Epidemic Prevention and Response to COVID-19 in the Automobile Industry Series Issue 2 — PwC China Automobile industry M&A Review and Outlook The epidemic has prompted many practitioners and managers in the industry to re-examine and plan for the medium-and long-term development of auto industry, accelerating industry transformation and upgrade. PwC auto team emphasizes on the following aspect of tax & legal, M&A and telematics system to analyze the related solutions. In this article, we mainly focus on the M&A aspect, hoping to give some inspirational idea to the practitioners in the industry. China’s automobile industry has developed rapidly in the opportunities. Moreover, an increasing number of companies past decade. Benefiting from “bringing in” and “going out” with advanced technology and capital will continue entering policy, both domestic and foreign OEMs have successfully into the market which fuels more M&A activities in the realized high growth through a series of mergers and automobile industry. acquisitions (M&A). Since 2018, the development of China In this article, we will analyze the automobile industry from automobile market has been slowing down, and the “CASE” four aspects: review of China’s auto industry M&A deals, trend has been having impact on OEMs. As new businesses main deal drivers and changes of auto industry, the future models are emerging, it has also led to blurring of M&A trend, and key initiatives in response to market boundaries between industries. Auto companies have been changes. actively using M&A deals to transform the automobile industry. At the beginning of 2020, the coronavirus outbreak severely impacted the supply chain of automobile industry, thus resulted in demands for business restructuring and transformation. With emergence of new business models, relaxation of industry policies, and change in consumer demands, M&A activity in China automobile market is expected to grow in the next 2-3 years. Most deals will likely be cross-region, cross-industry, and cross-function. Foreign companies will focus on optimizing strategic planning in Asia-Pacific region, especially in China, whilst local enterprises continue to accelerate globalization and seek more overseas M&A Part I: Review of China’s Auto Industry M&A Deals In the past decade, M&A activity in China’s auto industry has been highly correlated with the industry performance. More than 900 deals were completed between 2010 and 2019. Started in 2014, M&A activities was growing rapidly. However, in 2019, due to various macro- economic changes such as Chinese economic growth slowdown, the China-U.S trade war, and the decline in consumer demand, both M&A volume and size declined drastically. Only 112 deals were completed in 2019, which was down 16% from 2018. In terms of transaction value, the cumulative amount was about $18.6 billion, which was down about 40% from 2018 due to the decrease in of the transaction volume. Historical Transaction Deals and Size of China Auto Industry M&A 2010–2019 Vehicle Sales Volume # of deals （in mn unit） (in unit) -40% 35 350 31.4 30.9 30 300 25 250 20.8 20 18.8 18.6 200 15 13.2 150 11.9 12.4 11.3 10 8.5 100 5 50 0 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Deals size (bn USD) China Vehicle Sales Volume(mn unit) # of Deals (unit) Source: Statisata, MergerMarket, PwC analysis 2 In the last decade, M&A transactions were dominated by • Domestic transactions: Between 2010 and 2014, there domestic deals, which accounts for about 60% of total deals, were 159 deals completed, with a cumulative transaction and cross-border M&A accounted for the other 40%. As for value of ~$37.5 billion. A total of 416 domestic M&A transaction value, the cumulated deal size exceeded $170 deals (~$80 billion) closed since 2015, which is 1.6 times billion, of which domestic transaction accounted for 67% more than the previous five years. This was mainly due (about $118 billion), while cross-border transaction value to the acceleration of the industry integration. was around 37% (less than $60 billion). Between 2014 and • Cross-border transactions: in the past decade, China’s 2017, both size and volume of outbound M&A grew rapidly, auto industry has completed 363 cross-border deals, but declined significantly from 2018 onwards due to accounting for 40% of the total deals. Notably, there were tightening of foreign investment control. 194 cross-border deals closed between 2015 and 2019, which is up ~ 15% from the previous five years, and the cumulative amount increased from less than $2 billion to $40 billion, which resulted a 200% increase. Historical Transaction Deals and Size of China Auto Industry M&A 2010–2019 Deal size # of deals (in Bn USD) 250 25 200 20 150 15 134 128 129 107 112 100 93 10 59 57 61 58 50 5 0 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 # of Outbound deals Total transaction value of outbound deals (in Bn USD) # of Inbound deals Total transaction value of inbound deals (in Bn USD) # of Domestic deals Total transaction value of domestic deals (in Bn USD) Source: MergerMarket, PwC analysis 3 The number of transactions driven by OEMs was about 10-20 deals per year, while the transactions driven by non-OEM increased significantly. The average transaction value was relatively stable. Transactions initiated by non-OEMs were the main driving force of most M&A activities in the last 10 years. Historical Transaction Deals of China Auto Industry by Type of Acquirers 2010–2019 Deal size # of deals (in mn USD) 150 1,000 134 128 129 125 19 18 12 112 800 107 100 93 12 18 13 600 75 59 61 57 58 400 8 50 8 3 9 25 200 0 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 OEM Average transaction value of OEM (in mn USD) Non-OEM Average transaction value of non-OEM (in mn USD) Source: MergerMarket, PwC analysis The number of mega deals, deals over $5 million, has remained relatively stable since 2013, and peaked in 2018, as market consolidates, and large OMEs, technology and supplier consolidation, and restructuring continued to drive deal activities. The Number of Mega Deal Transactions 2010–2019 # of Mega deals 14 14 12 11 4 10 10 1 8 8 3 8 4 1 7 7 6 6 1 4 2 4 2 6 10 4 7 7 2 2 6 2 4 4 1 3 2 2 0 1 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 >5 billion USD Between1~5 billion USD Between 0.5~1 billion USD Mega deal transactions refer to transactions with a transaction value of more than 500 million US dollars Source：MergerMarket, PwC analysis 4 Part II: Main Deal Drivers and Changes of Auto Industry Based on current events and on-going industry reform, we To sum up, the epidemic put pressure on upstream and will review the impact of the new coronavirus epidemic, downstream enterprises’ operation and cash flow, and scrapping JV ownership limits and “CASE” trend on the M&A reduced large amount of capital expenditures. The on- deals of China’s auto industry. going operating pressure would accelerate enterprises cooperation, restructuring and integration, spinning off 1. The new coronavirus epidemic accelerated the distressed assets, and investing in future “CASE” auto industry transformation related area. At the beginning of 2020, the rapid spreading 2. Scrapping of foreign ownership limits has greatly coronavirus put serious pressure on both OEMs and promoted the development of JV M&A activities auto parts companies and will further accelerate the transformation From the demand side, the sales of new cars were In May 2018, the national development and reform expected to stagnate in the short term. However, due to commission (NDRC) announced that it will gradually the long-term decision-making behind car purchases, scrap foreign ownership limits and open up opportunity most of the demand will not disappear because of the for equity ratio of joint-ventures, and the plan is to fully epidemic, but the purchase behavior will be delayed. scrap any foreign ownership limit by 2022. The epidemic might promote some first-time buyer purchases. However, as the tertiary industry has been For foreign OEMs, the relaxing of foreign ownership severely affected by the epidemic, consumer disposable policy will help to realize their strategic planning in China, income has been reduced, which would restrain the and strengthen market share by increasing ownership, consumer purchase demand. establishing wholly foreign-owned enterprises or joint ventures. In addition, foreign OEMs can use joint From the supply side, the production and supply in ventures to actively expand new businesses in China. Hubei province and severe epidemic areas were disrupted temporarily. As the auto industry supply chain For domestic OEMs, this policy will further promote is highly integrated, domestic and foreign OEMs and partnerships and business restructuring, and it will parts suppliers were forced to suspend production or promote market competitiveness of Chinese brands and delay the resumption of production due to the epidemic, accelerate transformation. resulting risk of capital shortage. From the sales side, the epidemic impact led to a sharp decline of dealers’ income. High fixed cost and lagging rebate distribution would put pressures on dealers‘ cash flow. 5 3. The “CASE” trend will further promotes cross-region, cross-industry and cross-functional M&A, and drive the transformation towards smart mobility • Benefiting from “bringing in” and “going out” policy, both domestic and foreign OEMs have successfully realized high growth through a series of mergers and acquisitions In 1984, Volkswagen and SAIC established Shanghai Volkswagen, the first automobile joint venture in China, symbolized opening of Chinese automobile market and entering a period of joint venture partnerships, as a result of the economic reform and the open door policy.