Why Peugeot GM Deal May Never Get into Top Gear

(Bloomberg Gadfly) -- Peugeot CEO Carlos Tavares believes he can succeed where armies of General Motors Co. executives have failed.

On Monday, PSA Group announced the 1.3 billion-euro ($1.4 billion) purchase GM's European auto-making operation, which has lost money for almost two decades.

There's no questioning Tavares's talent for cost-cutting and the financial attractions of the deal. But it's far from certain he will be able to turn around the Opel and Vauxhall brands.

To be fair, he isn't putting up much cash. The purchase will be partly funded with stock (trading at a six year high) and the price equates to less than twice Opel-Vauxhall's adjusted Ebitda. Given PSA has 6 billion euros of net cash and won't be taking on large unfunded pension liabilities from GM, the deal looks well within the carmaker's means.

Tavares should be able to chalk up some quick wins, too.

Under U.S. GAAP, carmakers are forced to fully expense research and development costs through the income statement. Opel and Vauxhall will now adopt IFRS, meaning about 40 percent of their 1.4 billion euros in annual R&D spending can be capitalized on the balance sheet instead. This should immediately improve Opel's operating profit.

Welding the two carmakers together will cost about 1.6 billion euros, but Tavares has already identified a clever way to pay for some of that.

By cutting Opel-Vauxhall's working capital, which runs at a far higher level than PSA's, he thinks he can free up about 1.2 billion euros, helping to staunch the 1 billion euros of cash Opel-Vauxhall bleeds each year.

Tavares estimates he can achieve 1.1 billion euros of annual savings by 2020. Taxed, capitalized and discounted those equate to about 5 billion euros of value creation -- just under a third of PSA's current market value.

He expects to achieve a further 600 million euros of annual savings from 2026, once all of Opel Vauxhall's models have moved to PSA's production platforms.

So why my hesitation?

Firstly, carmakers are facing huge structural upheaval from the spread of driverless and electric vehicles.

Right now, European car sales are booming -- but things could look very different in 2020. Though PSA is free to start selling Opels outside Europe, boosting plant capacity utilization will be tough if vehicle sales enter a cyclical decline.

Tavares might then have to start closing plants, but doing so would surely mean he'd lose the co-operation of GM's European workers who he insists are key to turning round the company.

In the short-term, at least, absorbing Opel-Vauxhall will dilute PSA's own hard-won profitability. PSA achieved a 6 percent operating margin last year, but Opel is expected to hit only 2 percent by 2020.

Then there are broader strategic doubts. PSA and Opel both sell lots of compact cars and not enough of the SUVs customers increasingly want. Both carmakers are heavily focussed on Europe -- when much of the car industry's future growth is set to take place elsewhere.

GM has belatedly faced up to its inability to sell cars profitably in Europe. Tavares has turned round PSA. But repeating that trick at Opel could yet prove to be a leap too far. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

To contact the author of this story: Chris Bryant in Berlin at cbryant32@bloomberg.net.

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net.