Acquiring trouble?

Geely Group’s acquisition of Volvo was one of the iconic deals of the global downturn. When a young, brash car company from China picked up a longstanding European brand, it was interpreted as further proof that economic power was shifting eastwards.

As soon as the takeover was completed early last year, the pressure was on to make it a success, and to expand the Volvo business. But from the outset, critics questioned how Geely’s chairman Li Shufu, could succeed where previous owner Ford could not.

The pessimists will be feeling vindicated by the news that Geely’s progress is not running altogether smoothly. The company is already lumbered with a huge debt burden, and in order to carry out its plans, it needs to borrow more. That is, if it can.

A quick look at Geely’s balance sheet for the last three years shows how the company has gone from being a relatively debt-free concern to a company with gearing issues. In 2008, total liabilities were just Rmb4.78 billion ($747 million). They increased to Rmb16.05 billion in 2009, before leaping to Rmb71 billion last year, as it inherited the substantial debts of its acquisition. Geely’s debts are now equal to 73% of its total assets.

A key part of Li Shufu’s plan for Volvo is to start manufacturing the brand locally, and three plants are expected to be completed by 2013 – in Daqing, Shanghai, and Chengdu – requiring investment amounting to Rmb13 billion. China Business reports that the local government in Daqing is not providing any financial assistance; and that the relevant authorities in Shanghai and Chengdu have not made any promises to help out either. The financial burden rests solely on Geely’s shoulders.

Geely’s previous fundraising has demonstrated that the debt market still believes it to be creditworthy, mind you.

In June, it successfully issued notes worth Rmb1 billion. The seven-year bond carried an interest rate of 6.4%, and was the first corporate bond to be issued by a private company in China’s automotive industry.

But it seems unlikely that the bond market will meet the full amount needed for Geely’s Volvo plans.

“If Geely continues to borrow for expansion and new projects, while it cannot control the rising debt ratio, investors are bound to become worried,” Liu Feng, an analyst at Southwest Securities, told China Business.

On March 23, when the company released its annual report for 2010, it announced that it had sold 415,000 units (across all of its brands) last year, a 27% increase. This might seem like good progress but it actually lagged growth for the Chinese passenger car market in general. Investors took fright, and the company’s stock finished the day 5.66% down.

Volvo sales are also growing but they still trail competitors. Yes, the Swedish brand sold 21,000 vehicles in China during the first half of this year, a 36% increase. But other high-end car brands are not only selling in greater numbers, they are also enjoying more rapid sales growth. BMW, for example, sold 121,600 cars in the same period, representing a 61% increase.

Geely’s challenge is therefore multifaceted. Not only does it need to find the cash to scale up the Volvo business in China, it also needs to do so quickly. If there are substantial delays, Volvo could fall further behind its peers. And if that were to happen, an acquisition that was announced with so much fanfare could become a costly drag on Li Shufu’s automotive empire.

Not that he will be anything but sanguine about this – after all, Li once famously compared the business of carmaking to “suicide”.

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