Fiat Chrysler Automobiles NV (BIT:FCA) – market cap as of 10/31/2019: €30.28bn
Peugeot SA (EPA:UG) – market cap as of 10/31/2019: €26.22bn
Introduction
On the 31st of October 2019, France’s Groupe PSA and Fiat Chrysler Automobiles entered into an agreement to merge into the world’s 4th largest original equipment manufacturer with a capacity to produce 8.7m vehicles annually. The merger will ensure a 50/50 ownership of the new entity by former PSA and FCA shareholders and create a company with revenues of €170bn. This strategic move comes at a time when the automobile industry is facing rapid structural changes and is in line with the consolidation trend that has reigned over the industry over the last few years.
About Fiat Chrysler Automobiles N.V.
Fiat Chrysler Automobiles N.V. is an Italian-American multinational corporation and, at the time of this article, the 8th largest auto manufacturer globally. The group was created in 2014 as a result of a merger between Fiat and Chrysler and holds its corporate headquarters in Amsterdam (financial headquarters being located in London). FCA is listed both on the Milanese stock exchange and on the NYSE and serves a global clientele under the brand names of Abarth, Alfa Romeo, Chrysler, Dodge, Fiat, Fiat Professional, Jeep, Ram and the street and racing technology brand (SRT). The company employs nearly 199 thousand people and posted a net income of €3.63bn as of 2018.
About Groupe PSA
Groupe PSA, also knowns as PSA Peugeot Citroën, is a French multinational automobile manufacturer focusing on three major business segments. The Automotive Division covers the production and sale of passenger cars and light commercial vehicles under the Peugeot, Citroën and DS brands. The Automotive Equipment Division, corresponding to PSA’s stake in Faurecia Group, works on interior systems, automotive seating and clean mobility. The Finance Division is the one which offers retail financing to Peugeot, Citroën and DS customers while offering wholesale financing to the brands’ dealer networks. These three divisions make up more than 97% of the group’s product offerings while PSA also holds minority interests in logistic services and motorcycles. As of 2018, the company posted a net income of €3.295bn and has been employing over 184 thousand people.
Industry Overview
The automotive industry is one which has seen a tremendous amount of change over the last few years. Dropping car sales, tighter regulation and shifts to new technologies and trends have forced many manufacturers to consolidate in order to achieve economies of scale and gain access to new markets, China being the largest one as of the time of this article. Indeed, most markets have experienced a drop in demand for vehicles; the Chinese market has seen a drop of 4 per cent since 2018, a trend observable also in Europe where a fall of 1 per cent was experienced. The US has remained strong over the last few years, yet, over the backdrop of a global economic slowdown and geopolitical tensions, analysts expect a fall in sales this year.
Automakers have found it crucial to collaborate and consolidate in order to remain competitive. The share of revenues of the legacy giants of the auto industry such as Toyota and Volkswagen has dropped dramatically to little over a third due to entrance by mid-size car companies. Moreover, automakers currently hold very low valuations while, according to the Bloomberg merger calculator, their acquisition could increase first-year earnings by even 30 per cent. To crowd out the competition, in the current environment, many automakers have seen it lucrative to scale up creating many alliances such as those of Volkswagen-Ford and Daimler-Geely.
Automakers have also been experiencing increased costs, much of which is in the form of R&D. BMW, Volkswagen and Tata Motors have all seen a rise in R&D costs of 6 per cent to keep up with innovation, yet cutting into profitability. The automotive industry is one which is seeing a huge technological shift to electric vehicles and autonomy. Over the last years, we have seen the entrance of many non-automakers, such as Apple and Google, move into the sector, thereby placing themselves at the forefront of innovation while the larger giants have been somewhat lagging. Moreover, regulatory pressure to lower emissions poses a serious structural change to most car producers and, adding this to higher costs, reduced prices and the capital intensive race to electric vehicles, many more automakers will need to consolidate to reduce expenses and survive in this dynamic environment.
Deal Structure
Under the terms of the deal, equity ownership of the new entity would be split between previous shareholders of the two companies, allowing them to equally benefit from the combination. This deal will have a one-time cost of achieving synergies of €2.8bn, 80% of which will be achieved after 4 years. In order to balance the value of the two companies, PSA will distribute its 46% stake in parts manufacturer Faurecia to shareholders (amounting to a value of €2.7bn as of the 30th of October, 2019) while FCA shareholders will receive a €5.5bn cash payout and a further €200-300m as the result of the sale of FCA’s robot-making unit, Comau. The current chief executive of PSA, Carlos Tavares, will assume the same position in the new entity while FCA chairman John Elkann will retain the same role following the merger.
Deal Rationale
Earlier this year it seemed that FCA was about to tie up a deal with Renault and Nissan, but it ultimately fell apart as the French Government, owner of 15% of the French automobile manufacturer, had serious concerns about the complications arising from Ghosn’s trial in Japan on charges of financial misconduct. During the past recent years, Fiat has been performing poorly in Europe. The company believed that, in this extremely competitive market, making a substantial profit through mass-made small and medium cars was unattainable. However, PSA has proved that they can achieve exactly that. The Citroen-Peugeot ranges are profitable and widely admired and PSA has managed to turn around Vauxhall-Opel, a loss-making business for decades when it was owned by GM.
Yet PSA is not doing so well in all fields. Two of its biggest weaknesses are its absence from the American market and its lack of noteworthy premium brand. In contrast, FCA has a solid market presence in the USA and Mexico as well as the brands Alfa Romeo and Maserati, true premium assets. Last year, PSA sold 3.4m vehicles in EMEA region, while FCA sold about half of that. However, PSA did not sell a single vehicle in North America, whereas FCA sold 2.5m. In a nutshell, it would seem like they are a great fit since they have complementary areas of success.
Indeed, the companies believe that the combined company will greatly benefit from bringing together the companies’ extensive and growing capabilities. The joint entity is set to be the 4th largest global Original Equipment Manufacturer (OEM) in terms of unit sales (8.7m automobiles), with revenues of around €170bn and recurring operating profit of more than €11bn. In a statement released for the investors, the companies state that the substantial value creation resulting from the merger is estimated to be around €3.7bn in annual run-rate synergies. These synergies derive mainly from a “more efficient allocation of resources for large-scale investments in-vehicle platforms, powertrain and technology and from the enhanced purchasing capability inherent in the combined group’s new scale”. Even though layoffs and plant closures are a traditional reason for consolidation in the automobile manufacturing industry, synergy estimates are not based on any plant closures.
Furthermore, the combined entity is expected to capitalize on its large footprint and compete in new markets as well as further invest in crucial renewable solutions. Citi automotive specialist Brunel explained: “The merged business will be sharing platforms and technologies with a particular focus on all-electric and hybrid vehicles, an area where Fiat Chrysler, in particular, has been lagging. PSA will take advantage of the new group’s expanded footprint to make a comeback on the North American market, where they have been absent for more than 30 years”.
Market reaction
Some analyst reckoned that PSA had paid too much, as its shares fell 10% after the deal terms were announced, while FCA jumped about 8%. However, the general impression among industry experts is that the deal is very likely to be a win-win for both parts in the long-run.
Indeed, as Carlos Tavares, the highly-respected CEO of PSA, is set to be the CEO of the merged company, Bernstein Research analyst Warburton said: “Can Tavares work his magic? In simple terms: yes. But the opportunity here is less immediate and less simple than at Opel. This deal is more about ‘future-proofing’ PSA and protecting it on the downside than about powering up earnings in the near-term. Tavares’ playbook has been to take on loss-making businesses and fix them, rapidly. We believe he can achieve something similar at Fiat in Europe”.
Financial Advisors
Lazard is advising Exor, the holding company of the Agnelli family which effectively controls Fiat Chrysler.
Goldman Sachs and d’Angelin & Co are advising FCA, and Mediobanca is advising PSA through its Messier Maris & Associés unit.
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