Tuesday, 13 March 2012

Micro Level Trends – PSA & GM Alliance – The Alliance Mismatch...Yet Why The JV May 'Steel A March' on EU Auto-Sector Structural Reform

Industry and financial press discussion about the recent announcement of an alliance between PSA & GM has understandably been prolific.

investment-auto-motives' Previous Perspective -

Adding to the debate about conjectural value creation versus value destruction, on 28.02.2012 investment-auto-motives provided what it considers the end-game perspective between American and French interests. Specifically the hypothesis of GM seeking to 'return' the Chevrolet brand to France – the originator's own ancestaral homeland - so as to conquer those mainstream markets which the likes of Peugeot, Citroen & Renault (& FIAT) have ruled over decades. This done by purchasing and re-envigorating divested plants across France (as well as Italy and Spain) which provide for archetypical GM volume scale-led and US$ credit enabled empire building.

GM's 'Horizontal EU Expansion' Ambition -

Driven by the central issue of European production over-capacity and structural reform, that web-log of a few weeks ago sought to highlight how the very process of broad continental sector reform hastened by rapid need for corporate right-sizing amongst the national champion European VMs would provide the perfect storm for GM to re-invent itself inside Europe given its own much reduced 'balance sheet baggage' and the support of Federal Reserve enabled low cost liquidity exercises such as the various $2.3tr QE actions, $400bn Operation Twist and the recent initiation of 'Sterilised QE'.

That overview then gave the conjectural far-horizon view, and though aspects of the short-term were described, so providing the cautionary view on the alliance, it would serve to perhaps better explain why the synergies cited by PSA and GM are in reality far less tangible – especially so regards the key element of shared engineering platforms - than the corporate IR publicity machines headline grabbing rhetoric.

Exploiting The Trans-Atlantic Bourse -

The revelation of the cross-company dialogue which has been ongoing in earnest since early January is now well recognised by the investment community as seeking to create a 'good news' story with positive immediate and long-term effects on both company's respective share prices. A Franco-American hand-holding story especially pertinent in buoying stock prices given the corollary between the US and Europe by way of the NYSE-Euronext exchange - a conceivable case of pragmatic 'reverse pseudo financial engineering' – and the fact that the US is gaining economic traction whilst Europe is seemingly over the worst of its economic melt-down fears. Thus on the surface, a highly logical alliance given both company's European production woes, orchestrated as timed to macro-economic perfection; thus designed to impress Wall St, Paris & the City of London.

Managing Investor's Perceptions -

In reaction Volkwagen CEO Martin Winterkorn, who last week proclaimed that the alliance between GM & PSA essentially ratifies VW's synergy seeking in its own (brand differentiated) platform and systems sharing ethos.

However, whilst Winterkorn sought to proclaim VW's position as industry leader in this arena, there exists a very real difference between VW Group - as a unified entity that operates 100% holds over its divisional brands - and the new PSA-GM alliance. Whereas VW operates with singular control (as ingrained by Ferdinand Piech and seen with Porsche's eventual total absorption), the real-world dualistic demands of the PSA-GM alliance partners, driven by individual parent companies own strategic agendas, invariably means that it will not be able to act a decisively nor as deeply as the VW foe.

[NB Respective share-price and MarketCap valuation differences between VW and GM and PSA, highlights that point. As of 1.00pm GMT on 12.03.2012 : VW was E127.65 per ordinary share with MktCap of E59.39bn, GM was $25.62 and a MktCap of $40.11bn, PSA was E11.86 and MktCap of E2.69bn].

But Where is the Real GM-PSA Story? -

This is not to say that there is no synergistic operational overlap that can be leveraged for sizable 'behind the scenes' cost-down measures. Simply that investment-auto-motives believes that the ultimate outcome from the alliance may not provide the level of cost-saving that has been reported.- ie the overtly enormous $125bn purchasing pool first mentioned – given the lack of true synergies that can be captured which itself primarily results from the necessary need to defend core operations and primary product lines from intervention and thus interruption.

There undoubtedly are overlaps, the essential co-operative product stream to be highlighted where specific products can be targeted, but they in themselves will not provide the kind of 'supercharged' financial savings and income that the alliance message sought to propagate.

[NB. Beyond the alliance structure, GM and PSA are of course individual entities, and so the creation of the alliance hardly means that each is now “uninvestable”.

Instead, much depends upon both company's individual performance at cost and income levels. So, present and future proven progress in: regional markets (with +ve & -ve TIV trends), the divestment of redundant assets (as seen at both GM in its Chapter 11 procedure & recently at PSA), the strength of its technical strategy path which must marry regulatory demand with consumer needs and desires, the overall cost containment achievements spanning commodities and parts procurement, R&D , vehicle development & production out-sourcing , the 'externalities' impact of ongoing part-government ownership at GM and the dilution-effect of equity raising at PSA, etc etc etc. As ever, the grouped fundamentals, which must be grasped from the investor perspective to provide the ability to ascertain the 'sweet-spot' timing as to take either institutional, SWF, PE or private retail interests in these companies].

However, the central theme of this web-log is to convey the belief by investment-auto-motives that there is less innate 'investment power' within the new PSA-GM alliance than has been communicated by what are now mutually corroborative corporate PR machines.

[NB Exclamation by the popular car press states that critics say GME-PSA house has “ruinous dry rot, yet the pair are responding by building an extension”. This unfortunately over-emotionalises the necessary 'situational analysis' required].

Even so, it is only fair that the primary 'headlines' of the announcement be re-stated.

The JV Headlines -

- “Joint savings of $2 billion a year within five years”,
- “$125 billion purchasing power to be pooled”
- “Combined total of 12.5 million units”*

[NB * PSA annual build of 3.5m units / GM of 9.0m units].

Tim Zimmerman, Peugeot UK's Managing Director mentioned that “The terms of the alliance should be clear by the end of the year, and at the start we’ll make savings on commodities like steel. As the alliance progresses further, there’ll be savings on components, modules and platforms.” PSA's Director-General Frederic St Geours, a lead architect of the collaboration Alliance, has stated that alliance work started in earnest on 1st March, co-ordination via an 8-strong steering committee made up of four directors from both parties.

A main function of that committee will be to oversee what appears to be 4 matrix-type project teams which consist of multi-disciplinary departmental experts (ranging from procurement to engineering to production) which target a notionally identified 4 platform types:

1. B-segment platform(s)
2. D-segments platform(s)
3. Crossovers platform(s)
4. MPV platform(s).

The following very basically dissects the 'parts in the sum' to evaluate whether the 'sum of the parts' do indeed add up to 'more than the whole' as both alliance partners appear believe, and hope to convince investors.

Product Analysis -

The highlighting of 4 apparently very different vehicle types looks impressive, with seeming potential to accrue mass savings over what seem 4 distinct arenas; however, the reality is that since the emergence of 'module system sets' (pioneered by Ford & Toyota, Daimler, BMW and indeed PSA) the base 'platform' engineering of visually separate product lines is no longer wholly separate and distinct. Advanced IT systems and software have were developed to enable the creation of 'systems sets' which provide for far greater 'engineering exchange' in body structure, powertrain, chassis, electrical/electronic, trim & hardware across not only model variants, but across different models within a specific segment and importantly in recent years even across different segments.

[NB. Such engineering corroberation between A & B, B & C and C & D segment vehicles is much of the reason that basic vehicle dimensions have grown over the last few decades].

This basic explanation then demonstrates that increasingly MPV and Cross-Over engineering systems have merged, indeed Chevrolet's use of the separate terms to direct prospective customers viewing its European website toward the same product offerings highlight the trend of technical merge between these two once distinct classes. Moreover, the fact is that whilst there are smaller siblings of the same genre, the D-segment actually encompasses the majority of larger, space-functional MPVs and Cross-Overs, so a D-segment car (in its own sedan, coupe, wagon, body variants) will share much of the under-pinnings of a similarly foot-print sized MPV and Cross-Over.

Thus items 2, 3 & 4 listed by the alliance are in fact to a great extent the very same engineering platform base. But, any idea of a deeply ingrained platform share agreement which includes mutual R&D, engineering development and 'productionisation' appears hollow. Instead of heavy R&D and operational spend on such a platform, investment-auto-motives believes that PSA will simply in the medium term adopt and adapt (ie brand engineer) its partner's GM vehicles across the D-segment, thus effectually replacing the agreement with Mitsubishi and relieving itself of costly large car responsibilities.

[NB Since the demise of the Peugeot 505, history has proven it economically untenable for PSA to create its own platform in this field, though its does (at a reducing rate of loss) so as to appear a full-line producer (thanks to increased module share 'into' the 508 and to French government and French fleet sales].

However, whilst there may seem potential for far-horizon collaboration for a D-segment (mid-size in US) sedan and its variants, the fact that the majority of sales for this sized car are in North America and China – both GM strongholds – thus give GM the scale advantage, so the engineering eminance and so disadvantages PSA. Importantly, GM must necessarily maintain near total control over this platform to ensure its core American model Malibu can compete directly against the Ford Fusion (& Taurus), Honda Accord, Toyota Camry and now Hyundai Sonata & Kia Optima on both production cost vehicle attributes. Thus, the ability for PSA to notionally co-develop and so influence its base engineering for Peugeot, Citroen and DS attributes looks highly unlikely, more so since the 8th generation Malibu will be introduced in 2013, making it virtually impossible for PSA to 'mould' the car to its requirements, thus would either be forced to simply 'badge engineer' or to undertake an ill-advised 'SAAB-esque' approach.

[NB The SAAB experience under GM being that it had to add the high cost of a 'DNA' re-design programme to the original 'percentagised' development cost of the base car programme. Both these CapEx and R&D expenditures then required to be ammortised over dwindling sales volumes].

As for the mutual development of a B-segment platform, as investment-auto-motives stated in its previous essay, this segment has now become key to all volume manufacturers. The the case given that this segment has in recent decades it has held the largest portion of global industry TIV, with that trend set to grow because of continued economic expansion in 'BRIC' & 'Next 11' EM markets have a proclivity for compact cars, and the fact that the 'developed' 'triad markets (Europe, N.America and Japan) continue to 'down-size' in car size due to reduced spending power and an ageing population which seeks smaller car running costs and manouvrability.

As a result, it seems incomprehensible that any volume manufacturers - especially GM and PSA given their growth ambitions – would seek to share their individual control over such a critical issues as product, strategic and income destinies.

It was stated outright by both alliance partners that exploration of the A-segment was not included in the alliance, this it is assumed because of the in-house capability at GM which stems from its Korean operations, and the fact that PSA will very probably seek to retain commercial JV links with Toyota for future generations of Aygo/107/C1.

And it was equally stated that the C-segment would not be mutually explored because of PSA's recent introduction of the new 408 which will have approximately an 8 year lifespan, thus not to be replaced until 2018-19.

Thus all the conventional car arenas offer little collaborative space.

A Focus on Commercial Vehicles -

The only alternative arena is commercial vehicles, ie Vans and their myriad of model and variant types. Here, investment-auto-motives believes, the present JV experience of Chrysler-Daimler (ie not Daimler-Chrysler alliance of old) has had an important affect on GM & PSA executives.

Chrysler has ostensibly 'off-shored' a major part of its US commercial vehicle division by 're-badging' (and critically 'de-costing') Mercedes-Benz van products as its own under the Dodge brand.

It is suspected by investment-auto-motives that GM will undertake a similar strategy within Europe, done so by switching partners from Renault (from which its uses Master and Trafic models) to PSA, so as to fill capacity at its Luton van production centre in Luton, UK. Given that PSA already relies upon its FIAT alliance to produce its 'Eurovans' in both 'Sevel Sud' (Italy) and 'Sevel Nord' (France), the situation in turn generates conjecture that GM will join this duo as a third partner.

Steeling The Far Reach Competitive March -

Given the higher portion of metal content of box-vans – on a parts count and systems-value basis - this PSA-FIAT-GM joint venture could then better impose its will for raw materials discounting from global steel suppliers; an arena which Philippe Varin of course knows intimately.

Conclusion & Hypothesis -

To summarise, from the all important product perspective there appears little immediate and indeed medium-term scope for major cost-cutting exercises beyond that offered by the creation of a new commercial vehicles triumvirate group.

However, that group and associated conjoined commercial enterprise may seek to lay the foundations for broader materials procurement leverage on behalf of the passenger cars divisions within PSA and GM.

This then suggests the possibility that the PSA-FIAT-GM commercial vehicles group latterly spin-off a raw materials buying entity – essentially an intermediate broker - which could perhaps better serve the industrial bargaining needs of PSA & GM, and indeed become a co-ordinator for a much enlarged European Chevrolet (as described) aswell as other European based indigenous producers (eg Renault, VW, BMW, Daimler) aswell as present Asian 'transplant' producers (eg Hyundai-Kia) and possibly Chinese manufacturers (eg Geely, SAIC, BYD, Great Wall).

Given the lack of deep product and product programme rational behind the GM-PSA alliance, there must exist other compelling reasoning.

So the possibility may well exist that whilst GM expands horizontally further into Europe via PSA's production base, PSA itself could as well as climbing the value-ladder with the 'transport solution' ideology that is 'Mu', also seek to descend the value-ladder into the world of low-value metals, but as a broker not direct supplier, then possibly broadening to brokering higher value metals and materials which are becoming ever more critical to vehicle structures to achieve low CO2 targets by 2020 and 2050.

Thus, the rational of the GM-PSA alliance could then be far deeper than anyone imagined, with far greater consequences for structural reform of European car-making.

The rightly self-congratulatory Volkswagen (sat on its net liquidity cash cushion of E17bn) - like those at BMW & Daimler - might wish to consider more deeply the far-horizon consequences this conjectural hypothesis holds.

But for VM competitors and the myriad of investor types alike, the synergies of the GM-PSA alliance itself offers little immediate excitement. Instead, it seems a necessary case of reading between the lines to understand the true logic, and here the hypothetical influence appears set on the 'invisible' far horizon. That of necessary corporate structural change 'horizontally' and 'vertically' that can both serve and gain reward from the sector's own evolution as determined by a changed EU market demand dynamics and the broader competitive environment.