Nissan's Dongfeng deal a huge jump for foreign carmaker

Nissan''s $1 billion investment in Dongfeng confirms that it''s not always the first entrant to the market who reaps all the benefits. By waiting for WTO rules to bite, Nissan has taken a huge lead over its rivals.

Nissan Motor's $1.03 billion investment for a 50% stake in a joint venture with one of China's largest state-owned carmakers is a major development that shows how foreign carmakers can penetrate China's car market.

Joint ventures tend to be set up for specific time periods and with numerous conditions attached. These can include the number of models to be produced, the need to buy parts off the joint venture partner and quotas on using domestic content.

Nissan will be able to circumvent these problems, since all the assets of Dong Feng Automobile Co will be injected into the joint venture, Dong Feng Motor, creating what is in effect a direct investment in Dong Feng Automobile, without the social baggage commonly associated with state owned enterprises. The result will be the creation of a much larger range of vehicles without the need to constantly seek government approval.

Under the structure, the chairman of the company will also be the CEO. If the board is not unanimous in appointing the chairman, then Nissan will be able to name the incumbent. This should help clarify the control structure of the company. Nissan will also be able to appoint half of the management staff.

Scale is a vital component of today's car manufacturers. Huge research and development costs and state of the art production facilities do not come cheap, and a major goal of the China venture is to generate the scale to reduces these costs.

Nissan aims to produce 550,000 cars in China by 2006, of which 330,000 will be commercial vehicles and 220,000 will be passenger cars. Nissan aims to boost global sales by one million by March 2004, taking annual sales to 3.6 million.

Of that, almost 300,000 are planned to come from China.

Any visitor to China will notice that the variety and number of cars has increased dramatically in the pat few years. According to official figures, 120,000 cars were sold in Beijing in the first seven months of this year alone, a stunning 96% of them to private owners. In the past, only government entities such as ministries and state owned enterprises could afford to buy the expensive imports.

The deal also means that prices will continue to head south as China's car industry begins a gradual process of consolidation, on top of the sharp reduction in import tariffs mandated by China's entry to the World Trade Organization.

Previous ventures into China by car manufacturers have been stymied by the need for close association with the domestic joint venture partner. Shanghai Volkswagen for example, the earliest and so far most successful foreign carmaker in China has to buy most its supplies and parts off its joint venture partner, SAIC. But despite the much-vaunted lower production costs in China, costs tend to be higher than in Europe, say analysts, due to poor quality control and inefficient production techniques. And it has also been difficult for foreign car makers to get involved in setting up car dealerships and to get involved in car financing.

Nissan's China venture, on the hand, will be able to source its parts from all over the globe as well as building joint car platforms for all its major markets.

The deal means that for the first time a China investment will have a strategic benefit for the investor, since production for the China market will be so large that it will bring down costs for Nissan in Japan as well as France's Renault, which owns 44% of Nissan, says Professor Kenneth Courtis, vice Chairman of Goldman Sachs, Asia, who worked closely on the deal.

Courtis adds that the car market has entered a stage of explosive growth in China that will further benefit the deal. Nissan will not be fighting to take market share away from other manufacturers but will be tapping the new growth, which is the distinguishing feature of the Chinese car market today.

Dong Feng will focus on producing micro vans and small vans for the Chinese market. Dong Feng, which has a commanding position in the China's truck industry, will also be able to boost Nissan's position in the truck business, which lags its car division.

Also remarkable is that Nissan will finance the deal out of its cashflow, meaning that Carlos Ghosn's publicly announced goal of making Nissan debt free by 2004 is on schedule.

In addition, Nissan is buying into a profitable firm with 8% margins, considerably higher than car makers enjoy in Japan, says Goldman's Courtis. The price, he adds, equates to six time the Dong Feng Automobile's current annual earnings, he says.

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