Renault's Russian Woes

When Renault (RENA.PA) plunked down $1 billion last year to take a 25% stake in Russian carmaker Avtovaz, Renault boss Carlos Ghosn described the tie-up as "a relationship whose time has definitely come."

But could the relationship already be going sour? Clobbered by a steep decline in the Russian auto market, Avtovaz (AVAZ.RTS) lost nearly $800 million in 2008 on sales of $6 billion. Sales this year are down 45%. Avtovaz's auditors on July 2 questioned its ability to make payments on $1.7 billion in debt and raised doubts about its future "as a going concern." A few days before that announcement, Avtovaz said the senior Renault executive on its management board was leaving the company and would be replaced by a Russian.

Renault says the French executive, Yann Vincent, left the company for personal reasons and that Renault concurred in the decision to replace him with Igor Komarov, Avtovaz's executive vice-president for finance. A Renault spokeswoman acknowledges that Avtovaz is in financial distress but says it has sufficient funds to keep going, thanks to some $790 million in loans and other aid it has received recently from the Russian government. "We remain confident in the future of the partnership," she says.

Cushioning the HitSo far, Avtovaz's troubles have had limited impact on Renault's bottom line. Indeed, Renault received $305 million in royalty payments last year for licenses for automotive platforms, transmissions, and engines that it has provided Avtovaz to develop new versions of its Lada car based on Renault's low-cost Logan line. That helped cushion Renault against Avtovaz's operating losses. During the first six months of consolidated results, from March through September 2008, Renault booked a $162 million loss from Avtovaz, including a $117 million writedown on the value of the investment.

Losses from the subsequent six months of the partnership—to be reported with Renault's first-half 2009 results on July 30—will be heavier and could include a further writedown. But Gaetan Toulemonde, an auto analyst with Deutsche Bank (DB) in Paris, says the financial risk to Renault isn't worrisome. "When you look at the condition of Avtovaz, it's probably comparable to Dacia," a crippled Romanian carmaker that Renault took over in the 1990s and turned into the first production site for the Logan line.

A bigger question for Renault is the dire state of Russia's overall automotive market. Sales in June were down 56% year-on-year, to only 118,579 vehicles, the Moscow-based Association of European Businesses said on July 8, adding that it expected "a challenging second half" of the year as well.

The Russian government has been offering loan subsidies to car buyers but finding few takers, as the country's economy is forecast to contract 8.5% this year. On July 6, Prime Minister Vladimir Putin signed an order nearly doubling the price ceiling on cars qualifying for subsidized loans. But that won't help Avtovaz, because most of its cars are priced below the earlier ceiling of about $10,000.

Stiffer CompetitionFew think Moscow would allow Avtovaz, Russia's biggest carmaker, to fail. But the government life support it's receiving isn't enough to finance development of the low-cost cars it wants to build.

While Avtovaz and Renault wait for the crisis to ease, another Russian automaker is angling for a tie-up with a European partner. GAZ (GAZA.RTS), whose best-known car is the Volga, has teamed with Canadian auto parts group Magna (MGA) in a bid to acquire Opel, General Motors' European unit. That, along with Russian expansion by automakers such as Ford (F), Toyota (TM), and Volkswagen (VOWG.DE), means Renault and Avtovaz will face stiffer competition.

For now, Avtovaz says it will continue operating as usual. "The group continues as a going concern and has no plans or need to discontinue or significantly reduce activities," the company said in a statement on July 2.

And Renault says it remains optimistic that its bet on Avtovaz will pay off handsomely. "The Russian market still has enormous growth potential," a spokeswoman says. "When we do emerge from the crisis, we'll be able to tap into that potential."

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