Peugeot counts the cost

In late 1996, there was growing speculation of bankruptcy in the Chinese car market and possible withdrawal by certain manufacturers. Particular concern focused on the difficulties faced by the French automotive group Peugeot-Citroen PSA, whose problems in China have become more acute in recent years.

In a depressed domestic market, the two joint ventures of the French group, along with other international companies, have been downgrading their production plans to take account of stagnant sales figures. Running big losses and having interrupted production several times this year, the Guangzhou Peugeot Automobile joint venture is said to be on the edge of bankruptcy.

Further north, in Hubei province, Dongfeng Citroen Automobile Company (DCAC) has experienced serious delays. This is a cause for concern, not only to the parent companies but also to over 50 French spare parts manufacturers established in China to supply parts for the DCAC model, the ZX Fukang, a 1.36 litre hatchback. Weak demand from private customers, the influence of the national economic austerity programme and the absence of credit financing, have contributed to depress sales.

Management weakness

This is a new chapter for many investors. "We all came to China with the figures of the Chinese government in our head", remembers one investor in the automotive industry, "and it was forecasting 1.3 million cars by 2000." Guangzhou Peugeot, one of the
first joint ventures in China, is a good example of a venture which was attracted by big expectations. It set out in September 1985 to produce 15,000 Peugeot 504s in a start-up phase. Peugeot held 22 per cent of the capital, and its main partner with 46 per cent was
Guangzhou Automobile Group Company, a firm owned by the municipality of Guangzhou. The investment was capped at US$150m and reached US$300m in the second phase starting in 1989 to extend the production capacity to 45,000 cars a year.

However, at an early stage observers were puzzled by some apparent weaknesses in the management of the joint venture where the main Chinese partner was in charge of sales and marketing. A chronic lack of cash flow had become the norm, and the joint venture was never able to capitalise on initial gains. "The habits and customs of Chinese and French differ, the economic legal systems are not the same, and some situations have not been very fortunate," says a spokesperson for Guangzhou Automobile.

Huge stockpiles

This appraisal fails to account fully for the mediocre sales performance of the joint venture. Designed for taxis and high government cadres, the 504 and the 505 models introduced in 1989 have not sold well on the Chinese market. They were victims of an outdated image and fierce competition from the highly popular Santana, the sedan produced at the Volkswagen joint venture in Shanghai, as well as from imported cars.

Distribution has been erratic. "When my company wanted to buy a Peugeot, there was no way to do so in northern China," complains a representative of a Western company. "We had our driver sent to Guangzhou to get the car and drive it to Beijing." In 1995, severely hurt by the impact of the credit tightening policy, most of the production at Peugeot Guangzhou Automobile ended up in huge stockpiles while the joint venture registered record losses of Yn320m (US$38.4m). Since the beginning of 1996, production has slowed down even further. Only 1,748 cars were produced in the first half of 1996, compared with 3,531 in the same period in 1995. Production in the whole of 1995 reached 8,500 cars. The joint venture, which employs 2,500 workers, has been forced to stop production several times during recent months, while Chinese and foreign partners discuss the terms of a possible withdrawal by Peugeot.

If the Guangzhou joint venture became an early matter of concern, it didn't deter the French firm from repeating the experiment on a bigger scale. It was believed that the original structure of the project was one of the reasons behind the poor performances at Guangzhou. Thee project was only approved locally, which became a disadvantage in the 1990s when Beijing started to look less kindly on the independent spirit of the south. With the growing influence of the State Planning Commission, Peugeot Guangzhou found itself sidelined.

Government support

In February 1994, the State Planning Commission came up with a new framework for automotive industry development. It named three important automobile groups which the Chinese government pledged to support, if necessary. While Peugeot Guangzhou was excluded from this list, DCAC was getting official backing from the Beijing authorities together with the two Volkswagen joint ventures in Shanghai and Changchun.

Founded in 1992, DCAC was a partnership involving Dongfeng Motor Corporation, a manufacturer of civilian and military heavy goods vehicles, which took a 70 per cent shareholding in the project. Two French banks, Societe Generale (4 per cent) and Banque Nationale de Paris (1 per cent) embarked on the project with Citroen (25 per cent). The US$1.4bn project was also underwriten by government loans from France's state credit agency, COFACE, as well as from the Bank of China.

In April this year, during the visit of Premier Li Peng to France, a second credit deal of US$480m was concluded.

Originally, the plan at DCAC was to produce 150,000 ZX Fukang a year. Strictly bound by national regulations, the local content was scheduled to rise to 60 per cent at the end of 1996, reaching 85 per cent in 1998, one year before the end of the current phase of investment. These ambitious targets have proved difficult to attain. One reason was the delay in the construction of the DCAC industrial site, partly a result of its inland location. Several industrial projects have not been completed on time, including the final paint workshop already over one year late. One result was the level of localisation had only reached 42.44 per cent by the beginning of July. While the 60 per cent target for the end of 1996 may be possible, the management thinks that reaching 80 per cent by the end of this year will be more difficult. Unlike Shanghai Volkswagen, the Chinese authorities have not been so accommodating in facilitating the localisation process.

Continued stagnation

One solution the French group found to increase localisation was to persuade its traditional suppliers to set up satellite joint ventures in the region of Wuhan and Shanghai. Bundy, Lucas and Valeo are among over 50 international suppliers now engaged in these partnerships to provide quality spare parts. But in recent months, many have expressed concern about this year's prospects should the stagnation continue. "We were expecting 15,000 cars this year and the production was only 10,000," says one supplier. "Next year, much more than 5,000 cars could be missing from the production line."

DCAC, which has just begun this year setting up its own national network of around 1,000 distribution points dismisses these worries, arguing that the joint venture is going through a natural start-up process.

Still, many questions remain, one being the unexplained absence of the Chinese director Song Zuwei, since October 24. This has sparked rumours of possible embezzlement and shocked the Chinese automobile industry where the 58-year old Song was a respected figure. The management of DCAC and the Wuhan authorities have denied there were any accusations of embezzlement against Song, last seen taking a night train from Wuhan to the city of Shiyan in the extreme north-west of Hubei province where Dongfeng's headquarters are located. In December, without waiting for the results of the on-going investigation, DCAC's board of directors promoted a new Chinese vice-general manager, Zhang Shiduan, previously vice-general manager at Dongfeng Motor Corporation.

Possible withdrawal

Little is known officially about the future intentions of the French car manufacturing group in China. Industry sources believe the Guangzhou joint venture has technically gone bankrupt. A withdrawal by the French group would allow it to concentrate on the industrial site of Wuhan where more central government support is expected. But details of China's bankruptcy law applied to joint ventures are still too sketchy to allow Peugeot Citroen to get out quickly and efficiently from the Guangzhou partnership. A global solution involving the replacement of Peugeot by another international automobile company is believed to be one of the options being studied. Other shareholders include Banque Nationale de Paris (4 per cent), International Finance Corporation, which is part of the World Bank (8 per cent), and Citic (20 per cent). Sources at the majority shareholder, Guangzhou Automotive, say that Guangzhou has been looking for several months for an appropriate solution. However, Peugeot President, Mr Jacques Calvet, held a press briefing last month to dismiss rumours that the French group was discussing any cooperation with another international carmaker. His hesitation can be attributed to a reluctance to pull out of a potentially big future market, especially if it involved being replaced by an international competitor.

Considering the current restrictions on new automobile assembly sites with foreign investment, international car makers are queuing up to take over Peugeot: "We have seen many interested international car makers," says a Guangzhou Automobile spokesman. "Not only American, but also German, Japanese and Italian." Honda and Opel have so far been seen as seriously considering an involvement at Peugeot Guangzhou. Of the two contenders, Opel has the more obvious interest in the joint venture, having applied for a wholly-owned engine factory in Guangzhou. Taking over Peugeot would allow it to set up this engine project on the existing industrial site and develop at the same time a separate production line for a family car that it has the ambition of developing in China. Chinese and French sources agree upon a potential 12 months schedule to complete a possible takeover. Reviving the fortunes of the plant may take a little longer.