China’s First Global Car Maker Is in the Works

By guest author Jacky Wong from Wall Street Journal

China may be about to get its first global car maker. Investors’ initial reaction has been to celebrate the benefits rather than worry what it might cost them.

Hong Kong-listed Geely Auto and Sweden’s Volvo Cars are in talks to merge, according to exchange filings published after the Asian close Monday (February 10, 2020). The two already share the same controlling shareholder: privately owned Zhejiang Geely Holding, which bought the Volvo car brand from Ford for about USD 1.8 billion in 2010. Geely wants to complete the restructuring this year and then seek a second stock-market listing in Stockholm.

If the plan is approved, the combined company, with revenue of roughly USD 43 billion last year, would likely sit somewhere between India’s Tata Motors and South Korea’s Kia Motors in a ranking of global auto makers. Geely generates almost all its sales in China, so the merger will bring big diversification benefits. Its shareholders are already excited about the prospect of owning the prestigious Swedish brand: Its Hong Kong-listed shares jumped 5.7% Tuesday.

Geely has already benefited from engineering and technology from Volvo, which has a research-and-development joint venture with its parent. That’s one of the reasons why Geely has managed to weather the current market downturn in China better than many of its peers. Tighter cooperation between the two will certainly help Geely’s product development at a time when new technologies are pushing up costs.

Volvo has staged an impressive comeback under Zhejiang Geely’s ownership over the past decade. That’s mainly thanks to the wider industry rebound following the financial crisis and the brand’s focus on larger vehicles, which have become increasingly popular. But Geely also has likely helped the company sell more cars in China, which accounted for 22% of Volvo’s sales last year.

The biggest question for investors is how much Geely will pay for Volvo. If it is valued on a similar multiple of earnings to other European makers of upscale cars like BMW and Daimler, Volvo’s enterprise value would be around USD 7.5 billion to USD 9 billion, according to Bernstein. That would be a great deal for Geely. The Chinese company enjoys a much higher multiple and therefore has an enterprise value of USD 15.7 billion even though its revenue is only around half of Volvo’s, according to S&P Global Market Intelligence.

The risk is that Li Shufu, Geely’s founder and the owner of Zhejiang Geely, may ask for a more expensive price—perhaps including a big cash component—to consolidate his recent empire-building. A near 10 % stake in Daimler and 51 % of British sports-car brand Lotus are among his purchases in the past few years. There were no financial details in Monday’s disclosures.

Investors are right to be excited about a bigger and more diversified group, but they should still be careful not to overpay.