Feature Analysis - Ford and Volvo: Selling or lending?


Now that Volvo also appears to be up for sale the end is nigh for Ford’s Premier Automotive Group (PAG). Ford is not simply selling the family jewels in auctioning off its car making capabilities, it is consuming its own flesh in order to survive. The company needs cash for its core operations in the US and must avoid paying punitive rates of interest on debts. It has secured some loans against its plants, but the rest has to come from the sale of its car making assets. This does nothing to contradict the original strategy for creating PAG which was to act as a bulwark against the rise of premium brands like Audi and Lexus. By selling PAG Ford is buying itself a little time but then it must once again find a way to compete against the luxury brand names. The key to the long term might lie in the retention of PAG’s powertrain plant at Bridgend in South Wales. Is Ford holding on to this crucial source of technology in order to maintain the option of buying back its subsidiaries at a later date?

























Ford’s used car company lot is undergoing quite a clear out. Aston Martin is already gone, Jaguar and Land Rover are under the hammer and now Volvo is reputed to be receiving a spit and polish before going on display. Altogether they comprise the Premier Automotive Group (PAG), perhaps worth up to $10bn in total on the open market. All Ford would need to do after that is find another $2.7bn to clear up last year’s financial loss. There is a chance, though, that Ford is not quite as rash as it looks and engine production might hold the key.


Volvo Cars has been part of Ford since 1999 and of its PAG siblings has made the best of its corporate family. It extended the gains made in the mid-1990s when Volvo styling supplanted sense with sensuality under Peter Horbury. Volvo managed to combine voluptuous curves with a social conscience, clothing the traditional virtues of safety under stylish new garments: it was safe sex, if you will. This was reflected in the solid sales figures, over 400,000 in 1999 when Ford made its move and up to 427,000 last year. Having bought the company for $6.5bn a sale for $8bn would represent a fair return.


Clearly Volvo has shown itself to be as safe an investment for Ford as it purports to be for its customers. The question then is, why should Ford need to sell it? The obvious answer is that it wants the cash to invest in its own branded operations back in the States. This, though, is hardly what business is about. Companies do not need their own cash to invest in projects; if the business case is attractive then they borrow the money. The risk of the venture is represented in the loan’s interest rate, anything earned above that is profit for the company. Whatever present trouble Ford might have, if it can present attractive investment opportunities then the funds will be forthcoming in the financial markets. Therein lies the rub.


It has been some years since the car industry as a whole offered the kind of financial returns that would attract investments at low rates of interest. Outside of Toyota and Porsche, the returns on investments are low so the interest attached to the loans has to be set higher to cover the increased risk. In other words, money lenders do not see much profit in car making so they charge higher interest rates in order to compensate. To make themselves seem a little more attractive car companies have tried to diversify into other, more profitable, operations such as banking. These act as fig leaves to cover the embarrassment of the poor returns in production. Sadly for Ford, there is no corporate fig leaf big enough to cover the current financial shame. Despite the fact that the business case for holding on to Volvo is as strong as ever, the punitive rates of interest Ford would have to pay in order to invest elsewhere in its empire means that it is forced to liquidate its own assets to raise cash.


This is something that we are becoming accustomed to, not only at Ford but also GM and DaimlerChrysler. There seems to be an atmosphere of retribution, of hubris being rewarded with ruin. Much of this sentiment is down to schadenfreude in the industry, a feeling that Ford was being flash with its cash and has now been caught out, but it would be unfair to accuse Ford of being driven by mere human emotion. It is not as if Ford acquired Jaguar, Aston Martin, Land Rover and Volvo simply to impress the neighbours. The original business case for purchasing the PAG subsidiaries was quite sound since it was part of Ford’s strategy for taking the fight to the fast rising premium brands. BMW, Audi and Lexus may be dominant now, but when Ford began to put together its premium portfolio in the late 1980s it was showing extraordinary prescience. Had the strategy worked Ford would now be sitting behind a defensive wall made up of the main PAG brands, with Aston Martin thrown in for a bit of fun. This would have eased the pain as the Ford brand suffered inevitable contraction in the more commonplace mass market. The logic of this plan is as strong as ever, it only failed in the execution.


What Ford will know, though, is that surviving in the industry is about staying in the game. The company is gambling for its future and is holding a pretty poor hand, but it does at least hold the Joker. In this case it is powertrain, the production of engines. A common link between Jaguar, Land Rover and Volvo is the engine production facility at Bridgend in South Wales, even if they do not actually have all the same engines in common. Ford does not appear to be looking to sell this capability with the PAG brands, so whatever company bought the brands would soon find that it had to come back to Ford to ask for motive power. If the buyers are car companies then over a generation or so they could install their own engines but this would represent a huge additional investment over the original purchase price. For a private equity firm this would not matter as much since it would simply come to some contractual supply arrangement with Ford. This would then tie the PAG brands to Ford for this vital technical input and this might even be part of Ford’s plan. In the same way that Ford has kept a share in Aston Martin, by retaining a critical relationship with its erstwhile subsidiaries Ford can effectively lock out other car manufacturing rivals. Then when Ford has returned to health it can reacquire its old subsidiaries from the private equity companies. Naturally this will be at some significant profit advantage to the private equity firms, yet this would surely be less than the high rates of interest Ford would have had to pay in order to continuously fund PAG throughout these difficult times. The buy-back strategy would also be significantly enhanced by a rise in the dollar in future years from its current trough. It is quite possible that Ford and the private equity firms have found a very neat way of circumventing the banks and their pernicious charges.










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