FCA-PSA: 2 in bed, 4 to watch

FCA and PSA announced at the end of October that they are in serious negotiations to merge as equals. Since then, FCA’s shares have appreciated c. 11%. Simultaneously, PSA’s shares lost about 20%. Because of these diverging share price movements, the two companies’ market values are now on an even level of around €20bn. 

This merger of equals takes a hit on principle as FCA intends to pay an exceptional dividend of €5bn to its shareholders once the deal is wrapped up. After this pay out, FCA will contribute to the party a sizeable net debt backpack while PSA is expected to show several billions of net cash even if it potentially pays an exceptional dividend as well.

A potentially merged FCA-PSA Group will have four major shareholders (see projected shareholding table), with Exor clearly running the show.

Exor, a formidable cash extractor

Exor, the listed holding company of the Agnelli family, has brilliantly extracted cash from its ex-Fiat empire by spinning off and selling it piece-meal since its merger with Chrysler. Exor, clearly, is not dividend averse. An extraordinary dividend of €2bn was paid by FCA in Q3 19 from the proceeds after the disposal of Magneti Marelli. Exor, conversely, retained its 23% holding in the spun-off Ferrari, admittedly closer to a Hermes than to cars.

The next move is expected from CNHI (another Exor holding and ex-Fiat holding) which intends to split its business into ‘On-Road’ (i.e. trucks and powertrains) and ‘Off-Road’ (i.e. agricultural and construction equipment plus special trucks such as firefighters). By contrast, whether PSA sells its stake in Faurecia remains to be seen. 

Next in the pecking order come the French State (via BPI) and Dongfeng, a Chinese car manufacturer partner of its Chinese operations (in poor shape) plus the Peugeot family indirectly via FFP. While the Peugeot and Agnelli families might well have the same interests, it is our impression that the French State will keep an eye on the post-merger number of jobs remaining in France, whereas Dongfeng’s interest is somewhat unknown.

It has certainly not helped PSA to become successful in China and whether it has provided the French company with any goodwill is more than doubtful. Perhaps, the opposite is true. As US authorities might object to the merger because of Dongfeng becoming a (distant) shareholder in the new group’s substantial US operations, the Chinese shareholder might sell its stake. Rumours suggest that the Peugeot family is interested in buying some of Dongfeng’s shares.

FCA in a corner

Industrially and financially, it is FCA that painted itself in a merger corner as it serviced its shareholders first by spinning off the money-making bits and leaving the rump with debt and the illusion that US SUV super margins could be forever. 

Its problems in Europe are well known (no attractive new car models plus much too large production capacities), which have contributed to a remarkably low peak operating margin of 3.2% in 2017. Other mass-volume car producers (including PSA) generate about twice that. In addition, FCA is late (and probably too late) with its electric strategy.

In fact, it was not long ago when the CEO rather preferred to pay fines for not fulfilling emission requirements than investing cash into the development of electric vehicles. It eventually bought carbon rights from Tesla.

North America (i.e. the acquired Chrysler activities) experienced a phenomenal run until recently. While FCA sold about 1.64m vehicles in the US market alone in 2012 (its market share was 11.4% that year), the number increased to 2.24m until 2018 (market share: 13.0%). During those years, its Jeep and RAM brands benefited from US consumers’ appetite for SUVs and even more so for pick-ups. This resulted in a regional EBIT margin appreciation from 6.3% in 2012 to 8.6% last year. However, this demand boom has most likely come to an end. We do not see 2020 as being a severe problem as the US President intends to be re-elected and he needs a positive economic environment to achieve this.

However, the US auto market has been trending down since early 2016, but only marginally up to now. In fact, sales of SUVs and pick-up trucks have continued rising in 2019, but growth was very modest indeed through to April, again in June to become negative in September. Assuming FCA’s single most important profit contributing region turns sour, the company will have a sizeable profit problem. That is even before Tesla breaks the pick-up market price structure with its own (silly looking) full EV 4×4.

We clearly wonder why PSA is seriously investigating a potential merger with FCA. Its CEO might have gained confidence from PSA’s successful takeover of Opel/Vauxhall from GM, but that was a different story. GM was desperate to sell this ailing European car producer which had suffered sizeable losses during the previous decade or so. PSA’s 2017 purchase price was in the vicinity of €1bn for a company that sold about 1m vehicles in Europe in 2016. As the takeover was ‘asset-light’, the consolidation did not result in any material depreciation charges and, consequently, Opel was profitable once it was consolidated by PSA.

However, its European registration number fell to 884k in 2018 and has fallen by another 4.6% in 10M19 to 728k. As FCA will not come ‘asset-light’, the merged company’s future profitability will not benefit from a substantial fall in  depreciation charges (as a percentage of revenue). Finally, FCA will not bring any electric know-how into this potential marriage but rather CO2 emission excesses and no offset.

Coming to the hard figures, we plot below the flatlining of a long FCA-short PSA since mid 2018 (excluding the bump at the end of period). In other words, the two stocks were trading in synch in spite of their valuation gaps.

We also merged the FCA accounts with those of PSA at current prices, allowing for a €5bn FCA dividend and €3bn cost savings/synergies of some sort but not the potentially phenomenal costs of moving full blast to EVs. In such a rosy, simplistic scenario, the FCA earnings would benefit by c. 11-13%, all other things being equal…

Summary impact of a FCA-PSA merger

More AlphaValue’s research on FCA / PSA : click here