Tuesday, 16 September 2008

Company Focus – Volvo Cars – the Revolving Wheel of Fortunes in Gothenburg

As Ford and its Detroit brethren court the senators and purse-string holders of Capitol Hill - seeking the initial $25bn tranche of an ideally $50bn+ deferred low cost Federal loan - so FMC must concurrently also scope the value and potential of its remaining asset base to determine its budget contingency and so mould appropriate forward strategy.

In an environment where GM has HUMMER up for sale, Chrysler seeks to divest of the Viper business and the former step by step dissolution of the once mighty Premier Automotive Group (PAG) has set an apparent precedent within Ford, no-one is surprised that in recent weeks there has been much conjecture surrounding the fate of Volvo Cars. And the rumour mill has fairly buzzed at the expected 'parachuting-in' of a seasoned Ford executive in the shape of Stephen Odell; replacing on 1st October the much respected, but presently poorly politically positioned, Fredrik Arp.

Volvo, although part of PAG, always retained far more independence than many other Ford holdings, its most noted peer Mazda. Whilst Volvo served by providing various new generation large & mid platforms for FMC en masse, the nub of the business was always Swede-centric so as to retain a sense of self when attempting to grow volume via its crop of large and mid X-overs and large, mid and compact cars.

Previous buoyant economic times allowed for that level of autonomy given that Gothenburg was philosophically integrated, even if not administratively, acting as Ford's centre of competence for AWD drivetrains, safety technology, telematics & ecological technologies. Critical elements which under PAG ideology were to create a low-cost technology trickle-down hardware & software streams into blue-oval's mainstream products to keep them as respective class-leaders.

However, it is that very synergy and level of inter-dependence that is now being questioned by Detroit, Gothenburg and of course the investment community. Once seen as the perfect 'half-way house' relationship under a different era, times and corporate structure have evolved since. As the world's economy looks to absorb perhaps the biggest financially induced shock yet with the collapse of Lehman Bros (and its resultant squeeze effects on margins, budgets and disposable consumer consumption) so American industrialists will be seeking risk-averse strategic courses in what are very very choppy waters.

As a consequence of the last year's increasing turmoil, rationalisation exercises have been underway at Volvo Cars for the last 2 quarters - ever since FMC quoted a Q108 loss of $151m and subsequent H108 loss of $271m (compared to a previous recent peak of $3m profits in H107). [Though of course FMC accounting and appropriation of expenditure vs income cannot be wholly ruled out as it itself seeks to convey better figures for core blue-oval operations]. Whether wholly market-induced or partially financially engineered, that rationalisation has taken the form of headcount reduction (1,400 white collar & 600 blue collar) and a general 5% output reduction subsequent to the previously announced Torslander site's activity reduction due for October.

But the sign of the times is senior management change. Where as Arp held great goodwill from Volvo's supplier-base, dealership-base and importantly governmental contacts, it was no doubt felt that such 'bon ami' was counter-productive to this new period which requires 'hard-ball' negotiating with all internal and external stake-holders. The fact that Odell is the first non-Swede to take the reins at Volvo (additionally supported by non-Swede Steven Armstrong as COO), we suspect, demonstrates the seriousness of the stance that FMC seeks to take; intentionally distancing itself. If it was simply a matter of Volvo 'tinkering', keeping the business as an 'arm length's division, the necessary ongoing restructuring and stakeholder conversations would have been better (politically) accomplished by Arp or another respected Swede. That appears not the case, Detroit wanted a direct line to Gothenburg and is using Odell to ensure that it is accomplished.

At the matter's heart, Odell will be weighing-up pro and counter arguments behind the strategic disposal of Volvo Cars versus complete absorption into FMC:
Basic, preliminary thoughts from investment-auto-motives regards the black and white scenario choices are as follows:

Scenario A - Divestment (“Opportunity Cost”) :
1. The need to tread a fine line between cherry-picking retained technologies, valuable transferable capabilities & facilities whilst maintaining a attractive entity that would muster potential buyers.
(This greatly influenced by FMC's future 'make vs buy' philosophy)
2. Assess the level of potentially 'fiscally encumbered' deflated asset values - land, buildings, plant etc. (Though this could be less than instinctively presumed given Sweden's fortunate apparently limited direct domestic banking exposure to the global credit crunch).
3. Evaluate the potentially loss of future competitive advantage in Safety, Telematics & Eco IPR
4. Identify 'best-fit' suitors (assisted by a NOMAD) between trade, MBO/LBO, PE and possibly governmental interests.
5. Negotiate contractual FMC support & non-compete clauses. (regions / time-frames etc)
6. Develop an alternative FMC strategy for 'from scratch' creation of new Eco-associative Brand

Scenario B - Volvo Retention (“Cost / Benefit”):
1. Press for Swedish government assistance (grant, subsidy, tax credit incentive etc)
2. Continued operational rationalisation merging Volvo into FMC , deleting double-count activities and severely contracting autonomy (ie 5 cylinder engine design and manufacture)
3. Negotiate extended supplier leverage & demand co-op project and plant / tooling investments.
4. Supplier initiatives to gain volume economies and reduce payment, logistics complexity
4. Cost-down on R&D and project engin'g to reduce the competitive gap against low cost regions.
5. Assess dealer-base ownership structure to improve 'ex factory - retail' margins & customer experience, CRM and create repeat buyer loyalty.
6. Critically evaluate Volvo's brand and product strategy with serious consideration of alternative secondary, separately positioned new look & feel or sub-brand.
7. Develop a robust FX hedging strategy for the near to mid term (1-3 years) for US$ volatility.
8. Seriously consider Volvo production in the US (on flexible Ford & Mercury lines) scaling up Volvo volume as the Mercury marque continues its inevitable decline; assisting unit margins.

Of course, these are only a few highline considerations amongst a myriad of issues for both scenarios. To fully assess the ramifications of each scenario and make a fully explored decision would take time, but time is a luxury that Odell very probably doesn't have.

FMC and Mulally have heard supportive sound-bites from the Tracinda PR machine, but equally it and other institutional investors want to see plausible solutions to the haemorrhaging of Ford's P&L and an evidently uncomfortable rate of cash-burn on the quarterly Balance Sheets. Thus the relaxed and amiable Mulally will be trying to manage shareholder expectations, retain goodwill and effectively buy time .

The investment community would unsurprisingly be particularly interested in the sale potential of Volvo, both as an investment vehicle in its own right, as the probable short-term upswing in FMC stock value as the market would perceive such an act as effectively “lifting a weight off the corporation's shoulders”. Indeed Odell's statements that “Volvo will be more standalone” positively courts such conjecture. So looking slightly deeper at Divestment, which parties might be interested in Volvo's acquisition? As ever, potential candidates derive from Trade, Private Equity or the latter-day sizable influence of Sovereign Wealth Funds (esp Arabic & Asian).

In regard to the general trade sales environment, given today's current and worsening contraction of credit availability in western markets - where corps are willing to buy expensive short term paper to cover short/mid-term operating – the bygone possibility of heavily leveraged strategic M&A has drastically demised.

There has been press speculation that Renault-Nissan might be a potential given the French company's interest at time of Volvo's sale to Ford, but given the Franco-Japanese's companies organically developed leaps forward in both safety and eco-tech in the interim, the worldwide marketing of upscale Infiniti competing directly against Volvo and Ghosn's own performance pressures to fulfill R-N shareholder expectation, an additional car company purchase is looking very remote when he (like many CEOs) seeks the benefits of alliance partnerships over the headache of financing and meshing a 3rd entity with little upturn.

PSA, now coming to the fore playing its strong small car range and CO2 credentials, could theoretically be interested in gaining a premium brand to both reach into that territory and gain further volume economies on its larger platforms, but PSA has historically favoured alliances not M&As – its imbued in the Peugeot-Citroen DNA - and seen yet again recently with Mitsubishi partnering on larger vehicles and diesel & electric powertrain solutions, and major emerging markets potential such as Russia & Brazil. Integrating Volvo might be biting off more than it could chew, and the very pragmatic Streiff, renowned for seeking efficiencies, recognises that.

As for the German's, would either BMW or Daimler, both with their own performance issues, want to acquire a foreign company after the respective Rover Group and Chrysler 'divorces'? Probably not. Reithofer and Zetsche recognise that jittery capital markets will want to see them sort their own house-keeping first and will not speculate so rashly with valuable cash at hand or costly debt; if indeed available. Volkswagen has been running well as the doyen of the auto-stocks, but as of today it has the internal & external political concerns regards integration into Porsche Holdings. Whilst that should theoretically be a smooth process of conjoining 2 well associated, already cooperative firms (eg Toureg/Cayenne, Panamericana & smaller siblings) the reality with inter-family power-struggles and the case being pursued against Porsche by the State of Lower Saxony (seeing itself as 'defender' of VW) means that the situation is far to messy to seriously consider a acquisition and integration.

This leaves FIAT as the last major European candidate, again a case of a conglomeration that has won investor favour with positive results over the last 4 years, led by Marchionne. But this 'turnaround architect' of FIAT's fortune is to leave Autos for Banking and serve the troubled investment bank UBS to do the same. However, whilst he has undoubtedly left FIAT all the stronger, he did pick-up FIAT Autos at the bottom of its cyclical trough, and it didn't require strategic and tactical brilliance to get back on track aided by major GM assistance, Ford partnering and provision of a good small car line-up and exploitation of the iconic 500. He is now leaving at what could be argued as a FIAT Autos peak, the task of the next CEO far harder as FIAT fights the international battle and suffers from a growing hyper-competitive home-market and European backyard. Relations with TATA and Chery will undoubtedly assist in reducing vehicle programme costs and accessing EM regions, but any interest in Volvo would need to be ideally mutually beneficial to all increasingly important partners, like the Jaguar platform conjecture for Maserati. Perhaps Volvo's acquisition could also aid the business cases for Alfa Romeo and Lancia, and piggy-back Volvo's international market presence (esp USA), but that 'fit of mutuality' would be critical.

Lastly from the Trade-Buy angle, this leaves the Indian and Chinese manufacturers – the big players like TATA, Maruti and Mahindra & Mahindra, aswell as SAIC, FAW, Dongfeng etc. The likes of TATA and SAIC have proven themselves to be M&A protagonists in the premium sector and are presently continuing to absorb their acquisitions. Both MG-Rover and Jaguar-Land Rover were bought for their base technology and future IPR potential as much as their upscale brand names.

Volvo would need to prove itself a compelling buy that could be easily absorbed into the host organisation, and with what are essentially major FMC hardware and political ties. Of the Indians and Chinese, given economic slow-downs in both countries, it will only be the cash rich and heavily committed that could make such move. Of the aggressive players, it is perhaps only TATA who, now experiencing that complexity of M&A transfer from FMC, is best positioned to managerially undertake such a venture. But credit analysts such as S&P and Moodys had already downgraded TATA for taking on too much risk and incurring deferred earnings when it acquired J-LR, before the real bite of the credit crunch. Another major distraction renewed focus on the Nano project's present manufacturing concerns. And it will be noted that whilst Jaguar, Land Rover and Volvo share similar market-segment territory, their respective construction techniques are markedly different and in the short-term hard to merge - Volvo's higher volume conventional (FMC) steel-based platforms vs Jaguar - Land Rover's aligned advanced construction solutions. So whilst there are undoubted product synergies to be had in the longer term, the 3 brands spanning cars and X-overs, the macro-economic issues of the here and now look to make even an under-valued Volvo as a stretch too far for the redoubted Ratan Tata right now.

Looking at Private Equity, one argument that could be theoretically constructed is that Tracinda (individually or as part of a consortium ie Arabic or Asian SWF) looking to take advantage of Volvo potential relative to an over-stretched Ford empire focused on its own core operations. Such an approach by Tracinda could, given its political clout with a Ford invested SWF, seek obtain Volvo Cars at a bargain Fire Sale price. Jerry York, could well be eyeing-up Volvo for Tracinda's own uses, knowing it would secure Ford's 'guaranteed' operational support (in procurement & development services) as Volvo Cars transforms into a legally independent entity.

However, if Volvo's unsecured future persists with FMC's increasing loss of patience and a PE consortium failure to grasp the mid/long term potential at a reasonable price, the ultimate arbiter could well be the Swedish government itself. Today's centre-right governmental stance will be an important factor in how the company is able to move forward. Unlike far more socialist predecessors this government unsurprisingly takes a far more capitalistic attitude but appreciates its responsibilities to its people. That a once semi-protectionist Sweden is today recognised as meshed within global trade; whether that be mobile phones, medical devises, vehicles or indeed the corporations that produce these products and associated services. Thus, whilst full nationalisation of Volvo Cars would not be entertained, it may well consider the idea (if presented the problem) of a government assisted initiative to ensure a domestic LBO/MBO could be undertaken. Done so if necessary to rebuild the company if, at worst case scenario, Ford did indeed asset-strip core capabilities that would take time and support to rebuild.

Ironically, this could well be a negotiation tactic used by Odell to gain governmental flexibility to 'help' Volvo during these dark days for Ford and Detroit; recognising Sweden's desire to maintain its national base of upscale car companies. Enterprises that have done much to put the Scandinavian country on the global stage over the last 50 years and commercial engines that add so much to the national economy.

But the reality is that presently, premium saloons, station wagons,, coupes and X-overs like the S/V-80, S/V-60, C-70, XC-70, XC-90 and possibly even upcoming XC-60 have been hit hard by the broader economic malaise. Sales forecasts are 400,000 units for 2008, down more than 12% from 2007's 457,000 units. The prime US market is down 23% YoY and down a hefty 49% in August alone. And whilst the smaller vehicles such as S40 and C30 were introduced their performance has been patchy, the S40 well received, the C30 far less so.

Thus Ford will have a major job of evaluating both the “Cost-Benefit” and “Opportunity Cost” of retaining or divesting of Volvo. It all too well knows the frustration that in today's Eco-orientated world, encompassing society's & the consumer's return to family values & community spirit, that the Volvo brand is indeed a gem. The problem, as ever under financially pressured periods, is the cost in terms of commitment, time and of course finances that it takes to polish that gem and make that emerald sparkle green.