Safe Volvo a risk bet for China’s Geely

November 2, 2009

Shares in Geely Automobile have risen some 40 percent in the past month partly on hopes the Chinese carmaker’s parent company will buy Volvo. Ford has named Geely as preferred bidder for the Swedish marque. But on this occasion it could be better to travel hopefully than to arrive.

Buying Volvo would be a huge mouthful for Geely. If it goes ahead, Geely and founder Li Shufu will have to write Ford a cheque for $2 billion. But that’s just for starters. Volvo lost $1.5 billion last year. Assuming it continued at the same rate during Geely’s first year of ownership, the Chinese would pretty quickly be in for $3.5 billion.

By way of comparison, that is almost 20 percent more than Geely Automotive’s enterprise value of just $3 billion. And it doesn’t include any further investment Geely might make. The long-term plans being talked about in the media suggest the total could hit about $10 billion. Achieving an acceptable return on that would require a dramatic turnaround in Volvo’s fortunes.

Staunching the losses won’t be easy in the short term. The deal offers few quick fixes. Geely will find it hard to reduce Volvo’s costs because it doesn’t have any Western operations of its own to integrate. It will depend for the most part upon the supply arrangements that Volvo already has with Ford and others, and these are unlikely to go down in price because of the takeover. Geely has already said that if its offer goes through it will retain Volvo’s factories, research centre, trade union agreements and sales network.

Whether the deal works or not depends upon whether Geely can successfully implement what seems to be its longer-term plan. This is to turn Volvo around and transform its own fortunes by taking the Swedish marque into China as a locally-owned brand.

Geely Automotive is currently the smallest of the big Chinese carmakers, producing about 300,000 cars a year, and the most significant purely private sector operator. Like Volvo, which makes a similar number of cars, what Geely lacks is scale.

China is now the world’s largest automotive market. According to JD Power sales will reach 8.2 million cars in 2009, and grow to 12 million by 2016. The big opportunity then is to bring Volvo to China, where its S40, S60 and S80 are already positioned as luxury vehicles. A mere 5 percent share of the three segments these models compete in would amount to 300,000 units in 2009, and nearly 400,000 units in 2012.

That’s the ambition. But getting there will take supreme execution. Geely will need to work with Volvo’s domestic management, and Chinese companies do not have much of a tradition of managing complex global companies. One comfort is that Geely is a purely private company and therefore less likely to be distracted by Beijing-inspired investment and production targets.

A second is the presence of Goldman Sachs which is investing $250 million in Geely bonds with warrants over 15 of the company. This makes Goldman the most significant outside investor. The Volvo deal could in theory be a dry-run for other Chinese takeovers of other global brands, so Goldman will have every incentive to help make it work.

Nonetheless, the execution risk remains daunting. Even though Geely Automotive’s shares trade at just 15 times next year’s earnings, compared with an Asia Pacific sector mean of 30 times, there is still room for disappointment.

Comments

The deal is cheap for Geely which has little interest in the brand and a high interest in the technology. At a fraction of the price of internal development, and available immediately, Geely now acquires world class competitive technology from Volvo which it needs to compete in the Chinese market. Industry bets are Geely will acquire Volvo, strip out the manufacturing technology and then close Volvo all within the next 10 years. Smart strategy, at a rock bottom price.

Posted by roadrunner | Report as abusive
 

This is also a means for a Chinese competitor to establish itself quickly in the U.S. market by obtaining its sales network and organization via Volvo. So if they build a quality car while utilizing labor cost advantages, they’ll be able to import an instantly recognizable nameplate with the potential for large profit margins.

Here’s the question: is it shortsighted for Ford (or the big three) to expedite the entrance of yet another formidable competitor into an already tight U.S. market?

Posted by Aficionado | Report as abusive
 

I think Geely wants the Volvo brand name more than the technology. Just think of brandname : Geely vs Volvo. think global dealerships. Think reputation: Safety.

The technology can easily be bought but a Geely with Volvo level safety, fit and finish can only sell at Geely margins not Volvo margins. Geely wants to sell at Volvo margins. Also Geely is strong and cost effective in the subcompact range.

Thinks about Volvo designed, small 4 door subcompact with safety, good fuel economy. They can share production volume with a new Volvo badged subcompact of similar design. Geely badged version might have less performance, less quality fit and finish and less safety features like side airbags to keep cost low.

It could leapfrog Geely over other cheap Chinese makes and Geely and volvo could easily push 500K units of this new subcompact.

Posted by Togo | Report as abusive
 

After chinese company get the technology they wanted. All volvo workers in sweden will layoffs.
After chinese company get volvo technology, Chinese company kill US auto industry by cheap price volvo copies.

intellectual property? China is a big country. Sweden goverment and Ford can not do anything against to China.

Posted by J | Report as abusive
 

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