How Will Anti-Trust Probes Affect GM’s China Prospects?

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General Motors

General Motors (NYSE:GM) has become the latest car company to come under the scanner of the Chinese Government for alleged violation of anti-trust policies. [1] The investigations were initiated following several complaints from consumers about unfair prices of imported vehicles and auto parts. These investigations are part of the government’s wider efforts over the last two years to lower the prices of products offered by foreign auto, technology, pharmaceutical and dairy companies. Chinese regulators are investigating Shanghai GM, a joint venture between General Motors and state-owned Shanghai Automotive Industries Corp., which sells GM’s Buick, Chevrolet and Cadillac vehicles. GM is just the latest foreign company to be investigated — Volkswagen’s Audi recently agreed to pay $40 million for alleged violations, Fiat’s Chrysler faces unspecified penalties and Daimler‘s Mercedes-Benz had its offices raided by government officials. [2] Toyota’s Lexus and other Japanese companies also faced investigations.

We have a $40 price estimate for General Motors, which is about 18% higher than the current market price.

See full analysis for General Motors

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China’s Importance To GM

In 2010, China surpassed the U.S. as GM’s largest market. GM is China’s second largest auto company by volumes behind Volkswagen. Moreover, GM’s sales in China are growing at a faster rate than its U.S. sales despite having a bigger base. For the first six months of 2014, GM sold 1.73 million vehicles in China, up 10.5% from last year, compared to 1.46 million vehicles in the U.S., 2.8% higher than last year. [3] Additionally, the sales of Japanese automakers have suffered in China of late, leaving much more growth for German and U.S. automakers to capture.

Moreover, some of GM’s brands which struggle elsewhere seem to be popular in China. A prime example of this trend is the popularity of GM’s Cadillac. Cadillac sales grew by an enormous 72% in the first half of 2014 compared to the previous year to just under 34,000 units, making the brand a credible alternative to BMW, Mercedes-Benz and Audi in the country. Meanwhile, sales of Cadillac in the U.S. fell by 1% year-on-year to just over 82,000 units in the U.S., even as the overall luxury market continued to grow. According to estimates from McKinsey & Company, China should be expected to become the world’s largest market for luxury cars by 2020. [4] GM’s credibility as an alternative to BMW, Mercedes-Benz and Audi in China,which control a combined 80% of China’s high-end market, can allow it to sell 300,000 Cadillacs per year by 2020, which should make its market share about 10%.

The Chinese small car market is just as important as the luxury market to GM. Through its SAIC-GM-Wuling Automobile joint venture with SAIC Motor and Lizhou Wuling Motors, GM sold just under 890,000 vehicles in the first half of 2014. These cars are sold at price points of around $5,000-$10,000 and offer fuel-efficiency standards capable of competing with much pricier cars.

Effects of the Probe

There are two aspects to the probe: 1) an investigation into the prices charged by auto companies for cars, 2) prices charged by auto companies for auto parts used in servicing and repair. Regarding the second part, the markets that currently exist for auto parts are: 1) official auto parts sold either by the company itself or through dealerships; 2) the counterfeit market where these auto parts are reverse engineered; and 3) dealerships which manufacture official auto parts but are not allowed to sell their produce under their own brand name. Auto parts sold in the first market are much more expensive than those sold in the second market. The market these anti-trust investigations are most interested in, however, is the third – if dealers were allowed to sell their products under their own brand name, they would be able to supply enough high quality parts to be able to capture the market currently being served by counterfeiters by lowering their prices somewhat. Many customers would be willing to pay a premium for greater reliability and quality as long as the premium doesn’t appear to be price gouging. The after-purchase spend on auto parts is sometimes estimated to be as high as 40% of the purchase price of the car itself. If the changes outlined above were to come into place, the revenues gained from selling auto parts should be expected to decline in the future, but the availability of reliable and cheap servicing, maintenance and repair post-purchase might persuade consumers to enter the market. So the net effect of these changes is hard to predict.

Are GM Car Prices Too High?

The second aspect concerns whether GM will have to take a cut in the average price it charges Chinese consumers for its cars. Most foreign automakers charge much higher prices for their cars in China than they do elsewhere. Almost unanimously, they blame taxes for the higher prices in China. The Government charges a 25% tax on import, 17% tax on purchase and a consumption tax based on engine size. Foreign automakers have tried to pass these taxes on to consumers. However, even accounting for the 50% hike in prices to account for the taxes, car prices seem prohibitively high. Consider BMW’s X5 luxury crossover, for example: it costs just over $100,000 in the U.S. but costs as much as $330,000 in China.

Compared to BMW, GM’s prices seem much more reasonable. GM’s entry level Cadillac ATS, which starts at $33,065 in the U.S., debuted in China at around $50,000. Moreover, to lower the average pricing of its vehicles in China, GM is building a $1.3 billion plant in China where it will manufacture Cadillacs to avoid the import tax. The plant is expected to manufacture the Cadillac SRX Crossover locally. The SRX Crossover sold around 14,5000 vehicles in the first six months of 2014, a 23% increase compared to the previous year and 40% of Cadillac’s overall sales in China. The imported SRX currently costs more than $68,000 in China, compared to ~$38,000 in the U.S. Moreover, Chinese regulators are only investigating the Shanghai GM joint venture, which is only one of the 13 joint ventures GM runs in China. Even if Shanghai GM faces a penalty, the downside should be limited.

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Notes:
  1. Shanghai GM latest maker in China antitrust probe, USA Today, August 2014 []
  2. China to fine Audi $40 million for breaking monopoly law – newspaper, Reuters, August 2014 []
  3. GM China Sales Rise 9.1% in June on Buicks, Cadillacs, Bloomberg, July 2014 []
  4. Upward Mobility-Understanding China’s Premium Car Market, McKinsey & Company []