PSA-GM: The final solution?

It is quite clear that executives of General Motors Europe and PSA Group have been working behind the scenes for quite some time in secret to cobble together a deal to off-load General Motors’ Europe (GME) vehicle-making operations.

Even then, it does seem strange that the announcement of PSA Group’s acquisition comes just hours before the opening of the Geneva Motor Show, as if perhaps in some way it was deliberately stage-managed to achieve maximum exposure and effect

Of course, PSA Group will want to be seen as trying to create a ‘good image’ in the UK, which might give a clue to various remarks being made about wanting to ‘make the two plants in the UK (Luton - making Vivaro vans - and Elllesmere Port - making Astra passenger cars) profitable’. The clear inference being that if this is not done then they will be closed. Failure cannot be tolerated.

However, it has to be remembered that PSA Group does not have a good record when it comes to operating in the UK. It closed its plant in Ryton, Warwickshire in 2007 with the loss of some 2,000 jobs. So workers at both Ellesmere Port and Luton will be bearing this in mind as their respective plants move to profitability.
Two years later, in 2009, but in mainland Europe, Carl-Peter Forster, GME's then chief executive, supported a deal to sell Opel/Vauxhall to the Canadian parts maker Magna International. He was replaced by UK's Nick Reilly who repoprtedly turned round GME's operations. When Reilly retired in 2012 his place was taken by Karl-Frederick Stracke.

But more recently than, in May 2012, GME executives had their own problems as they unfurled restructuring plans in a bid to return the operation to profit. At that time, GME executives had to placate German workers in Opel’s mother plant in Russelsheim.

Even then GME was in the midst of making intricate and politically sensitive decisions on future production allocation to its plants, including vehicles made in conjunction with PSA Group. No doubt these included plans for small vans.

So even at that point, GME executives must have been mulling the ‘final solution’ – dump the European vehicle plants on PSA and run away from Europe. In 2011 GME made a loss of US$747 million.
                       Cross-company review of performance

At the time – May 2012 – Karl-Frederick Stracke said: “it is in no way a pure cost-cutting exercise, rather it will be a comprehensive strategy under which we will quickly return to profitability. By 2016 we will clearly improve our margins, market share and revenues.”

Well, here we are in the first flush of 2017 and nothing has changed. Stracke’s forecast of profits has come to nought. So the only solution was – the ‘final solution’.

Either Stracke did not know what he was talking about, or the plans the GME executive cobbled together were completely off register in being able to deliver the returns needed. The ‘plan’ clearly was not a sensible plan – one that could deliver the results required.

It cannot be argued the European market is dead. BMW, Daimler and Volkswagen (which launched its Arteon (below) at Geneva and despite its fraudulent diesel emissions episode) can make vehicle-building a profitable activity. And PSA Group likewise, even though owned 14 per cent by the French government, has been able to turn round its business.

Of course, in one sense the writing has been on the wall ever since GM unloaded its Millbrook Proving Group in the UK. This was, in effect, the beginning of the end as work was centralised in its Technical Centre in Germany which will become part of te National Sales Company. quite what its long-term future will be remains to be seen but insiders are expecting no immediate changes - and changes will be long-term.

GME was founded on 4 April 1986. It has lasted just 31 years. It this period it has developed operations in Germany, Spain, the UK, Sweden, Hungary, Poland, Belgium and Russia and in 2009 employed 54,500 people. Today, the GME operation has 12 plants and 40,000 employees.
It is, according to sources, too early to say what will happen to these factories that remain. THere will, for example be a large cross-company review of plant efficiencies and productivity levels. Arising out of these benchmarking exercises decisions will be taken as to closure or otherwise.

It is quite clear from the latest statement that GM and PSA Group have been talking about the acquisition of Opel and Vauxhall plants for some time. Still to be thrashed out is the future of GME’s engine plants. It might seem that until there is a complete switch-over to PSA Group powertrains then there is some future for GME’s engine plants.

                        The future: strengthening both companies?

And so it is that we have arrived at today’s announcement. But before the deal is finally closed there is considerable work to be done in the area of due diligence – a headache for in-house financial staff but a huge bonus for those legal firms employed to carry out the work.

Under the deal, General Motors and PSA Group have reached an agreement under which GM’s Opel/Vauxhall subsidiary and GM Financial’s European operations will join the PSA Group in a transaction valuing these activities at €1.3 billion and €0.9 billion, respectively.

With the addition of Opel/Vauxhall, which generated revenue of €17.7 billion in 2016, PSA will become the second-largest automotive company in Europe, with a 17 per cent market share.

The wording of the statement is most interesting. Notice the use of the words ‘proud’, ‘fine’, ‘strong’ and ‘valued’ in PSA Group/General Motors management-speak.

“We are proud to join forces with Opel/Vauxhall and are deeply committed to continuing to develop this great company and accelerating its turnaround,” declared Carlos Tavares, chairman of the managing board of PSA. “We respect all that Opel/Vauxhall’s talented people have achieved as well as the company’s fine brands and strong heritage. We intend to manage PSA and Opel/Vauxhall capitalizing on their respective brand identities. Having already created together winning products for the European market, we know that Opel/Vauxhall is the right partner. We see this as a natural extension of our relationship and are eager to take it to the next level.”

“We are confident that the Opel/Vauxhall turnaround will significantly accelerate with our support, while respecting the commitments made by GM to the Opel/Vauxhall employees,” added Tavares.

“We are very pleased that together, GM, our valued colleagues at Opel/Vauxhall and PSA have created a new opportunity to enhance the long-term performance of our respective companies by building on the success of our prior alliance”, said Mary T. Barra, GM chairman and chief executive officer. “For GM, this represents another major step in the ongoing work that is driving our improved performance and accelerating our momentum. We are reshaping our company and delivering consistent, record results for our owners through disciplined capital allocation to our higher-return investments in our core automotive business and in new technologies that are enabling us to lead the future of personal mobility.”

“We believe this new chapter puts Opel and Vauxhall in an even stronger position for the long term and we look forward to our participation in the future success and strong value-creation potential of PSA through our economic interest and continued collaboration on current and exciting new projects,” Barra concluded, no doubt hoping that by dumping Opel/Vauxhall she and her team in the US can indeed “accelerate our momentum”.

                                           Long-term benefits?

The statement says that the transaction “will allow substantial economies of scale and synergies” in purchasing, manufacturing and R&D.

“Annual synergies of €1.7 billion are expected by 2026 – of which a significant part is expected to be delivered by 2020, accelerating Opel/Vauxhall’s turnaround. Leveraging the successful partnership with GM, PSA expects Opel/Vauxhall to reach a recurring operating margin of 2 per cent by 2020 and 6 per cent by 2026, and to generate a positive operational free cash flow by 2020,” the statement adds.

It is clear, just looking at PSA Group’s figures for last year, that 6 per cent is PSA’s magic number.

PSA, together with BNP Paribas, will also acquire all of GM Financial’s European operations through a newly formed 50/50 joint venture that will retain GM Financial’s current European platform and team. This joint venture will be fully consolidated by BNP Paribas and accounted under the equity method by PSA.

The statement notes that the transaction is another step in GM’s ongoing work to transform the company, which has delivered three years’ record performance and a strong 2017 outlook, and returned significant capital to shareholders.

Of course, the question has to be asked here: If GME has been transformed and there has been record performances, why the need to sell it?

Without answering this question, the statement notes the deal “will strengthen GM’s core business, support its continued deployment of resources to higher-return opportunities including in advanced technologies driving the future, and unlock significant value for shareholders.”

It adds that by immediately improving EBIT-adjusted, EBIT-adjusted margins and adjusted automotive free cash flow and de-risking the balance sheet, the transaction will enable GM to lower the cash balance requirement under its capital allocation framework by $2 billion, which it intends to use to accelerate share repurchases, subject to market conditions.

It adss that GM will also participate in the future success of the combined entity through its ownership of warrants to purchase shares of PSA. GM and PSA also expect to collaborate in the further deployment of electrification technologies and existing supply agreements for Holden and certain Buick models will continue, and PSA may potentially source long-term supply of fuel cell systems from the GM/Honda joint venture.

                                           Terms of the Agreement

Opel/Vauxhall automotive operations will be acquired by PSA for €1.3 billion. GM Financial’s European operations will be jointly acquired by PSA and BNP Paribas for 0.8 times their pro forma book value at the closing of the transaction, or approximately €0.9 billion.

The transaction has a total value of €2.2 billion for Opel/Vauxhall automotive operations and 100% of GM Financial’s European operations.

The transaction value for PSA, including Opel/Vauxhall and 50 per cent of GM Financial’s European operations, will be €1.8 billion.

In connection with this transaction, GM or its affiliates will subscribe warrants for €0.65 Bn. These warrants have a nine-year maturity and are exercisable at any time in whole or in part commencing five years after the issue date, with a strike price of €1.

Based on a reference price of €17.34 for the PSA share, the warrants correspond to 39.7 MM shares of PSA, or 4.2 per cent of its fully diluted share capital. GM will not have governance or voting rights with respect to PSA and has agreed to sell the PSA shares received upon exercise of the warrants within 35 days after exercise.

The transaction includes all of Opel/Vauxhall’s automotive operations, comprising Opel and Vauxhall brands, six assembly and five component-manufacturing facilities, one engineering center (Rüsselsheim) and approximately 40,000 employees. GM will retain its engineering centre in Torino, Italy.

The statement adds that Opel/Vauxhall will also continue to benefit from intellectual property licenses from GM until its vehicles progressively convert to PSA platforms over the coming years.

It remains to be seen what will happen with respect to GM’s van joint venture with Fiat (in that programme the latter’s Doblo van is badged by Vauxhall as the Combo). With this due to end the project seems to be dead in the water. No doubt a quite different Combo will emerge by way of a re-badged PSA vehicle – either Peugeot or Citroen.

Meanwhile, in connection with the transaction, GM will take a primarily non-cash special charge of $4.0-4.5 billion.

                                         Pension Fund Commitments

All of Opel/Vauxhall’s European and UK pension plans, funded and unfunded, with the exception of the German Actives Plan and selected smaller plans will remain with GM. The obligations with respect to the German Actives Plan and these smaller plans of Opel/Vauxhall will be transferred to PSA. GM will pay PSA €3.0 billion for full settlement of transferred pension obligations.

The transaction is subject to various closing conditions, including regulatory approvals and reorganizations, and is expected to close before the end of 2017.
COMMENT. Former top GM man, Nick Reilly, who has run plants in other parts of the world, including the Far East, makes the observation that the main problem with the two UK plants, and therefore issues which make the plants vulnerable to acts of closure, centres on purchasing: both plants have to import two key and expensive components for their products, namely the powertrain. In the case of the van plant in Luton these are supplied by Renault in France. And, with Brexit just round the corner, this could be another contributory factor.