Chinese automakers are shifting to higher gears. An entity owned by the chairman of one of China's biggest automakers has snapped up a stake in Germany-based Daimler AG (A/Stable/A-1). S&P Global Ratings believes the transaction between Geely Group Co. Ltd. (Geely Group) and Daimler points to a strategic move for the wider Geely group to tackle disruption risks in the industry.
In February 2018, Geely Group acquired a 9.69% equity holding with voting rights in Daimler, according to media reports. The market value of the stake was about US$9 billion. Geely Group is 100% owned by Mr. Li Shufu, the chairman of Zhejiang Geely Holding Group Co. Ltd. (Geely Holding). Geely Group is independent from Geely Holding and its subsidiary, Geely Automobile Holdings Ltd. (Geely Auto: BBB-/Stable/--).
Although Geely Group has no shareholding relationship to Geely Holding and its subsidiaries, investors want to know more about the likely impact of its acquisition on all Geely entities. We've addressed the most frequently asked questions in this article.
Frequently Asked Questions
How did Geely Group pay for the deal?
According to media reports, Geely Group built up the stake using a combination of directly purchasing shares from the secondary market and derivative instruments. We believe the immediate cash hit for Mr. Li could be materially below US$9 billion.
What's the financial impact on Geely entities?
None, for now. According to Geely Holding, the company and its subsidiaries have not provided any financial assistance or guarantee for the acquisition. However, we'll keep a close eye on whether this will stay the case, given the large deal size and potential for collaboration between Daimler and Geely Holding.
What's the likely impact on the rating on Geely Auto?
Currently, our rating on Geely Auto is driven by our assessment of its parent, Geely Holding. We could lower the rating on Geely Auto if the acquisition leads Geely Holding's ratio of debt to EBITDA to exceed 1.5x. Under our base-case scenario for 2018, we expect Geely Holding's ratio to be 1x-1.5x, excluding any impact from the Daimler acquisition.
For a possible upgrade, Geely Auto's product competitiveness would need to strengthen and lead its market share to materially increase in China. As of 2017, the company accounts for about 5% of the total passenger-car market in China. At the same time, the group would need to establish a significant mass-market presence outside of China, notably in South-East Asian countries.
Any potential joint development with Daimler or international expansion will take time to materialize and execute. A further upgrade therefore seems limited for the next 12-24 months.
Why did Geely want a stake in Daimler?
Geely considers Daimler an ideal partner for its future development. Daimler is a global market leader in car design and manufacturing. It also has significant expertise in autonomous driving and development of new energy vehicles, as well as other online/digital services.
These areas of expertise are important to Geely because it sees keen competition over the next five to 10 years from disruptors outside of the auto industry. In particular, the company anticipates a growing competitive threat from Internet firms specializing in auto-related online/digital services.
Is Geely right to see this risk?
In our view, the short-term risk is relatively low because Internet companies are still acquiring auto-manufacturing expertise. Nevertheless, these disruptors could revolutionize the industry and materially squeeze the profits of conventional car manufactures along the value chain, as has been the case for a few other industries.
In light of such competition, Geely believes that conventional auto manufacturers should form closer alliances not only to maintain their strength in auto design and manufacture capability, but also to jointly develop competitive online/digital service capabilities. The bottom line is staying ahead of the game.
Why was Geely Auto upgraded to investment grade last year?
We upgraded Geely Auto to 'BBB-' from 'BB+' on Dec. 15, 2017, because we reassessed the credit profile of its parent (Geely Holding).
We expect Geely Holding to continue to improve its group-wide competitive position while further gaining market share in China and globally. This is the result of sustained material spending on research and development (R&D), further upgrades in design and new product development, and very diligent cost-control efforts.
We further believe that Geely Auto has benefited substantially from the acquisition of Sweden-based Volvo Cars in 2010. The quality, design, and technology of the car models that Geely launched in recent years have notably improved. In turn, Volvo Cars benefited from strong financial support from Geely Holding (to sustain large R&D spending), as well as Geely's cost-control expertise. These factors led Geely Holding's volumes and profitability to materially improve in 2017.
In our view, the changes at Geely are structural rather than temporary. We expect the company to maintain robust growth in volume and profits over the next 12-24 months. That's even without considering any business impact from recent acquisitions.
We also raised Geely Auto's stand-alone credit profile (SACP) to 'bbb-' from 'bb+' in December 2017 to support our view that the company's revenue growth will remain strong over the next 12-24 months and that it will maintain a net cash position.
Is Geely Group looking for additional acquisitions after Daimler?
Geely says not. The company will now focus on digesting its recent acquisitions, including its share acquisitions of AB Volvo and Daimler, and explore in detail areas of collaboration with these entities. Specifically, Geely says it wants to maintain its current leverage profile, and does not intend to fund large acquisitions with additional debt.
Related Research
- Bulletin: Geely Automobile Holdings Ltd. Rating Unaffected By Positive Profit Alert And Parent's Acquisition Of AB Volvo Stake, Jan. 10, 2018
- Research Update: Geely Automobile Upgraded To 'BBB-' On Sustained Business and Financial Improvements; Outlook Stable, Dec. 15, 2017
Only a rating committee may determine a rating action and this report does not constitute a rating action.
| Primary Credit Analyst: | Leo L Hu, Hong Kong + (852)25333594; leo.hu@spglobal.com |
| Secondary Contact: | Andy Liu, CFA, Hong Kong (852) 2533-3554; andy.liu@spglobal.com |
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