Last week an article was published online by Auto Express magazine, with the title; Lotus’ future is safe. In the interests of transparency and to ensure an honest dialogue, I’ll provide a little background on the source of this article and why you should still maintain an open mind about Lotus’ future.

I will also explain the wider economic context within which Lotus’ parent company sits and why this matters, not just for Lotus, but any other low volume sports car maker who gets sucked into the politics of the East Asian car industry.

Perhaps the most annoying aspect about the tug-of-war between hyperbole and fact, is the way it’s being used to mislead customers, and I must admit to thinking long and hard about whether to respond to this latest curve-ball.

The Latest Article

The article, published in Auto Express on 23rd October, was in fact an extract from the original article written by Ken Gibson and published in The Sun newspaper on Friday 5th October. However, in the intervening 3 week period, the title changed from “Why is Lotus in this awful position?” to “Lotus’ future is safe”.

The article published by the same author in The Sun newspaper, preceded that which was published on last week, and yet carried a very different conclusion.

It’s a curious outcome, given the content of both articles comes from the same source interview with Lotus COO Aslam Farikullah, with virtually identical quotes, and written by the same author. One wonders what changed between publishing each article in order for the tone to change from deep concern to unreservedly upbeat.

Even though the original article in The Sun newspaper claimed an ‘Exclusive Q&A’, Farikullah gave the same interview to several outlets over the course of a few weeks, including Ollie Marriage and Jason Barlow of Top Gear (You can read it here).

But hey, no harm no foul – it is standard practice to repurpose articles between print and online, and for several publications to claim exclusives, when in fact the story has been shared with many.

The Surrounding Economic Context

When you read the above article with its unequivocal tone, the clear subtext being conveyed is that DRB-Hicom know what they’re doing and should be trusted.

So let’s look at some of the surrounding context, which any writer would need to know before making such an assertion.

A little over 10 days ago, DRB-Hicom’s new COO, Datuk Seri Che Khalib, stood before a dozen market analysts for the first time since joining the company three months ago. Six months before he joined, DRB-Hicom agreed to buy Proton Holdings for RM1.29 billion ($528 million) and ever since then, the market has been waiting impatiently for a turnaround plan to be announced.

Since the deal was announced in January, DRB’s share price has dropped by 25%, chiefly due to the long period of silence and absence of any plan. Just imagine if Obama’s bailout of General Motors had taken this long to bear fruit?

Ironically, as global carmakers such as GM, Peugeot and Ford make drastic cuts to stem massive losses in Europe (due to over capacity), DRB-Hicom’s reasons for buying Proton include gaining control of its 350,000 vehicle per year capacity, which will enable it to grow the assembly services it provides to VW, Suzuki, Mercedes-Benz and Mitsubishi.

However its plans to turnaround Proton depend on agreeing a platform-sharing deal with one of the global car makers. Volkswagen has been the partner who most people assumed this would be – since they’ve been sniffing around Proton since 2007 and have agreed an assembly deal for DRB to build the new Passat.

However during the past few days we hear this foreign partner may in fact be one of the big Japanese car makers, who will help Proton build its own engine, share platforms and make use of the spare production capacity at Proton’s underutilised Tanjung Malim plant.

It’s now a necessity for any volume car maker to collaborate with their rivals and share the design, development and inventory processes for their floorplans, steering systems, engines and powertrains. Proton has lacked such efficiencies and this has been the single biggest hurdle to their growth outside Malaysia.

Che Khalib went so far as saying at the recent luncheon “if we don’t solve Proton’s problems, not only Proton, but the whole DRB-Hicom group will go down.” Which could hardly be viewed as encouraging the conclusion that “Lotus’ future is safe”.

But he did say that Lotus is no longer a cash flow drain on the group, which had been injecting £3million – £5million a month just to keep the Norfolk car maker solvent.

Production at Lotus has restarted again, with the company starting to clear the 600-car backlog that’s built up since January. However we understand that 2,000 per year are needed in order for the car maker to ‘break even’. Bear in mind that Lotus sold just 120 cars in the UK during 2012, and around 700 to overseas markets including the US, Japan and China.

In fact, at the moment China represents 50% of forward orders, although since this accounts for only 300 cars, it’s still a stretch to believe that 2,000 cars is possible with an out-of-date model range, and prices uncomfortably high relative to the class leaders such as Porsche’s Boxster and Cayman.

The consortium of six financial institutions (CIMB Bank Bhd, Malayan Banking Bhd, Overseas-Chinese Banking Corp Ltd, Export-Import Bank of Malaysia Bhd, Affin Bank Bhd and Hong Leong Bank), have now been appeased and will not be pulling the credit already drawn down by Lotus.

However, neither will they be releasing the remainder of the £270m loan until such time as long-term plans are finalised and agreed. This is scheduled to occur by the end of the year or early in 2013, but the key point to note is it’s yet to be achieved.

Once again one wonders how Auto Express could have talked in detail with Farikullah about their plans for Lotus, when those plans have yet to be finalised and agreed..

It’s unclear how many of Lotus’ creditors have been paid in order for production to restart. DRB claim that the unrest (and impending legal action) was due to suppliers not having the proper documentation for the invoices being raised (which I’m sure is partly true) and therefore DRB’s tight cost control measures were leading to such a backlash.

DRB’s first objective has been to keep Lotus solvent, but thereafter they must find a way of selling more than 2,000 cars and develop new models to rebuild confidence in its future.

Whether it’s also able to deliver a return on the capital invested is something of a mute point, since in order to achieve profitability, they must either sell many more than 2,000 cars or raise the price point of their model range in ways not dissimilar to that which former-CEO Dany Bahar set about doing in 2010.

So is Lotus ‘safe’?

Only the most giddy of optimists could claim Lotus is now ‘safe’, or accept the assurances of those who don’t yet know themselves.

What we do know is DRB are working on a plan that they believe will return Lotus to profitability, and that such a plan depends on markets outside Europe for growth. While China’s GDP growth declined in the past year, their average growth rate until 2020 is still forecasted at 7.9% – which is huge compared to the markets in the US and Europe.

So Lotus will need to capitalise on the demand generated by the Evora GTE China Limited Edition, and keep feeding this demand with new and exciting premium models.

But before any such plan can be agreed, Proton must first be on a solid path towards growth, otherwise the crippling debts taken on by DRB (in acquiring Proton and Lotus) will result in the whole kit-and-caboodle going to the wall.

Proton were set a target of 200,000 units in FY13, which has proven something of a challenge given they’ve only sold 72,000 units in the first half of the year. Achieving this will depend on the successful introduction of new models (such as the replacement Preve and Perdana), reducing debt through the sale of non-core assets and refinancing the remainder of the debt to reduce their overall cost of capital.

Let’s hope we see more pictures in the future of real cars being delivered to real owners.

DRB will have spent nearly US$1 billion in acquiring Proton, leveraging 85% of this with debt, so it’s believed this 200,000 unit target must be achieved just to adequately service this burden. Remember DRB are not a big company (in the scheme of global automotive players), they’re the 61st biggest company in Malaysia (by market cap) but at US$1.5 billion they’re still tiny compared to BMW (US$50 billion), Daimler-Benz (US$49.5 billion) or Hyundai (US$45.4 billion).

The survival of DRB-Hicom as a group depends on Proton’s performance, and with the turnaround plan yet to be presented, the market is understandably nervous about the company’s prospects – who, less we forget, have never run a car company before.

So, if you’ve made it this far, hopefully you’ll now understand why Lotus is not (yet) safe – in fact there’s still a very long way to go, and those who say the Esprit is “on track for production” need to think long and hard about the credibility of such a statement.

Let’s wait and see. There are very few positives to take away from Lotus’ current position, and i believe we do their employees, suppliers and customers a disservice by implying the battle is already over.

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Written By

Steve Davies

Steve is an investor, private equity advisor and former Partner at KPMG, PwC and Bain.   Most importantly he's a life-long car enthusiast, mountain biker and active sports enthusiast. He designs and builds technology platforms and is the architect behind Transmission.

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