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Of Mice, Men and Where the ChemChina-Pirelli Deal Will Take Us

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chem-chinaRen Jianxin, the 57-year-old chairman, referred to the $7.7 billion acquisition of Pirelli SpA, as “revolutionary” for ChemChina, almost as though it was the mouse that had swallowed the elephant.

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In fact, Ren’s ChemChina, which he created 30 years ago on a $1,600 government loan, is six times Pirelli’s size, certainly the elephant in most rooms. Yet in the tire world, its most visible brand – Aeolus – isn’t much on the radar outside of China.

That’s why Ren also refers to his deeper partnership with Pirelli chief Marco Tronchetti Provera, 10 years his senior, as a “very beautiful marriage,” one that came from three years of quiet dating, advanced by world events outside of their control, and poised to make multiple significant splashes across the industry.

Tronchetti, whose dealings with oil giant Rosneft gained Pirelli a wide tire distribution foothold across Russia, now has a wider door into China’s premium tire market, too. Not that the Italian firm wasn’t already a player in China; it produces car, motorcycle and truck tires out of a plant in Yanzhou. But this deal gives Pirelli stronger OE contacts and the full faith and credit of a mega-corporation known across China. And the added distribution comes at a time when Russian consumers are the collateral damage of an oil price crisis and blowback from their government’s foray into Ukraine.

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We’re not going to bog readers down in a swamp of micro-details about the structure of the complex financial deal, except to say it its both complex and vintage Tronchetti. The real news comes in what the deal, expected to clear regulators and shareholders by the turn of summer, will and could mean to markets and marketers.

Obviously, gaining greater access to the Chinese premium car parc is a big, big deal for Pirelli, which has placed its consumer tire eggs in the prestige car market basket. While not yet the largest vehicle market – and well behind in prestige vehicle population – China is getting there. Fast. Even as its economy cools to just 7% year-over-year growth (compared to our blistering 3% growth rate), the country with one of the most millionaires per capita will keep minting uber-rich and upper middle class folks at an epic pace, creating a prime market for Porsches and Lambos and Audis and Lexuses yearning for rubber.

Less apparent may be opportunities not currently considered. For instance, Tronchetti is emphatic that none of ChemChina’s consumer tires will be produced in Pirelli plants (“No, not at all,” he told trade press last week when asked about that potential). But while the ill-defined “never” may seem a long time, Tronchetti is in place for just five more years; after that point, other thoughts may prevail, and other markets may require conquering.

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So why not produce Aeolus consumer lines at Pirelli plants in Mexico and South America or elsewhere? Why not sprinkle in some Pirelli-tech magic and leverage the Aeolus name for a strong, technologically advanced second brand that can play in China, North America and everywhere? Pirelli’s prestige play is interesting, but they are giving up more than 50% of every market they work. Try as one might, the premium market will only ever be so big.

Aeolus-LogoA second brand means stronger ties with consumers and distributors and another means to advance the company out of the tall timbers of the Continentals and Bridgestones and Michelins and Goodyears.

The real crown jewel, as both Ren and Tronchetti pointed to, is in radial truck tires. The melding of Pirelli’s commercial business (it does have some ag and OTR business in certain markets that will match up with ChemChina’s offering) under the Aeolus banner will create what one observer called “the fourth or fifth largest truck tire company in the world.”

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While long absent from the North American truck tire game, Pirelli nonetheless has superior technology at its disposal. Aeolus has the production room, domestic brand name and global reach to take a fused radial product around the world – even to the U.S. (once distribution issues are sorted out; Aeolus is currently distributed in North America by Alliance Tire Americas, and we have no idea how that may be impacted by the ChemChina-Pirelli deal).

We do know that this combination is a “new business growth strategy” sought by ChemChina in the deal. It is the part of “Pirelli” it will be able to control, and it will be its best pathway to international prominence. The combination will double ChemChina’s commercial tire “volumes from approximately 6 million pieces to approximately 12 million pieces” and could result in an entirely separate stock-issuing company that will make a sizeable noise in an already noisy business.

The Aeolus unit has an old bias ply plant near its headquarters in Jiaozuo, Henan Province, a heavily industrialized city of 3.6 million nearly 400 miles southwest of Beijing and hard against China’s main coal mining region. That plant won’t do, but across town are twin tire plants, massive million-square-foot facilities for radial consumer and truck tires that opened in 2011.

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And ChemChina is really not limited in capacity. As Tyres & Accessories pointed out in some of its recent analysis, the Chinese tire market is over-built; multiple 20-million-unit plants churn out 20 million tires with no market and no forecasting and no plan. They become ripe for the picking. Not that ChemChina has hinted at such but buying a fully fitted tire plant isn’t that hard. And the Chinese government, which has a large share in ChemChina anyway, will happily welcome professional management to some of these operations.

So despite some initial misgivings by a few observers, the deal makes sense as a defensive move by Pirelli, which saw limited ways to move the needle past being an $8 billion turnover company overshadowed by Goodyear, Michelin, Bridgestone and Conti, all with revenues exceeding $20 billion annually.

“Talking to some market insiders, there are real concerns that the Pirelli-ChemChina merger means the Italian manufacturer has beaten other bigger players in the top five to the punch when it comes to directly accessing the burgeoning domestic Chinese tire replacement and OE supply markets,” T&A wrote in an analysis piece. “Add in the fact the impending Sino-Italian nuptials connect Pirelli with a state-owned firm in a quasi-communist country and, they say, there is more reason to worry.”

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So, as they say, now what? There is no sense in covering a major merger without speculating about the next move and the one beyond that, right?

Well, some folks have well started.

“Aeolus’ post-Pirelli truck tire merger plans add fuel to the Chinese market consolidation fire,” wrote Tyres & Accessories, which recently reported that “a number of modern mid-sized Chinese plants are relatively precariously positioned economically,” meaning that “the bargain-basement acquisition of on-the-brink manufacturers is a very quick way to increase capacity without having to build more factories.”

Could the ChemChina-Pirelli deal “spark a wave of micro-consolidation within the Chinese tyre manufacturing industry in the next few years?” T&A asked. The country is as overburdened with aimless tire plants as it is with tire companies.

So certainly that seems a likely result. But what about outsiders looking to bolster their places? Well, one need look no further than recently jilted Cooper and Apollo, both of which have a need for Chinese production and market entry. Cooper, as you know, lost its joint venture Cooper Chengshan (Shandong) Tire Co. last year in a sale to former partner Chengshan Group Co. Cooper got $284.5 million in the deal but lost an important production resource.

Neeraj Kanwar Apollo Tyres Ltd

Neeraj Kanwar, vice chairman and managing director, Apollo Tyres Ltd.

In a recent interview with Hindu Business Line newspaper, Apollo vice chairman and managing director Neeraj Kanwar said flatly, “I cannot ignore China. If our ambition is to become a top 10 in the world, we cannot ignore the U.S. or China. I don’t have anything right now – eventually one has to enter those markets.”

Kanwar said it will take a mix of organic growth and a significant acquisition to make that leap forward, but no acquisition plans are at hand. “We are growth oriented, and we want to go to new continents,” he told the business newspaper.

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Karel Cool, professor of European competitiveness and professor of strategic management at INSEAD, wrote an article on March 26 where he offered his thoughts on what the ChemChina-Pirelli deal might bring.

“China National Tire & Rubber Co. (ChemChina’s tire unit) also buys a technology base in passenger and truck tires, elevating it into the major technology league. This may become a major headache for Michelin and Bridgestone. They have been trying to crack the Chinese market in passenger tires and truck tires for years without much success. While Michelin has been forced to invest in the production of budget tires to counter Chinese imports into Europe and the U.S., the CNTR-Pirelli tie-up creates a challenge in the core proposition and markets of Michelin and Bridgestone. If CNTR succeeds in also deploying Pirelli’s truck tire technology to the booming truck tire market in China, this would create a major challenge for Michelin and Bridgestone.

“As important and symbolic as this acquisition is,” Cool continued, “the question is: what tie-ups are to follow next? The rising U.S. dollar makes acquisitions in the U.S. more expensive, but Cooper Tire & Rubber Co., which ended up being severely scarred after the failed merger with India-based Apollo Tyres, remains a prime candidate. Germany’s Continental Tire is owned by the debt-laden family-owned Schaeffler Group, which bought Conti in 2008 for €12 billion and almost bankrupted the company. The tight cash situation of the mother company has forced Conti into a delicate “surplace” act while being the bank for Schaeffler’s ball-bearing automotive activities. The company is rumored to be close to an IPO for the non-Conti activities, which would give a fresh inflow of capital – and options for Conti. A Conti-Hankook tie-up would create a major new force. While other combinations are possible and a bid would be pricey, the low euro would sweeten the bid,” Cool wrote.

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“And while once all-mighty Goodyear may seem beyond reach, its $7 billion market cap – less than a quarter of Bridgestone’s market cap of $32 billion – and total enterprise value of $12 billion (TEV/EBITDA of 5.4) makes it within reach of several bold Asian players. It would be a repeat of Bridgestone’s Firestone takeover and Michelin’s Uniroyal-Goodrich acquisition in the 1980s that then reshuffled the deck of cards,” Cool ended.

Will any of this come to pass? Who knows? It’s always fun to play ‘What If?’ but heading into 2015, it was oft stated across the business that tiremaker consolidations were coming. Will this be the first and only, or will this deal set others in motion?

We’re one quarter into 2015 and already we’ve been struck twice by lightning (Goodyear’s online direct sales scheme being the first flash). The next three quarters could be quite interesting.

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