By William Boston in Berlin and Trefor Moss in Shanghai
Daimler AG and Chinese auto maker Zhejiang Geely Holding Group have agreed to create a joint venture in China to transform Daimler's struggling Smart compact city car into a global all-electric brand, the companies said Thursday.
The agreement is the latest evidence of China's breakthrough as the world's leading market for electric cars. Some 1.26 million electric vehicles were sold there last year, roughly 60% of the global total and manufacturers' enthusiasm for the market remains undimmed despite the recent slowdown in China's economic growth.
Last year, BMW AG formed a joint venture with Great Wall Motor Co. that will produce an electric version of the Mini small car. Another new joint venture between Volkswagen AG and Anhui Jianghuai Automobile Co. dedicated to producing electric vehicles is set to start production this year.
The deal between Daimler and Geely marks the first major venture from the partnership born in the wake of Geely Chairman Li Shufu's acquisition last year of nearly 10% of Daimler shares, which made Mr. Li the largest shareholder in the maker of Mercedes-Benz luxury vehicles. Previously, Daimler and Geely agreed to work together on a ride-hailing venture.
"We will jointly design and develop the next generation of smart electric cars that combine high-quality production and known safety standards for sale both in China and globally," Daimler CEO Dieter Zetsche said.
Mr. Li said the Smart brand had a "unique appeal and strong commercial value."
The venture between Daimler and Geely will be based in China and in 2022 will begin building a new generation of electric Smart vehicles there. Until the beginning of production in China, Daimler will continue to build current Smart models at its Hambach plant in France. In the future, it will make its new all-electric Mercedes EQC model there.
The companies didn't release financial details of the joint venture, which is expected to be completed by the end of the year.
The agreement marks a deepening of Geely's partnership with Daimler, which began last year when Mr. Li amassed a 9.7% stake in the company. The holding was worth around $9 billion when the purchase was revealed in February 2018, although Daimler's share price has fallen significantly since then. In October, Geely and Daimler announced they were setting up a premium ride-hailing service in China in their first cooperative step.
The tie-up makes good sense for both partners, said Janet Lewis, head of industrials and transportation in Asia at Macquarie Group. "For Geely, if it works well, there is more to gain by moving closer to Daimler," said Ms. Lewis. And for Daimler, "partnering with Geely helps spread the risk" of attempting to revive a brand that needs major investment if it's to survive and thrive.
Daimler is betting Smart's survival on China's lower manufacturing and labor costs and its burgeoning electric-vehicle market.
The growing partnership between the two has signaled Geely's arrival as an important new player in the global auto business, after a spree of acquisitions that began with the 2010 purchase of Volvo Cars from Ford Motor Co. Analysts were initially skeptical of Geely's ability to run Volvo, but under Mr. Li the Swedish auto maker has enjoyed an impressive revival, topping 600,000 annual sales for the first time last year.
The future of Smart, which makes small city cars, had been uncertain: analysts say the unit has probably never made money in its 21 years of operations, and Daimler has never published figures to counter that impression. Arndt Ellinghorst, an automotive analyst at Evercore ISI, a brokerage, estimates that Smart loses as much as EUR700 million ($787 million) a year because of high production costs in Europe.
Evercore had advised Daimler to abandon Smart entirely, Mr. Ellinghorst said in a note to clients, doubtful that the brand could be revived. But after the announced partnership with Geely, Mr. Ellinghorst saw a thin ray of hope.
"If the brand can successfully transition into the subcompact segment it may be able to price accordingly and turn the business around. But for now we remain skeptical," he said.
Daimler sold over 2.3 million Mercedes-Benz cars in 2018, compared with 128,802 Smarts.
In 2014, Daimler teamed up with Groupe Renault to create a common platform for some new Renault and Smart vehicles as a way of sharing development costs. Geely's interest in Smart would likely mark the end of Renault's involvement, according to a person familiar with the arrangement.
Renault said in emailed comments that it cooperated with Daimler on many fronts and saw no changes from the Geely partnership.
Geely has been growing its international footprint. It acquired a controlling stake in Malaysian auto maker Proton in 2017, launching its first local product in December. It also controls British sports-car maker Lotus Cars, and in 2017 invested $3.24 billion in a stake in Swedish truck-and-bus maker Volvo AB (which is separate from Volvo Cars).
The Geely group sold 2.15 million vehicles last year, with the company's main Chinese brand, Geely Auto, contributing around 1.4 million of those. Lynk & Co., a new Geely brand targeting young urban buyers with internet-connected vehicles, sold over 120,000 cars in its first full year of sales.
Write to William Boston at email@example.com and Trefor Moss at Trefor.Moss@wsj.com