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China Lifts Cap on Foreign Auto JVs: Will US Carmakers Gain?

Ritujay Ghosh
Barnes Group (B) doesn't possess the right combination of the two key ingredients for a likely earnings beat in its upcoming report. Get prepared with the key expectations.

Dispelling trade war fears, China, on Tuesday, announced that it will remove the cap on foreign ownership of domestic auto ventures. This will allow foreign carmakers to take full ownership of their local joint ventures. The decision will certainly bring a smile on the faces of U.S. automakers, which have been operating in China under this restriction since 1994. Full ownership means complete control and no sharing of profits, which definitely is going to help U.S. carmakers.  

At the same time, this development will also help investors breathe easy after reeling under fears of a trade war for the last few weeks. When both the United States and China announced tariffs and retaliatory tariffs on each other, the markets went into a tailspin.

However, the recent announcement by China is more a move to expand and support its self-sufficiency in almost every market and is part of the Made in China 2025 plan. Moreover, it needs to be seen if U.S. carmakers operating in China decide to buy out their joint venture (JV) partners in that country. This is because working in JVs for years have made them enjoy a certain comfort level to operate smoothly.

China Eases Trade War Worries

Markets have been volatile since March on fears of a possible trade war between the United States and China. However, China’s announcement on Tuesday to remove restrictions on foreign ownership of domestic ventures will ease these fears to some extent. The announcement comes exactly a week after China’s president Xi Jinping said that he will make efforts to open the country’s economy and cut import duties.

The announcement should give a major boost to the confidence of U.S. carmakers like Tesla, Inc. TSLA, General Motors Company GM, Fiat Chrysler Automobiles N.V. FCAU and Ford Motor Company F as full ownership will help them have complete control of their operations and allow no sharing of profits.

How U.S. Auto Companies Will Benefit

Currently, foreign automakers producing or selling cars in China cannot own more than 50% of the JVs they are mandated to establish with local firms when operating inside that country. This restriction has been in place since 1994.

Moreover, they also have to share 50% of their profits with their respective Chinese partners. The lifting of this cap will now allow foreign automakers to buy out their partners and enjoy full ownership. But most importantly, these companies will no longer have to share 50% of their profits with their Chinese partners (read more: 5 Auto Stocks to Buy as Xi Promises to Lower Tariffs).

This certainly gives U.S. car manufacturers a chance to rejoice. General Motors, Ford and Fiat Chrysler, each have a joint venture with Chinese companies. However, the company that is immediately going to benefit from this move is Tesla, as it has been struggling to enter into a JV to open an assembly plant in China. With relaxed ownership rules in place, Tesla can independently own and operate a plant in China.

Moreover, the restrictions will be lifted in phases, with the cap to be lifted first on production of electric cars in 2018. That makes Tesla among the first companies to reap the benefits of the relaxation. Also, a market without a joint venture partner means that Tesla would not have to share it technology with anyone, which had so long been one of the primary reasons for the company failing to strike a joint venture deal.

The restriction for commercial vehicles will be lifted in 2020 and passenger vehicles in 2022. Hence companies like General Motors, Ford and Fiat still need to wait for some time to enjoy the benefits. However, shares of German and U.S. carmakers increased on the news with Fiat jumping as much as 2.9%.

Fiat’s shares have gained 16.5% in a month’s time, while General Motors has increased 5.8%. Ford, which had announced a $756-million deal in 2017 to produce electric vehicles in a joint venture with Zotye Auto in China, has seen its shares increasing 3.4% in the last 30 days.

Fiat sports a Zacks Rank #1 (Strong Buy), while General Motors, Tesla and Ford carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank stocks here.

All That Glitters is Not Gold

News of China lifting restriction on foreign ownership of domestic ventures is being seen as a huge move but there’s definitely another side to the story. Lifting of the cap is likely to benefit companies like Tesla that still don’t have a Chinese joint venture partner. This will now allow them to start a plant in China independently giving them full control over their technology and at the same time a respite from having to split their profits.

However, it at the same time they will now have to invest 100% of their own money, which many would prefer to in order to save on costs. Moreover, the lift on the cap starts with electric vehicles, which Tesla specializes in. China, on the other hand, is the world’s biggest electric vehicle market, selling 770,000 vehicles, reflecting a year-over-year increase of 53% in 2017. Hence the lift in restriction is more to support China’s domestic electric carmakers and is part of the Made in China 2025 plan.

Moreover, it doesn’t seem that U.S. automakers operating in China will ultimately buy out their local partners. Operating in joint ventures has its own set of benefits and working together for years creates a certain comfort level. Moreover, it also doesn’t require the company to invest 100% of its own money. So despite the news being welcomed by foreign automakers, General Motors has already said that China has been its biggest market for the last six years and that its success is largely owing to its working relationship with its partners.

Given this scenario, it is to be seen what course of action foreign carmakers take as the lift on the cap isn’t with immediate effect and automakers still have some time to assess the pros and cons of this announcement.

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