VW’s part exchange offer

Good together: the joint venture just extended its life by 25 years

“I am the Chinese Machine Building Minister and I would like to speak to somebody in charge,” the Mao-suited official informed an astonished gatekeeper at Volkswagen’s head office in Wolfsburg.

It was 1978 and the beginning of the first Chinese-German car venture. The anecdote is recalled in Martin Posth’s book 1,000 Days in Shanghai, with the former Volkswagen executive explaining how the visiting Chinese delegation had originally arrived in Germany intending to do a deal with Daimler-Benz. But it was surprised to see so many Beetles and Golfs on the streets, so the minister decided to make a visit to Volkswagen too. He turned up unannounced at the factory gates and the seeds of the groundbreaking tie-up with Shanghai Auto were sown.

More than 35 years later it’s the Germans who are anxious to get a deal done, pressing their noses against the boardroom glass at FAW (First Auto Works) – Volkswagen’s other key partner in China – to ask for more equity in their barnstorming joint venture.

Currently FAW holds 60% of the FAW-Volkswagen Automobile Company, which makes Audi and Volkswagen cars for the China market. VW owns 30% of the venture and its unit Audi 10% more. Together, that accounts for a smaller share than German carmakers like Mercedes-Benz and BMW, which split ownership 50-50 with their Chinese partners.

Earlier to start in China than its German peers, Volkswagen saw the lower stake as a way of reducing risk and incentivising its local partner. But it has long regretted its caution, with the Audi going on to become China’s preferred luxury car. There has been speculation for some time that FAW will sell an additional 9% in the venture back to its German partner and the idea emerged again last month when Li Pengcheng, the company’s head of public relations in China, advised that discussions were ongoing. “The future equity ratio is likely to be 51:49 [in FAW’s favour], which is the arrangement that we have negotiated but not yet finalised,” he explained.

At first glance, Volkswagen’s bargaining position might have seemed weaker at the end of October than at the beginning of the month. By then it had agreed to extend its venture with FAW by 25 years in a contract signed during a visit by Chinese Premier Li Keqiang to Berlin. The two partners promised deeper cooperation in research and development, and that they would step up investment in fuel-saving technology. Volkswagen bosses also confirmed that it would be investing more than $2.5 billion alongside FAW in two more assembly plants.

Like some of the other foreign carmakers, Volkswagen has dropped hints that it might push harder to sell more made-in-China cars in other countries should its shareholding terms be sweetened. Perhaps its tie-up with Shanghai Auto – it makes the brand’s less luxurious models like the Santana – is a positive too, offering another partner to turn to if the other says no. Otherwise the German firm’s leverage looked limited and most likely the window of opportunity on the deal is only opening at the choosing of the Chinese side. For its part, FAW has wanted to IPO for a while, and confirmation of the new shareholding structure would give investors a clearer picture. Granting it a 51% stake (more than the 50:50 deals at similar ventures) would allow it to reflect the full revenues on its books too.

But FAW is also under pressure from policymakers frustrated that the domestic giants haven’t done more to build competitive cars of their own. Easy profits from the joint ventures have been blamed. “It’s like opium. Once you’ve had it, you’ll get addicted forever. So many years have passed and we don’t have a single brand that can be competitive in the auto world. I feel red-faced,” a former minister complained two years ago (see WiC242).

The implication is that FAW has been the worst performer on this score, far too content to ride in Volkswagen’s slipstream. Part of this failure is because the Germans have been so stingy in transferring key know-how, China Economic Weekly believes. But FAW has to shoulder much of the blame for happily raking in the cash but doing little to develop decent cars of its own. “Because it’s always getting fed by someone else, it has forgotten how to use its chopsticks,” an unnamed insider was said to admit.

A lower share of profits might stir it from its slumber. And a new deal could also help FAW get access to the most up-to-date foreign technology coveted by all the Chinese automakers. They are rightfully suspicious about foreign commitments on tech transfer, which haven’t worked out as hoped. But upping its stake in the FAW venture might strain Volkswagen’s balance sheet, so it might be persuaded to pay partly with tech, China Economic Weekly says.

There’s also a view that FAW could be instructed by the State Council to sell down some of its stake in the wider national interest. Writing in the German press during his visit to Berlin last month, Li Keqiang said the request from Volkswagen would be considered. But there was a clear quid pro quo: his wish that Berlin “will approve qualified Chinese companies to participate in tenders for German high-speed train projects”. Not that Volkswagen can bang the table too hard during the bargaining. It delivered 2.7 million vehicles to customers in China in the first nine months of this year. That’s a third of its global sales, and it’s the market that’s most crucial to its goal of overtaking Toyota as the world’s bestselling carmaker by 2018.

In the meantime neither party will want to see the Volkswagen brand tarnished in China, a potential risk after 564,000 Sagitar cars (a popular sedan) and 17,000 Beetles were recalled after reports of faulty suspensions.

Owners are said to be angry at the FAW-Volkswagen fix for the fault, which is to fit a metal plate to the rear axle of the problem cars. Customers have been demonstrating outside dealerships, demanding an axle replacement or a refund. Parts of the Chinese media have been supportive, saying that the handling of the case has been arrogant, while China’s quality watchdog has said that it will look into the effectiveness of the carmaker’s response.

Here, at least, Volkswagen might reflect on some of the value of its relationship with its state-owned partner. It’s not implausible to suggest that FAW’s sway at governmental level could help the joint venture to sidestep the worst of the potential backlash in a way that might not have been open to smaller or privately-held players, for instance.

Staying close to the modern-day equivalent of the Machine Building Ministry can still pay a useful dividend, perhaps.

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