Commentary on Political Economy

Tuesday, 18 August 2020



Getting a Foothold in China Comes With a Price

BMW’s risk is rising under a scenario where the state restructures its main partner. 

The risk of persistent uncertainty isn’t limited to Covid-19.
The risk of persistent uncertainty isn’t limited to Covid-19. Photographer: Chen Wen/China News Service/Getty

BMW AG’s partner in China is facing challenging times. It’s a warning to automakers looking to boost their stakes in the world’s largest car market: Beijing’s hand is pervasive, no matter how big or small a stake you own in the web of government-backed companies that make up the industry.

The German carmaker sells vehicles through a joint venture with Hong Kong-listed Brilliance China Automotive Holdings Ltd., whose stock price tanked Thursday after onshore bond prices for its state-owned parent, Huachen Automotive Group Holding Co., dropped by 35%. Questions have arisen around Huachen’s liquidity and ability to pay down debts of 43.3 billion yuan ($5.2 billion) by year-end, with banks forming a creditor committee to start laying their claims. Huachen has promised to repay investors and says it has the needed funds, local media reported

Investor anxiety is worsened by speculation that the company may sell more of its stock to Liaoning Transportation Investment, another government-backed entity, to fund its debt payments. The Liaoning provincial government is looking to consolidate its auto assets. Daiwa Securities Group Inc. analysts have said that a previous sale, which cut Huachen’s stake by more than 10%, and other recent changes indicate that Brilliance China could be in for a restructuring and “would shrink a lot in terms of asset(s) and profitability.”

There are other scenarios, but the bottom line is that the sudden interference from the province risks severely undercutting the automaker. Huachen is Liaoning’s largest state-backed auto company. Where it ends up may determine the future of Brilliance, and thus BMW in China. The German company has had a lucrative business with the more than 15-year venture, and its local partner has ridden the tide. BMW has strategically produced and imported parts years after they’re introduced in its Bavarian plants to protect its technology.

Still, BMW and other foreign manufacturers face the risk of persistent uncertainty. The problem is the state’s unpredictable role and sometimes sudden change of plans. In this case, the provincial government has functions in strategic industrial policy and as an investor. This can be too much for partners to digest. Analysts with Jefferies Financial Group Inc. note that more reform at state-owned enterprises is needed “to deepen collaboration with partners to accelerate the development of self-owned brands to enhance profitability.”

This isn’t to say that foreign carmakers should stay away. Enthusiasm for the Chinese market is well-placed. German auto partnerships’ results from the first half of 2020, when global companies were reeling under the Covid-19 pandemic, show as much. Daimler AG announced 586 million euros ($694.3 million) equity profits from Beijing Benz, down just over 12%, with volumes falling 4.2%. BMW came in at 529 million euros, up 22% from a year earlier, according to Jefferies. Even as the market matures and some players are pushed out, premium manufacturers that have played it right have held up.

For provincial players like Brilliance and Huachen, though, the future isn’t bright, especially as more vaunted foreign carmakers step up their presence in China. Efforts to reduce debt and restructure may just leave them with much smaller businesses contributing little to their balance sheets. 

Two years ago, Beijing allowed foreign companies that had to form joint ventures under earlier rules to raise their holdings, lifting the 50% ownership limit by 2022. BMW was the first to enter the brave new world, with Brilliance agreeing to sell a 25% portion to BMW for 36.6 billion yuan. The deal will be completed by June 2022 and bring the German company’s stake to 75%. By then, Huachen’s liquidity issues could start weighing on the joint venture, which pays dividends up to the parent.

At the time, I questioned the valuation of the stake and noted that BMW was paying a high price. Since then, subsidiaries of the Brilliance group have suffered losses because it’s unclear what will happen to the Chinese unit’s profitability as the German firm takes control. Most of Brilliance’s earnings were via the venture with BMW. Meanwhile, others like Daimler and Volkswagen AG have followed suit by looking to increase their stakes with their partners. 

All told, China is a massive opportunity for those who know how to navigate it. That’s why what happens at Brilliance China should be worrying. If the state can intervene with a sudden restructuring or its priorities supersede any other business interests, then how do companies looking to take bigger stakes quantify such risks?

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

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