Renault Takes Russia's Lada for a Spin

CEO Ghosn knows how to turn Eastern Bloc brands around and make them thrive. His new deal with No. 1 Russian automaker Avtovaz gives him another chance

French automaker Renault just shifted its cheap-car strategy into overdrive. On Dec. 7, Chief Executive Carlos Ghosn inked a preliminary agreement to become the strategic partner of Russia's No. 1 automaker, Avtovaz, which produces the down-market Lada. Under the terms of the proposed agreement, Renault (RENA.PA) will take a 25% stake in Avtovaz and help modernize its outdated cars and manufacturing with technology and know-how. "The development of the Lada brand will be a priority," Ghosn said during the signing ceremony.

At first glance, Avtovaz (AVAZ.RTS) hardly looks like a dream partner for Ghosn, who is also chief executive at Nissan Motor (NSANY). Modernizing the 40-year-old Togliatti plant (1,000 kilometers east of Moscow), which churns out 700,000 cars a year, will require a massive investment, and the poorly built Lada is rapidly losing market share to an onslaught of higher-quality imports, such as Hyundai, Chevy (GM), and Toyota (TM). Avtovaz's market share in Russia this year has fallen to 25%, down from about 32% a year ago and 80% in the early 1990s, analysts say.

But an unexpected surge in car sales has transformed Russia into the fastest-growing auto market worldwide, making Avtovaz, with all its problems, an alluring strategic partner. The country already is on track to become Europe's No. 2 car market behind Germany this year, and is expected to become Europe's largest single auto market by 2010 with sales of more than 3 million passenger cars. Russia's auto market growth of 26% this year even has eclipsed growth in China (19%) and India (12%).

"More Opportunity Than Risk"

Russians' auto-buying binge has triggered a slew of recent automotive investments by Western automakers (, 2/15/07) in Russia, including Ford (F), Volkswagen (VOWG.DE), and Toyota, and put four suitors at Avtovaz's door: General Motors, Renault, Italy's Fiat (FIA.MI), and Canadian supplier Magna International (MGA). Renault's victory gives it a new competitive edge in Russia, even if Avtovaz's problems loom large.

"The alliance with Avtovaz provides more opportunity than risk for Renault," says Adam Jones, senior analyst at Morgan Stanley (MS) in London. "The most compelling factor is Renault's ability [now] to localize faster in Russia—it gives Renault a big head start" over the competition.

Some analysts were surprised Renault emerged as the victor. "Renault didn't really seem to need this deal as much as, say, General Motors," says Tony Thompson, head of corporate advisory for consultancy KPMG in Moscow. A spokesman for General Motors' European headquarters insisted the decision was not a defeat for GM and that GM would continue its six-year-old Avtovaz joint venture in Togliatti, which makes 40,000 Chevy Niva small SUVs a year (, 2/7/07). GM is currently the No. 1 non-Russian-built auto group in Russia, with three production sites, five brands, and estimated sales this year of 250,000 cars, up 92% over 2006.

"Nothing changes for GM Russia," said spokesman Marc Kempe, adding that further collaboration with Avtovaz was "one option to support growth plans in Russia, but not the only one."

Ghosn Can Do It

For Ghosn, the alliance is likely not only to accelerate sales of Renault and partner Nissan in Russia, but also is likely to boost Renault's profitability through sales of a high volume of engines, transmissions, and other parts to Avtovaz, while extending Renault's leadership in building no-frills cars for emerging markets. Renault may also use some of the production capacity of Avtovaz to assemble its Logan models in Russia. "It's an excellent move for Renault," says Ferdinand Dudenhoeffer, director of the Center for Automotive Research in Gelsenkirchen, Germany, who figures sales of cars costing $2,000 to $7,000 will top 10 million a year by 2015. "Ghosn is market leader and the Logan is the most profitable car in the segment." Ghosn plans to sell 1 million Logans worldwide by 2010, up from zero in 2004, when the boxy model was launched in Romania. "Dacia is one of the greatest successes in the history of the auto industry," says Dudenhoeffer. "Zero to 1 million cars in six years is incredible."

For Renault, turning around decrepit Eastern Bloc factories is old hat. In 1998, Chairman Louis Schweitzer sealed a deal in Romania to acquire 100% of the dilapidated, loss-making Dacia brand. Renault quickly revamped Dacia, transforming it into a fast-growing global pioneer in the low-cost car segment with its €5,000 ($7,000) no-frills Logan model. "It won't be easy to transform Avtovaz into a company with (sustainable) profits, but with the assistance of Renault, they can do it," says Dudenhoeffer. "Ghosn has this kind of restructuring experience." Indeed, he turned around a near-bankrupt Nissan in 1999, eventually making it one of the most profitable companies in the auto industry.

Politics Behind the Deal?

Still, notes KPMG's Thompson, the Togliatti plant "is in severe need of reorganization and new investment." Avtovaz actually reported net profits of $316 million in the first nine months of 2007, but a large portion stemmed from a one-off tax rebate. Analysts believe that under Western accounting standards, Avtovaz would be loss-making.

Many see Renault as a dark-horse victor in the race to nab Russia's largest carmaker. Analysts believe the decision may well have been steered by politics, with Russian President Vladimir Putin weighing in behind the scenes after a visit from French President Nicolas Sarkozy. Sarkozy was the only European leader who congratulated Putin on the result of Russia's Dec. 2 parliamentary elections (, 12/3/07), which many European leaders criticized as neither free nor fair.

Renault indicated that it would pay "a reasonable multiple" over Avtovaz's $5.7 billion market capitalization for its 25% stake—making the investment roughly $1.5 billion to $2 billion.

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