and Uzbekhistan plainly have car-making ambitions of their own via the more stable route of using western partners. Domestically, Western and Asian VMs operate freely in the domestic market and have to a point carved-up the segments for themselves. Thus the only viable route forward is courting of the new automakers, promoting the country's long association with, and high population-mix, of ethnic Chinese & Indian Malays. Although they personally have less political weight than the more priveliged indigenous Malays, they would act as front-men to bolster cross-border relations.

Many will say the die has been set (forgive the manufacturing pun) and what we are witnessing is Proton's metamorphosis (possible death and rebirth) as a very different entity. That process of change will take time, and Proton management are in the process of best managing that change:

a. forging links with future business partners
b. endeavouring to utilise its current vehicle range as an intermediatory instrument
c. assisting newcomers to bring cars to their own market
d. laying the foundations for what could essentially be B2B contract supply of products & services.

The most interesting proposition, to sensitive to formally air, is perhaps the wholesale divestment of Proton to a Chinese or Indian player, a firm looking for geographic expansion, immediate access to market and a sizeable slice of TIV (like Proton's 23%...remember that's better than Ford, GM or Chrysler's own domestic slice).

The stumbling block to such a radical direction may be the close-knit culture and interests of Malaysian government, finance and commerce who are both politically tied to Proton (in the interest of votes) and have major commercial interests in parts and distribution. But that's not to say that further examination of the transformation process is not warranted. If there's greater value-creation 'angle' to be extracted the powers that be will undoubtedly have open minds.

But given the export 'isolated' geographic location of Malysia relative to the heart of Asia, its industrial cost-base, the country's lack of a true engineering skills-base, the limited opportunity as the Muslim Car and critically the very directed flow of Automotive Asia-Pacific investment, the odds look - at a first glance at least - presently unfortunately appear stacked against it.

The government does indeed have a hard task on its hands. It's given Proton a few more years to find a viable survival plan, thereafter (it says) there are no promises. We believe that if there is no credible 3rd party interest in a JV and the China/India supply strategy doesn't grow, that the Malays may not have an alternative but to amalgamate Proton with Perodua to theoretically create an effectively nationalised body to maintain the the momentum in what is a very important contributor to the national budget and perhaps seek new opportunities as a bigger, better and far more cost-efficient 'national conglomerate'.