Global Economics

Toyota Breathes New Life into Subaru


When GM sold shares of Fuji Heavy, owner of the Subaru brand, Toyota bought. The resulting synergies could well prove the catalyst for Subaru's recovery

When General Motors (GM) needed to raise cash in a flash last year, it wasn't a shocker that it decided to sell off its equity stake in Fuji Heavy Industries, owner of the Subaru auto brand. GM's alliance with Fuji Heavy dated back to 1999 and had included an effort to develop a Saab crossover vehicle, but like GM's stakes in Isuzu and to a lesser extent Suzuki, the venture came up short of expectations.

"Both GM and Fuji Heavy came to the conclusion that there were not enough collaborative projects to sustain the alliance," Troy Clarke, GM group vice-president and president of GM Asia Pacific, noted in a statement at the time. In short, both sides accepted that the benefits had been smaller than hoped for and were unlikely to improve.

Much the same can be said of Fuji Heavy's profits. Despite rising sales, the Tokyo-based company expects to post operating profits of just $430 million in the year through March, 2007, compared to $502 million a year earlier.

Fuji's Prospects Improving

The company's operating profit margin of 3.3%—down from 4% in 2005—will be a little over a third of Toyota's (TM) likely margin and less than half that of Nissan or Honda. Fuji Heavy's share price is also on the slide. At close of Tokyo trading on Nov. 29, the company's stock price was $5.11—down 17.6% from its 2006 high on Apr. 21.

Yet thanks to GM's exit or, more accurately, to Toyota's entry in GM's place, Fuji Heavy's midterm prospects could start to improve in the coming months (see BusinessWeek.com, 10/5/05, "Fuji Heavy Trades GM for Toyota").

When GM raised $740 million by selling its 20.1% stake in Fuji Heavy last year, Toyota bought up 8.7%. It could have bought more, but limited its purchase to avoid running into difficulties with Japan's anti-monopoly regulators. A year later, Fuji Heavy's new alliance will begin to bear fruit. Next April, Fuji Heavy will begin producing Camrys for Toyota at its Subaru of Indiana Automotive (SIA) subsidiary in the U.S.

Win-Win Relationship

In time, the plant will churn out 100,000 vehicles a year. The move is a welcome one for Fuji Heavy's loss-making U.S. operations. On one hand, Camry production solves an excess-capacity problem at the Indiana plant since former co-owner Isuzu, a Japanese truck maker, stopped production at the unit and sold its share to Fuji Heavy in 2003.

On the other hand, Toyota is introducing its quality control systems at the plant as part of the agreement, which will benefit the Subarus built there. "That's quite an advantage," Ikuo Mori, Fuji Heavy's president, who was appointed in June, told BusinessWeek in an interview last month. "For us there's improved efficiency and we can learn from Toyota. For Toyota, without much investment they can increase capacity."

That combined with much-needed new model launches, such as a new Impreza compact in fall, 2007 and a Forester sport-utility vehicle in 2008, could be a catalyst for recovery. "Improving North American earnings is the key management issue facing the company," Noriyuki Matsushima, analyst at NikkoCitigroup in Tokyo, told clients in a research note.

Doubling U.S. Market Share

"The trigger for this will be an offsetting in fixed costs from new model launches and consigned production of the Camry for Toyota." Fuji Heavy's U.S. operations recorded operating losses of $43 million during the six months through September due to weak sales and rising incentive costs. Toyota is stumping up two-thirds of the $220 million capital-expenditure cost at Subaru of Indiana.

Fuji Heavy's Mori, who will unveil a new medium-term business plan next spring, says he wants to increase North American sales by 50,000 a year to 250,000 in the short term and eventually gain 2% of the market, up from around 1% today. "The Japanese market isn't going to expand dramatically and that means [we must look to] overseas markets," he says.

As well as learning a few tricks from Toyota, Mori is also keen to strengthen Subaru's brand image as a producer of sporty cars. "In America we've pushed our all-wheel drive system and are appreciated where the roads get snowy and so forth, but in Japan we're regarded as the maker of performance cars," he says.

Hybrid Technology Tie-in

The tie-in with Toyota should also have an impact in Europe, where Fuji Heavy's sales were just 58,323 in the year ending March, 2006. Following the tie-in, Fuji Heavy has sidelined plans to develop its own hybrid system. It now plans to use Toyota's technology in future gas-electric cars.

That's similar to Nissan (NSANY), which has borrowed Toyota's hybrid system in the new Altima. Fuji Heavy will now concentrate its resources on developing a diesel using its renowned horizontally opposed boxer engine technology for launch in 2008.

The company promises that its boxer engines will perform well in comparison with other diesels in terms of vibration and will offer high levels of torque. "Before, we couldn't really put much investment into diesel research, but we've now found a way," says Mori.

New Need for Diesel

Americans, though, will have to be patient. Mori adds that strict rules on nitrous oxide (NOx) will make it difficult to sell the same engine immediately in the U.S. and Japan, but says the company is closely monitoring demand for diesel in the U.S. Earlier this year, Honda said it was planning a new type of "green" diesel for the U.S. market by 2009 (see BusinessWeek.com, 10/30/06, "Honda's Green (Diesel) Machine").

"Two years ago we asked American dealers 'do you want diesel cars?' and nobody did, but that's changed," he says. "We think there can be a market for diesel in the U.S and we will look at the market closely."

Further in the future, some analysts believe that Toyota and Subaru could also work together to develop performance cars for Toyota. After all, Subaru is respected for its engineering, and one conspicuous gap in Toyota's product range is sportier cars. The MR2 two-seater, known as the MR-S in Japan, was phased out in the U.S. in 2004, while the last Toyota Celica rolled off the production line in Japan in April.

Timely Alliance

What is clear today, though, is that Fuji Heavy can't rely on the Japanese market for growth. Auto sales in Japan, excluding mini-cars, are down 7.3% since April and show few signs of recovery. Fuji Heavy's passenger car sales have slumped even more—down 17.3% during the same period. That's troubling for Fuji Heavy because it relies more heavily than other Japanese automakers on its home market.

Indeed, most Japanese automakers make the majority of their profits, about 60% in Toyota's case, in the U.S. "All of its larger competitors take advantage of their strong sales in U.S. but Fuji Heavy is dependent on Japan where competition is keen and margins are considered very thin," says Yasuhiro Matsumoto, an analyst at Shinsei Securities in Tokyo. "The alliance with Toyota, especially for U.S. business, is quite timely for Fuji Heavy."


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