The automotive industry is not easy to grasp at first sight. Profitability is also likely to shrink in the future as growth prospects decreased in emerging markets such as China, Russia, India or Brazil, all countries that used to be key growth drivers for European and US manufacturers. Sergio Marchionne, the CEO of Fiat-Chrysler Automobile (FCA), seems pretty convinced that a merger between FCA and General Motors would be the next strategic step to cope with such a challenging industry environment. Under his management, Fiat and Chrysler already merged in 2014 and Mr. Marchionne seems determined to go further in the M&A path by considering the acquisition of the US giant, General Motors.
A question of size
In 2008, Thomas LaSorda, former CEO of Chrysler, already tried to approach GM for an acquisition, without success. However, the car company did not totally abandon the idea. By the beginning of September 2015, FCA’s CEO Sergio Marchionne indicated that a merger with General Motors Company was a “high priority” for the company, describing General Motors as “the ideal partner” for FCA and FCA as “a not easily replaceable alternative” for GM.
In the automotive industry, the advantage of a merger lies in the fact that it decreases the number of players in the market, improving the market share of the companies that merge. Additionally, a merger allows spreading the huge costs of research and development for eco-friendly and intelligent cars. This is the reason why Mr. Marchionne seems determined in pursuing his approaches to GM, despite the US company’s rejection of the proposal in March (year?). According to GM, going on its own way without opting for the merger path would be the best way to deliver sustainable value to its shareholders. As stated by GM’s CEO, Ms Mary Barra, the company already has scale and can leverage it if needed. In other words, GM is still in the process of „merging with itself”, even though Mr Marchionne repeatedly declared that potential costs savings were impossible to ignore by GM’s Board of Directors.
Key insights on the automotive industry
The automotive industry has been experiencing a downward trend in profitability since the years 1960s as global competition consistently intensified. The existence of a lot of different players in the market combined with a sluggish demand generated a problem of excess capacity. This industry is also extremely capital intensive, which means that fixed costs account for a larger proportion of total costs than variable costs. As a result, the automotive industry benefits from significant economies of scales, leading it to produce a lot of cars in order to cover its fixed costs and make a profit. This combination of facts feeds further on this problem of excess capacity. The automotive sector is also much more fragmented than other comparable industries such as aircraft and motorcycles, putting additional pressure on each individual player.
For many years, experts have been saying that a merger wave within the automotive industry would be the only solution for individual car companies to grow. Nevertheless, in the aftermath of the financial crisis of 2008, this “M&A wave” did not occur yet. Because of the macroeconomic importance of the automotive industry in terms of job creation and employment, governments were reluctant to let their national automotive companies be acquired by foreign competitors. This political interference led to governmental aids to avoid plants closure, resulting in many companies being held artificially able to survive in an environment which would have otherwise forced them to exit the market or be acquired by a competitor.
On the other hand, a consolidation of the automotive industry would have dampened the problem of excess capacity stated here-above. Merged companies have it easier to achieve economies of scale while sharing their capital investment.
To merge or not to merge: Cons
Given the advantages that we pointed out here-above, one could therefore question why would GM oppose a merger with Fiat-Chrysler. A quick look at financial ratios tells us that GM is overall more profitable than FCA. In the second quarter of 2015, FCA’s net profit margin was only 0.93% in comparison to 3.61% for GM. In the same period, FCA had a lower credit rating and a higher gearing ratio than GM. As a result, a merger with FCA would potentially lower GM’s credit rating.
From a strategic point of view, Fiat-Chrysler has a better exposure to markets in South America and Europe. In case of a merger, GM could theoretically benefit from that exposure. However, Brazil is currently in a phase of technical recession and Europe (where GM is also somehow present through its Opel brand) is a mature market with very low growth opportunities. GM and FCA both experienced stable or even declining sales in their European segment for the last couple of years.
A merger of this size also poses problems from a legal point of view due to the existing regulations regarding anti-trusts. Moreover, as a merger usually comes with increased efficiency, it could lead to significant job cuts and plant closures. For this reason, local governments can step in to stop the merger. Many analysts also object that a merger would result in too many brands and that it would be necessary to eliminate at least some. However, eliminating brands is a lengthy process from a legal point of view and is even likely to take years. To these critics, Mr. Marchionne firmly replied that a merger itself “has nothing to do with implant shutdowns and brand structure”.
According to Mr LaSorda, the merger would be profitable but still unlikely to happen. One of the main problems that arises in the case of a merger is the question of “who is going to be running” the firm in the end. On top of the strategic issues we pointed out previously, managerial issues are also at hand.
To merge or not to merge: Pros
The major advantage of a merger between FCA and GM would certainly come from the synergies between the two firms in terms of distribution channels and investments in R&D and capital equipment. The alliance between Nissan and Renault in 1999 proved to be a successful example of such synergies. After the merger, the Nissan-Renault alliance generated profit after tax of approximately $30 Bn per year.
GM is a far larger company than FCA (about $54 Bn market capitalisation for GM against only $17 Bn market capitalisation for FCA). GM also has its own weaknesses. Among others, the company went through a tough time because of serious safety issues and quality crisis that eroded GM’s brand name.
According to many observers, General Motors cannot exclusively rely on areas such as South America (and Brazil in particular) or Europe in order to achieve sustainable growth. On the other hand, Fiat-Chrysler has a better exposure to these regions. A merger with FCA could also be beneficial for GM as it could dampen the effects of shrinking car sales in now struggling Chinese markets.
Mergers within the automotive industry seem to be a sine qua non condition for car companies to survive given the tough business and economic environment they navigate in. Producing cars also require a tremendous amount of capital investments and these investments are likely to increase even further as companies continue developing new technologies and green solutions that meet the ever stricter European and global regulations. In such a context, we will make the hypothesis that the merger between FCA and GM will only be a matter of time.
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