PSA-FCA: Sergio's ghost is hovering over the deal

Some in the industry need a haircut

As the exact terms of the deal being negotiated and the reactions of the markets become clearer, the scope of this 50-50 appears a bit different from "parity". Indeed, the financial community is calculating, on the basis of the respective valuations of the two groups before the announcement of the project and the operations that will be carried out before the deal, that we would rather be at 60-40 for the benefit of PSA, and that PSA therefore is agrees for the deal to be made at a significant sacrifice.

 Indeed, at the closing of Wednesday evening, PSA's capitalization amounted to 23.19 billion euros while FCA's was 18.22 billion euros. It has been reported that, prior to the completion of the transaction, FCA would pay out to its shareholders an exceptional dividend of €5.5 billion, as well as its estimated €250 million stake in Comau.
At the same time, PSA would distribute to its shareholders its 46% stake in Faurecia, valued at €2.725 billion.
The respective values of the two groups adjusted for these exceptional dividends therefore amount to approximately €20.5 billion for PSA (62% of the combined valuation) and €12.5 billion for FCA (38%). A 50-50 merger therefore implies that PSA pays an implicit control premium of 32% to FCA, according to Philippe Houchois' (Jefferies) calculations. 

This would explain why FCA shareholders, including Exor, are very happy and PSA shareholders less so.
The former will receive €5.5 billion in cash. The latter €2.7 billion in Faurecia shares -that will hopefully be sold at a price at least equal to today's price.
In addition, as others point out, "FCA is significantly less profitable in terms of operating margin than Peugeot (respectively 4.6% versus 7.7%), so the new entity will be mechanically less profitable than PSA taken on a stand alone basis".
This is also what makes Chris Hughes, Bloomberg columnist and deals specialist, say that what is called "merger between equals" in fact looks much more like a takeover of FCA by PSA: the acceptance of such a "premium" is usually found in this type of configuration.
The composition of the "board", which will include 6 membres from PSAs and 5 from FCAs and will be headed by Carlos Tavares, would reflect the nature of the deal, which in a way reverses what was feared when the deal with Renault was specified.

This is reassuring given what has happened at FCA in recent years.
Indeed, this analysis can be used to nurture the hope that Carlos Tavares will be able to structure with the American and Italian teams an industrial and commercial project closer to the one he led at PSA rather than a financial project that will exempt the new group from the high investment requirements that will weigh on it. Indeed, the current changes that characterize the period impose such constraints on all automakers.
In addition, in the case of PSA-FCA, there are the investments that will have to be made to remedy the difficulties encountered by FCA when dealing with issues other than RAM and Jeep.
In China and Asia, in Europe, at Chrysler, Dodge, Fiat or Alfa Romeo, an important reconstruction work should be launched and will require both clear governance and a certain "patience" on the part of the shareholders.
If this were to be the course taken in the coming months, we would be reassured, but things may not be so clear.
Carlos Tavares' mission statement could be much more "marchionnian" than what the somewhat simplistic opposition between FCA, a financialized American company, and PSA, a French industrial company with a long-term vision would suggest.

Indeed, some of us remember that four and a half years ago, Sergio Marchionne tried to theorize why it was imperative to set up very large automotive companies.
His presentation was called "Confessions of a Capital Junkie". It was subtitled "An insider perspective on the cure for the industry's value-destroying addiction to capital".
It summarizes a posteriori quite well both how he led the FCA boat, why a merger was for him the only possible outcome and what the project of the new entity could be and - therefore - Carlos Tavares' mission letter. It showed that, by combining R&D and capital expenditure, a growth in the industry expenditure of almost 50 billion euros (from 76 to 122 billion euros) over 5 years (from 2010 to 2014) was shown, which he considered to be economically unsustainable.
He associated it with regulatory and commercial pressures and tried to demonstrate that no other industry was subject to such an appetite for capital and that this explained the low operating margins in the automotive industry.

The origin of this problem was from his point of view associated with manufacturers' expenses to develop and produce "proprietary components" that consumers were very often unable to identify.
The reduction in the number of "active" platforms and the commonalisation of modules equipping different brands were from his point of view the answers, but they were far from sufficient judging from the returns on investment and the valuations obtained by the manufacturers.
This was due to the fact that these strategies were often carried out too timidly and without all the necessary discipline and, above all, the consolidation of the sector had not been completed.
He recognized the risks and even identified the five main ones: cultural differences, inequality between integrated parties, radical differences in operational models, insufficient sensitivity to brand differences and lack of respect and/or trust in each other. But he concluded that the potential savings were too significant to be ignored: it would be possible by consolidating a 70% reduction in investment and R&D and optimizing "industrial allocations" without impacting employment levels.

Bertrand Rakoto explained on Friday in his column that, unlike what could be said when commenting on the Renault-FCA project, Carlos Tavares' PSA is not so far from this vision: "The main restructuring principles applied by PSA are based on rationalising ranges and markets only to profitable products and countries, shifting financial schedules, transferring operational costs to subcontracting and minimising R&D".
And, in fact, if PSA is not at the minimalist level of FCA's R&D spending (2.5% of sales), it is only one point above while Renault is rather at 5%. It will therefore not be a question of taking advantage of the size of the new entity to invest massively in technologies associated with the connected and automated vehicle or electrification, but in Marchionne's words to try to "do more with less" to improve the profitability of the entity and the capitalisation of the new entity.

The implicit project stands out quite clearly as a consolidation/rationalization project entrusted to Carlos Tavares.  Given the traces left by Marchionne's "management to the economy" on at least four brands (Fiat, Alfa Romeo, Dodge and Chrysler), the question will arise as to what will be considered worthy of saving through reinvestment in brands and models backed by PSA platforms and engines compared to what will be considered as undue capital expenditure.
In the United States in particular, the Chrysler brand, which will end the year with just over 100,000 vehicles sold (-23% in the third quarter), could be in danger.
For Fiat in Europe, which was increasingly resembling to what Opel had become for GM at FCA, it could be an attempt to rebuild a brand by possibly reconstituting a range on the basis of PSA platforms and engines.  We could also consider that the enterprise is now too complicated and expensive.
Similarly, from Marchionne's perspective, drastically reducing the number of "proprietary components" (engines and gearboxes typically) as well as the number of platforms will be the first priority and this should result in a significant scope reduction for engineering departments or even Italian mechanical plants, as shown by the previous Opel-Vauxhall.

To take the head of the merged entity, it is highly likely that, beyond the 32% premium granted to FCA, the shareholders of PSA and Exor have agreed on a very "marchionnian" strategy.
The American press does not hesitate to call Carlos Tavares the "new Sergio".

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Translated with, corrections by Géry Deffontaines


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