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Fiat Chrysler-PSA Mega Merger to Create Industry Behemoth

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Consolidation in the automobile industry is the need of the hour. The car industry, which has become extremely competitive, needs consolidation and requires forming strategic alliances to reduce the ruinous levels of competition. As the global markets are weakening, auto production and sales are slowing down. The world’s leading automakers are coming under pressure amid margin compression and high capex burden. These factors are resulting in strategic tie-ups among automakers to share research & development (R&D) costs effectively, and fund new technologies like electric and autonomous cars. Amid the changing dynamics of the auto industry, Fiat Chrysler (FCAU - Free Report) and France’s PSA Groupe recently announced their intention to merge in a 50-50 share swap. Fiat Chrysler currently carries a Zacks Rank #4 (Sell).

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The board members of both the companies have approved the merger and binding MoU is expected to be reached in the coming weeks. The merger news is unfolding at a time when global carmakers are struggling with industry slump and high capex requirements for new technologies. Fiat Chrysler- PSA merger plans certainly makes sense, albeit its share of challenges. Let’s delve deeper.

On the Path to Become #4 Global Carmaker

The proposed tie-up between Italian-American automaker Fiat-Chrysler and PSA will lead to the creation of the world’s fourth-largest carmaker, with roughly $50 billion of market cap, $190 billion in annual turnover and 400,000 employees. Shares of the new entity will be listed in New York, Paris and Milan. The combined company will be headed by Fiat Chrysler’s John Elkann as the Chairman and PSA’s Carlos Taveres as the CEO. 

The merger will bring several brands together, including Fiat, Chrysler, Alfa Romeo, RAM, Jeep and Maserati,along with PSA’s Peugeot, Citroen, Opeland Vauxhall. The combined entity will create an industry behemoth with 8.7-million vehicle sales, only behind Volkswagen (VWAGY - Free Report) , Toyota Motor (TM - Free Report) and Renault-Nissan Alliance, each of which sell more than 10 million units.

In the rapidly changing and challenging auto industry, this deal will help pool the strengths of both the carmakers to invest efficiently in new technologies, foster innovationand compete globally. The pact would bring about annual run-rate synergies of around $4.1 billion. Around 80% of the synergies are expected to be achieved after four years.

Deal Rationale for Fiat Chrysler and PSA

Apart from financial and operational synergies, the deal will help the company to solidity their positions in different markets. While Fiat Chrysler would aid PSA to achieve a long-sought presence in North America, the latter will help Fiat Chrysler to strengthen foothold in Europe.

While Fiat Chrysler is performing well in the North American market, sluggish operations in the European market are a cause of concern. The company — which came out with quarterly numbers yesterday — posted wider year-over-year loss in Europe. Considering its ongoing troubles in Europe, the company’s decision to merge with PSA — Europe’s second-largest car manufacturer in terms of sales — seems prudent. Tavares, who is currently at the helm of PSA, is credited with rescuing PSA from near-bankruptcy. The man is known for his ability of turning loss-making European automotive operations to profit-making ones and will hopefully be able to fix Fiat’s sluggish European operations. The merger may also help the companies to make their way into Chinese markets, wherein neither company has much of a presence.

Further, Fiat Chrysler — which lacks low-emissions technologies — is likely to benefit from PSA’s expertise.PSA is on track to introduce seven EVs by 2021 and offer either electric or hybrid versions of all models by 2025. For PSA, the chief motive is to benefit from a dealership network to sell vehicles in the United States. 

The Merger Has Its Share of Issues

While the deal makes strategic sense, there are a few hurdles in the way that need to be tackled.The deal is expected to face scrutiny from European Union antitrust regulators on grounds of hurting competition. It might be difficult for the merged entity to cut jobs, considering Europe's tight labor market restrictions. In particular, if the deal materializes, the combination would have a formidable presence in countries like France, Italy and Spain, where it would face challenges regarding the future of under-utilized plants.

Tougher emission rules set to kick in the next year in Europe remain a concern. With the carmakers having to comply with stricter caps, Fiat is likely to be in a vulnerable position as it lacks adequate green technology. The company has paid hundreds of millions of euros to pool its fleet with Tesla’s (TSLA - Free Report) EVs in order to avoid EU emission fines. This will enable Fiat Chrysler to offset emissions from its cars against Tesla’s, lowering its average figure to a permissible level.

Will Fiat Chrysler-PSA Merger News Bring Renault Back on the Table?

Markedly, the Fiat Chrysler-PSA association plan comes five months after the former ended the merger talks with PSA’s French rival, Renault, amid political complexities and Nissan troubles. Renault-Fiat merger discussions collapsed pretty quickly due to Renault’s uneasy relationship with Nissan and the interference of the French government that holds 15% of Renault. While the government also holds 13% of PSA, interference is unlikely to surface this time around as the government has already signaled support for the deal with positive comments.

But will the merger plans of Fiat Chrysler and PSA provoke a reaction from Renault to revive its deal? Well, no! Renault’s Chairman Jean-Dominique Senard has reportedly said that the company won’t be making any counteroffer to top Fiat Chrysler-PSA deal. Instead, Renault will be focused on strengthening ties with the Japanese automaker Nissan, in which it holds a 43.4% stake.

Last Words

With Renault having no intention to get back to the negotiating table as Fiat Chrysler and the company’s merger plans with PSA got positive comments from the French government, it is most likely that the deal shall go through. In this era of sustainable mobility, such mergers are essential for the auto industry that is facing an expensive upheaval in an attempt to shift away from fossil fuels toward battery EVs and autonomous technology. If the deal materializes, it is likely to herald further mergers, in the wake of changing dynamics of the industry.

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