Scepticism over Fiat chief’s call for megamergers

It was called Confessions of a Capital Junkie. An industry insider said it was more like Car Industry 101.

Sergio Marchionne, chief executive of Fiat Chrysler Automobiles, last month gave a presentation on mergers and acquisitions, the latest in a series of calls for consolidation in the industry from the former accountant and lawyer.

Marchionne argued that carmakers should combine to help fund the increasing development costs of greener cars involving electric motors, as well as new technologies such as self-driving vehicles.

His presentation set off fevered speculation.

Did this dealmaker – who brought together Italy’s Fiat with Chrysler of the US – have a transaction in the works? The company declined to comment.

The story was given another spin when Marchionne said he had spent time in early May with Apple chief executive Tim Cook and Tesla co-founder Elon Musk, and taken a ride in one of Google's self-driving cars.

These Silicon Valley companies are threatening to disrupt the car world, but Marchionne – who was born in Italy and grew up in North America – insisted that the US groups should be involved in the “dialogue” on consolidation.

Industry insiders, ever sceptical about the prospects for car sector megamergers, say Marchionne may have ulterior motives.

Some analysts believe Fiat Chrysler, more than any other large carmaker, needs a deal in order to tap capital, among other things.

The company suffered during a sharp downturn in European sales following the global financial crisis.

Fiat Chrysler has large borrowings – net debt stood at €8.6 billion at March 31st – and low profit margins.

Moreover, it has big investment plans, including building Jeeps in China and reviving the struggling Alfa Romeo brand.

Glued together

Marchionne has glued together two carmakers. The question is: can he pull off the trick again?

Marchionne said in a conference call: “I think it is absolutely clear that the amount of capital waste that’s going on in this industry is something that is not to be countenanced . . . and the remedy in our view is consolidation.”

No one doubts that the argument made sense. Making cars is an expensive business. In the past five years, the top three carmakers by sales – Toyota, Volkswagen and General Motors – spent a combined $315 billion on research and development and capital expenditure, which includes new machinery and plant maintenance.

There is nothing wrong with heavy spending. But as Marchionne pointed out, carmakers do not cover their cost of capital. The returns do not justify the investments.

Marchionne has described the industry’s low trading multiples as “embarrassing”.

The pro-consolidation argument says mergers between the big carmakers would reduce competition and costs, and allow for better profit.

That would boost share prices and help towards a stock market re-rating.

Dominic O’Brien, an analyst at Exane BNP Paribas, says: “The market punishes [car makers] for being profligate, for not consolidating parts that should have been shared long ago.”

There are deeper reasons low valuations is assigned to car makers, including the fact that it is a commoditised sector with little distinction between products and that real car prices are declining.

Standing in the way of dealmaking are blocking interests of families and governments.

Many of the voting rights in carmakers are held by families such as the Quandts at BMW, the Porsche-Piëchs at VW and the Ford family.

"They appear to retain a deep sense of responsibility to their companies, a responsibility to their employees and communities and a keen sense of legacy," says Bernstein Research analyst Max Warburton. Despite all the arguments against tying up wealth in the cyclical, capital-intensive car industry, "they show little interest in selling".

Significant stakes

There are regional and national interests. Lower Saxony state holds a fifth of VW's voting rights, while Paris has significant stakes in Peugeot and Renault.

A barrier to consolidation, analysts say, is the fact that the car industry is in relatively good shape.

Sales in the US are close to all-time highs. Europe is recovering after six years of decline. China is slowing but fuelling profit at many carmakers. History says this situation is not the cue for large-scale M&A in the industry.

There has been no shortage of M&A activity. The US had 272 car producers in 1909. By the 1950s, the oligopoly of GM, Ford and Chrysler had taken shape.

But few sectors do M&A quite so badly. From failed combinations such as DaimlerChrysler to scrapped alliances such as VW-Suzuki, car history is littered with takeovers, mergers, and partnerships that sought big cost savings but collapsed. (c) 2015 The Financial Times Limited