50 Has Always Meant 51 in Shanghai

Events continue to unfold in China’s rapidly changing automotive industry. The Financial Times summarized the most important of the recent developments: Beijing Automotive Industry Corp. wheeling its shopping cart around the world in search of distressed car assets like Sweden’s SAAB; Geely negotiating to acquire Volvo; and last but not least, General Motors selling majority control of Shanghai GM, its highly successful joint venture in China, to its partner, Shanghai Automotive Industry Corporation (SAIC).

Foreign assemblers are limited to a maximum 50 percent ownership of an assembly joint venture in China and cannot have more than two partners in the country. In a hotly contested battle between Ford and General Motors in the early 1990s, General Motors won the right to negotiate a 50/50 joint venture with SAIC. The resulting joint venture has become one of the most successful auto companies in China, now the largest car market in the world, and Shanghai GM is by far the brightest star in the General Motors portfolio.

Given this background, why on earth would General Motors sell a majority stake to SAIC? Many analysts were baffled by the decision. “It’s ceding precious ground,” said Mike Dunne, an auto analyst who focuses on Asian markets. “Nobody in the industry wants to give up ownership.”

The truth of the matter is that General Motors is giving up very little in exchange for valuable financial support from its well-heeled Chinese partner.

From a strictly accounting point of view, General Motors has never been able to consolidate the sales and earnings of Shanghai GM. As a 50 percent shareholder that does not control management, it has instead been reporting its share of Shanghai GM’s earnings as a one-line item on its income statement. Owning 49 percent does not change the accounting treatment.

Operationally, 50 percent has always meant 51 percent for SAIC in Shanghai GM. Since inception, the Chinese partner has controlled decision-making in key areas such as purchasing. In this sense, the sale of a 1 percent interest giving SAIC 51 percent ownership merely brings the legal ownership of the joint venture in line with the way that the company has operated in the past. Let me explain with an example.

When General Motors was completing its negotiations with SAIC, the U.S. car giant still owned Delphi, its parts subsidiary that was subsequently spun off as a separate company. Naturally, Delphi began to negotiate a number of joint ventures in China to support the new assembly operation which its parent company would be setting up in Shanghai. One of the technologies that General Motors wanted in China was for alternators, a very important part of a car’s electrical system.

Five years earlier, General Motors had granted a license for starter technology to a Chinese company in Hubei province that produced both starters and alternators. Due to this pre-existing relationship, the Hubei company was a natural choice to complete a joint venture with Delphi in alternators. The two companies had an existing relationship upon which they could build; Delphi supplied alternators for the Buicks made in the United States; and the new joint venture would do the same for the Buicks made in China.

That’s not the way it worked out, however. Somehow, Shanghai GM’s alternator business was awarded to a joint venture in Shanghai between SAIC and a French supplier of starters and alternators, providing new meaning to the term “local protectionism.” Given this reality of how key decisions have been made in the joint venture, owning 49 percent of Shanghai GM is no different operationally for General Motors than owning 50 percent.

In return for selling a 1 percent stake to SAIC, General Motors receives $85 million in cash and SAIC agrees to partner with General Motors in a new $650m joint venture in India to produce and sell small cars. General Motors gets valuable cash and a partner with deep pockets to expand in India in one fell swoop.

In a perfect world, Mike Dunne is right. No global company would ever give up any piece of a valuable operation in China at this early stage of the country’s development. But the world is not perfect. According to the terms of the U.S. government’s bailout of General Motors, the company cannot send cash to its China operation — yet another concession to the politically powerful unions that helped bring about GM’s downfall in the first place. Cut off from financial support from its parent, GM China needs to find new ways to survive. The comprehensive deal that the company has negotiated with SAIC is a good way to obtain much needed expansion capital, while giving up very little in the process.

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