HONG KONG (S&P Global Ratings) --S&P Global Ratings said today that the cost effectiveness and research and development (R&D) of Geely Automobile Holdings Ltd. (Geely Auto, BBB-/Stable/--) are likely to benefit from the company's proposed merger with Volvo Car AB (BB+/Positive/--). However, we do not see any immediate rating impact on Geely Auto and its parent Zhejiang Geely Holding Group Co. Ltd. (BBB-/Stable/--), given that the transaction is still at the preliminary stage.

We understand details of the transaction, such as the organizational structure and funding methods, are still being discussed. However, we believe Zhejiang Geely Holding, which currently owns 44.1% of Geely Auto and 99% of Volvo Car, will maintain majority control in the combined entity post the merger. We also believe the merged entity will remain a core subsidiary of Zhejiang Geely Holding.

Zhejiang Geely Holding is likely to gradually improve operational efficiency if the merger materializes. Since Zhejiang Geely Holding acquired Volvo Car in 2010, Geely Auto and Volvo Car have closely collaborated on technology development and procurement among other things, leading to enhanced competitive strengths and notable cost savings for both.

After the proposed combination of the companies' internal combustion engine businesses in 2019, we believe this merger is another significant step to further streamline operations, reduce duplicate spending, and better leverage on the group resources. In our view, the proposed merger would strengthen the group's ability to face challenges in global auto market in the form of sluggish demand and tightened emission regulations.

We understand the Zhejiang Geely Holding management plans to list the combined business on both the Hong Kong and Stockholm stock exchanges. The expanded access to global equity capital markets could potentially help Zhejiang Geely Holding lower its leverage, if the merged entity raises additional equity capital. Given Geely Auto's market capitalization of US$17 billion in Hong Kong and Volvo Car's larger revenue scale than Geely Auto, the additional share placement may potentially raise billions of dollars for the group. Yet, the deal valuation and the equity issuance plan will depend on market conditions and carry significant uncertainties. We estimate Zhejiang Geely Holding's adjusted debt-to-EBITDA ratio rose to 1.8x-2.0x in 2019 from 1.4x in 2018 due to lower EBITDA owing to a decline in sales and margins. The company's outstanding gross debt balance was about US$16 billion as of end-September 2019, by our estimate.

The merger proposal is subject to approvals from relevant boards, minority shareholders, and regulators. We believe the merger and the subsequent listing will take at least 6-12 months to materialize.

In our base case, we project Zhejiang Geely Holding's EBITDA margin will recover to 9%-10% in 2020, from an estimated 8%-9% in 2019, driven by mild growth in sales and continued cost control. However, the outbreak of the novel coronavirus in China and resultant production disruptions bring notable uncertainties and could exert downward pressure on the company performance. Before the epidemic broke out, Geely Auto targeted 4% sales growth in 2020 and Volvo Car aimed at a double digit increase in sales.

This report does not constitute a rating action.

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