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Capital Markets

Equities: Rights issue drives Peugeot/GM alliance

Overcapacity dogs sector; Analysts sceptical on strategy

Trying to pick the least attractive company, in the least attractive sector in the least attractive region for ECM is a tricky proposition – but French auto firm PSA Peugeot Citroën must be a contender.

All power to the company then for completing an ambitious €1 billion rights issue last month that might – it’s a big might – set it on the road to recovery.

The rationale for PSA’s rights issue, which sold shares at a 32.4% discount to the theoretical ex-rights price of €12.23, is wearyingly familiar to auto industry observers. Like many of its rivals, PSA is too small to compete globally and faces challenging conditions: net income fell from €1.13 billion in 2010 to €588 million last year.

In response, PSA has come out fighting with a strategic alliance with GM. The alliance targets two perennial bugbears of the auto sector: the high cost of product development – which the companies hope to reduce by sharing vehicle platforms and components – and the rocketing cost of commodities, which will be addressed through a global purchasing joint venture, worth around $125 billion a year.

The move has been cautiously received by analysts. "There is execution risk on the synergy side," notes Sven Kreitmair, co-head of corporate credit research at UniCredit. Moody’s was equally sceptical, downgrading PSA to Ba1 – junk status – on March 1, stating that alliances "have often not resulted in the anticipated competitive advantage and improved performance".

Unexpected results

Tony Blanchard, senior vice-president, investment banking at Deloitte Corporate Finance in Detroit, agrees that alliances – which have grown in number every year, in contrast to auto M&A, which fluctuate with the economy – "need active management and alignment to make them work".

He adds: "We’ve seen instances where the results were not as expected." For example, in 2005, GM was forced to pay Fiat $2 billion to get out of a put option that was part of a failed alliance formed in 2000.

PSA’s chief executive Philippe Varin admits that the rights issue and alliance don’t tackle the European auto industry’s most pressing problem: overcapacity.

Varin, speaking at the Geneva Motor Show early last month, called for political intervention to help carmakers restructure. He added, in a vivid demonstration of how politically sensitive the sector is, that the GM alliance would "have no bearing on restructuring capacity" at the two firms – both of which have around 25% overcapacity.

Thierry Olive, global head of ECM at BNP Paribas
Thierry Olive, global head of ECM at BNP Paribas

Nevertheless, the alliance is seen as a step in the right direction. "The auto industry has suffered from the crisis – much more so than other sectors," says Thierry Olive, global head of ECM at BNP Paribas, one of three joint global coordinators and joint bookrunners with Morgan Stanley and Société Générale in a 13-strong syndicate. "The rights issue and alliance generate medium-term benefits and demonstrate a belief that the business has a long-term future and that the capital structure must be reinforced to ensure that future. It’s a message investors responded positively to during the roadshow."

Blanchard states that alliances with specific goals – such as expansion in China or production of an alternative drivetrain – have the highest probability of success. "One would hope the GM/PSA deal has the right characteristics," he says. "The reality is that it’s a struggle to make money in Europe – yet all major auto producers have to be there – so the search is on to find a way to make it profitable. Alliances can be such a way."

The alliance was facilitated by the rights issue, although PSA’s reinforcement of its capital structure was the more pressing need. The Peugeot family, which owned 30.3% of the company before the offer but had voting rights of 46.26%, exercised only part of its rights and sold the remainder to GM at the theoretical value of €2.05.

GM did not get any special favours but neither is it paying a premium – giving GM 5.76% of the expanded share capital. GM then topped this up to 7% by buying treasury shares from PSA at the theoretical ex-rights price of €12.23. The Peugeot family retains control of the company following the deal.

The rights issue had an ideal backdrop: the ECM market has improved markedly, boosted by the long-term refinancing operation in Europe, a respite to the Greek crisis and improving economic figures in the US.

"Conditions have improved significantly with three months of market gains, lower volatility and a recovery of investor appetite for risk," says Olive.

Stock rally

After a steep dive when reports of the GM alliance leaked, and a further fall to €11.53 as investors unwilling to take up their rights sold out, the stock rallied in mid-March as short-sellers covered their positions. The stock is the most shorted in Paris.

Given the French rights issue system, which allows rights holders to oversubscribe, take-up of the issue was not in doubt. However, Olive says, in addition to generating enthusiasm among existing investors, the deal spurred new interest in autos.

"Some investors have noticed that based on several criteria, including break-up value, PSA is worth twice as much as its current valuation," he notes.

That is probably not the sort of interest PSA hoped for from its rights issue and alliance. But as the pace of change in the auto sector accelerates, it might feel it’s better to be noticed – for whatever reason – than to be ignored.

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