BY NEIL UNMACK

Internal combustion engines may be the toxic assets of the electric-vehicle revolution. Volkswagen, Ford Motor and other industry veterans are rapidly shifting to battery- powered rides, while demand for automobiles that burn fossil fuels is dying. After the 2008 financial crisis, banks cleaned themselves up by shifting dud loans into so-called bad banks. Carmakers could do something similar.

Setting up bad banks helped lenders limit their exposure to questionable assets and present a healthier image to shareholders. Carmakers’ combustion engine divisions aren’t quite as toxic: for one, they’re still profitable. But their days are numbered. In Europe, over three-quarters of new cars will be electric by 2030, according to Jefferies analysts. Spinning off gas-guzzling divisions could limit exposure to shrinking assets and highlight the value of Tesla-like electric businesses.

Take Volkswagen. Assume electric vehicles bring in a fifth of the German carmaker’s sales by 2025, producing revenue of 55 billion euros, according to calculations based on Refinitiv data. Put that on a conservative multiple of 3 times – roughly a third of Elon Musk’s group’s equivalent valuation in early December – and the business would be worth around 160 billion euros today. That’s about the same as VW’s entire worth, including debt.

Carmakers could unlock further value by teaming up. Assume two rivals pool their fossil-fuel units and sell a chunk of the combination to a financial investor. The new entity could cut costs, helping it to maintain profitability even as sales of combustion engines shrink. And by retaining only a minority stake the carmakers would no longer have to fully consolidate the legacy business in their accounts.

Volvo Cars provides a prototype. The $24 billion Swedish carmaker, which recently listed in Stockholm, has transferred its fossil-fuel operations to a new group controlled by Chinese parent Zhejiang Geely, allowing it to deconsolidate the business while locking in a supply of engines for hybrid models.

Mimicking that arrangement won’t be easy. Bigger carmakers face less pressure to explore risky spinoffs, which could involve high costs and a loss of control over what remains a key part of their product. Still, as the green revolution accelerates, automakers will have to consider ever more radical repairs. They could do worse than following the banking industry’s lead.

First published December 2021