Why is Fiat Chrysler Automobiles (NYSE:FCAU) beating the merger drum again?
FCA chairman John Elkann reopened one of the auto industry's biggest cans of worms last week, saying that a move to combine FCA with one of the auto industry's "big guys" could lead to a net savings of over $10 billion a year. FCA made repeated merger overtures to old Detroit rival General Motors (NYSE:GM) last year, only to be soundly rebuffed. Is the company about to revive its push to acquire or be acquired?
A claimed $10 billion savings, but at what cost?
Elkann's remarks were included in his annual letter to shareholders of Exor (EXO), the company that serves as the investment vehicle for the descendants of Fiat founder Giovanni Agnelli.
In the letter, Elkann picked up the arguments made by FCA CEO Sergio Marchionne last year. Elkann said that the world's automakers are "an industry in denial" about the sheer amount of capital required to run their businesses, and the clear (as he sees it) benefits of consolidation.
As Elkann sees it, FCA's rivals are distracted by the wave of technological change expected to sweep the industry in coming years:
"For FCA, if you look at doing something with the "Big Guys", our internal analysis indicates that you could end up with annual savings close to $10 billion. If you value that in perpetuity it starts to become very interesting. But you need two to tango and most of our competitors are busy with the great opportunities that technological disruption has to offer."
Pressed on Elkann's remarks, Marchonne doubled down on them on Friday. In remarks reported by Bloomberg, Marchionne said that while he still thinks GM would be the best merger partner for FCA, he also sees Ford (NYSE:F), Toyota (NYSE:TM), and Volkswagen (OTC:VWAGY) as potential partners for a "big" merger. (Ford quickly issued a statement saying that it had no interest.)
So will this happen? I don't think so -- at least, not in the way that Marchionne hopes.
Why the "big guys" don't want to merge with FCA
I don't think that companies like Ford and GM and Toyota and Volkswagen are "in denial" about the benefits that could accrue to the overall industry if there were fewer, larger competitors.
But I'm also not surprised that nobody wants to take up Elkann and Marchionne on their plan to fold FCA into another rival.
Here's why: FCA isn't exactly a healthy business.
FCA has one big shining asset, namely the Jeep SUV brand. Beyond that, while there are bits and pieces of its portfolio that some automakers might want to own (the Ram pickups, the Alfa Romeo brand), the company itself is barely profitable in what should be nearly ideal market conditions. And while Elkann thinks rivals are distracted by high-tech innovation, the reality is that FCA is far behind on those same fronts.
Think about this: Global demand for SUVs is booming, and FCA has arguably the best SUV brand of all. The U.S. market for pickups is terrific, and Ram is the biggest player after Ford and GM. But FCA managed a net profit of just 377 million euros ($426 million) last year on 111 billion-with-a-b euros ($125 billion) in net revenue. The company's EBIT profit margin was just 2.4% -- far behind nearly all of its serious rivals'.
Marchionne has a number of efforts underway that might help margins over the next few years. But simply put, it's clear why he wants a merger partner: His company needs more scale and more resources to be sustainably profitable.
How this is likely to play out
I think it's possible that FCA could be acquired by a Chinese automaker looking to establish itself in the West. (I also think that such an acquisition would be politically fraught, but could be made to work with some accommodations.) Such a deal could make good sense for both sides.
But I don't think a deal with a big global automaker is likely simply because FCA doesn't bring enough to the table.