Autos

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

Modern cars are designed with structurally weak crumple zones to absorb the impact of a crash and protect passengers in the cabin. Mitsubishi Motors could do with one of its own.

The fallout from 25 years of improper handling of fuel-economy tests is threatening to swamp the business. It's ``a case that could affect our company's existence,'' President Tetsuro Aikawa told reporters Tuesday.

Slow Lane
Valuation of major Japanese carmakers, based on blended forward 12-months EV/Ebitda multiples
Source: Bloomberg data

With more than half its value wiped out in the six trading days since the news emerged last week, the company's 415 billion yen ($3.7 billion) market capitalization is now less than its 426 billion yen of net cash at the end of March. Mitsubishi's valuation had already been drifting to the bottom of the class of major Japanese automakers for several years.

It doesn't need to be like this.

While Mitsubishi's Japanese, North American and European units were clearly struggling even before the latest scandal, the business as a whole has some gems worth salvaging. Revenue from Asia excluding Japan jumped 30 percent in the December quarter, Bloomberg Intelligence analyst Nikkie Lu wrote this month, and the company is well placed to benefit from rising incomes in the region.

Pulling Ahead
Year-on-year changes in sales volumes of major automakers in Thailand
Source: Bloomberg Intelligence

Southeast Asia, where Mitsubishi's line of rugged SUVs and pickup trucks appears to chime with consumer tastes, looks particularly strong. In the Philippines, sales rose 50 percent from a year earlier in January. They climbed 54 percent in Thailand in March. While car sales in Indonesia have been suffering amid economic weakness and a cut in fuel subsidies, the company is investing about $600 million in a local plant scheduled to open in 2017 that will eventually churn out 240,000 vehicles a year.

After Suzuki, Mitsubishi has the highest exposure to developing markets of the major Japanese automakers, based on sales volumes. That puts it in a good position to capitalize on regions where growth is likely to be strongest.

The Rich and the Poor
Share of vehicle sales in developed markets, by major Japanese carmakers
Source: Bloomberg data
Note: "Developed markets" represents sales volumes in North America, Japan, Europe, and Oceania, as reported by the company.

Emerging Asia also outstrips Mitsubishi's other regions in terms of profitability. It accounted for about 21 percent of net sales in the year ended in March, according to annual results released after local markets closed Wednesday, but about 54 percent of operating income.

So why not split the two businesses? If the testing problems do turn out to be confined to Japan, it seems unjust that they should drag down successful overseas units as well.

Imagining what a spin-off would look like is a bit like fantasy football. There's a huge wildcard in the fact that Mitsubishi is still investigating whether the misleading test practices were used in overseas markets as well as at home. But a back-of-the-envelope calculation suggests there's value worth preserving.

Let's imagine a Mitsubishi divided into an emerging markets operation focused on developing Asia, and a legacy company holding everything else. The former business posted 74.9 billion yen of Ebit over the 12 months through March; the latter had 63.5 billion yen.

Value both businesses at the median Ebit multiples for carmakers in emerging Asia and Japan -- 17.33 times and 8.1 times respectively, according to data compiled by Bloomberg -- and you produce enterprise values of 1.3 trillion yen for the emerging Asia arm and 514 billion yen at legacy Mitsubishi.

Let's then assign all of Mitsubishi's 426 billion yen in net cash to the legacy business -- it's probably going to need it to deal with future liabilities. And let's assume that the reputational and financial damage from the current scandal leaves the legacy business at an 80 percent discount to its notional value, and the Southeast Asian unit at a 40 percent discount.

Based on these numbers, the combined companies would be worth about 967 billion yen. That's more than double Mitsubishi's current valuation.

Such a split would have the useful effect of quarantining the best bits of the business from the liabilities associated with all those dodgy fuel economy tests. But that's not the only reason to do it.

At present, Mitsubishi Motors is effectively controlled by affiliates of the Mitsubishi Corp. trading house. Of the company's 18 directors and supervisory board members, at least 13 are veterans of either Mitsubishi Corp., Mitsubishi Motors, Mitsubishi Heavy or Mitsubishi Bank, despite major group companies being identified as holding just 27.92 percent of the company's stock in its most recent annual report.

Shaking up the cozy practices of corporate Japan is the much-vaunted, little-seen ``third arrow" of Prime Minister Shinzo Abe's plans to remake the economy. Splitting Mitsubishi Motors would give outside investors the chance to make up their own minds about which business has better long-term prospects. That sounds like a smart way to kill two birds with one arrow.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net