Dongfeng takes bold punt on troubled Peugeot

Dongfeng Motor invests €800 million in Peugeot for a stake of about 14% and analysts deem the valuations to be reasonable.

Dongfeng Motor, a China state-backed group, is buying a 14% stake in troubled French automaker PSA Peugeot Citroen for €800 million ($1.1 billion) in a bold, if risky, move.

Peugeot, the second largest European automaker, has been racking up losses in recent years and is in need of cash, with analysts only expecting the group to turn around in the financial year 2015.

However, based on the company's projected earnings at that time, the valuation of the deal looks reasonable.

“It has been priced at 4.5 times Peugeot's financial year 2015 consensus earnings,” said Eva Yip, an analyst at Sun Hung Kai Securities. “Overall, the transaction looks reasonable,” she said, adding that, based on Peugeot's closing price of €12.50 on Tuesday, Peugeot trades at 7.5 times its financial year 2015 consensus earnings.

Hong Kong-listed Dongfeng will be paying €7.5 per share, a deep 40% discount to Peugeot's last closing price for an initial amount of €524 million, and will also subscribe to a subsequent rights issue, which is expected to take its stake to 14%, the same level as the French government and the Peugeot family. CICC, Lazard and Clifford Chance advised Dongfeng, while Morgan Stanley and Rothschild advised Peugeot.

Given that it is a small stake, analysts say the main upside for Dongfeng would be the transfer of research and development capabilities. “A technology transfer would be one of the key priorities that Dongfeng is going for,” said one analyst at an investment bank who declined to be named. “With this deal they would be able to inherit some technology from Peugeot or have more negotiating power in obtaining technology from Peugeot,” he added.

Concurrently with the investment, Dongfeng and Peugeot have struck a so-called “non-binding” framework agreement to collaborate in research and development for their joint venture. While the agreement isn't legally binding (except for some provisions), Dongfeng and Peugeot will “contemplate” entering into a legally binding framework agreement around the end of March 2014, Dongfeng said in a Hong Kong Stock Exchange filing.

The two companies have ambitions for their partnership beyond China. According to a filing, Dongfeng and Peugeot plan to deepen their co-operation for their joint venture and sell 1.5 million vehicles under the Dongfeng, Peugeot and Citroen brands each year, from 2020. They are also contemplating establishing a new export company to increase sales in Asia-Pacific, particularly the Asean region.

Will Dongfeng's bold investment pay off? That remains to be seen. Tata Motors similarly made a bold gamble when it bought the troubled Jaguar Land Rover from Ford in 2008 but it has proved detractors wrong, with Jaguar Land Rover now driving its earnings, even as its business in India has been struggling.

But Tata Motors acquired all of Jaguar Land Rover, which allowed it to steer the company and consolidate its earnings. In contrast, Dongfeng is a minority stakeholder in Peugeot and none of the French automaker's three major shareholders will have major decision-making rights.

As such, analysts see a limited impact on Dongfeng's earnings, at least in the near term. However, given that Dongfeng has bought its stake in Peugeot at a deep discount, perhaps there is upside, if and when Peugeot turns around.

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