This article first appeared in Corporate, The Edge Malaysia Weekly, on June 13 - 19, 2016.

THE government may be bailing Proton Holdings Bhd out with RM1.25 billion but after 30 years, the national automotive project, as we know it, may finally be over. That is not to say that the company is going bust. However, it will take on a new life with a new business model.

Solely producing cars for the Malaysian market is simply not commercially viable in the long run.

One of the key conditions of the government bailout is that Proton must secure a strategic partner — ideally one with technology, scale and global brand recognition.

In other words, Proton may become a contract manufacturer or original equipment manufacturer for a more established marque.

Previously, it could not pursue this move due to a sentimental need to maintain its status as a national marque. In fact, at one time, the carmaker nearly tied up with Germany’s Volkswagen but the deal fell through.

That said, entering into a strategic partnership is not entirely alien from what Proton is doing now. After all, the new Perdana that it plans to launch on Tuesday will be powered by a Honda engine.

Another drastic condition that will shake up Proton is the shutdown of its Shah Alam plant and the relocation of all manufacturing activities to its Tanjung Malim plant.

Despite suffering losses of RM2 billion over the past four years on a RM1.29 billion acquisition, DRB-Hicom Bhd has not been able to muster the will to rationalise Proton’s underutilised manufacturing capability.

But now, Proton simply has no choice.

It had literally been on the brink of financial collapse before the government funds came in.

Last week, the government injected RM1.25 billion into Proton via the issuance of redeemable convertible cumulative preference shares (RCCPS). According to Minister of International Trade and Industry Datuk Seri Mustapa Mohamed, this is part of the RM1.5 billion soft loan announced in April.

Most of the money will be used to pay off Proton’s debts owed to its vendors.

From DRB-Hicom’s perspective, it will no longer be fully exposed to the downside risk from Proton. The government may convert the RCCPS and effectively take control of 79.28% of the company.

The government may recover some of its money through the monetising of the 247-acre tract in Shah Alam, which has an estimated gross development value of RM4 billion. DRB-Hicom, however, will only enjoy a limited upside from the monetisation of Proton’s assets. 

Another condition of the RCCPS is that Proton will not pay any dividends over the next five years.

The government will still be entitled to a 4% dividend each year on the RCCPS, which will be accrued. And once the dividends are payable, assuming Proton is profitable, the government will have the first preferential rights of payment.

Nonetheless, it is seen as a good deal for DRB-Hicom, which would not have been able to support Proton any more. Over the past four years, Proton’s market share has declined from 30% to less than 15%. Meanwhile, its debt has shot up to an estimated RM2 billion.

Can Proton be saved?

While Proton looks for a strategic partner, it will be making one last attempt to revive its brand this year. Though based on past experience, new models have not been enough.

Despite launching the Iriz, Prevé and Suprima models, Proton’s sales volumes have been falling. For the financial year ended March 31 (FY2016), sales volumes fell 15.4% year on year to 93,718 units. Revenue fell 16.8% y-o-y to RM4.78 billion during the same period.

Looking ahead, Proton does have an aggressive pipeline of new models, including a revamped Perdana, Persona and Saga that are supposed to be launched this year. While its pricing is not yet known, the Perdana will have an engine capacity of up to 2.4 litres and compete directly with models such as the Honda Accord and Toyota Camry.

“If Proton is having trouble selling cars like the Prevé and Suprima, it is going to have trouble selling the Perdana. Competition between the Japanese carmakers has been very intense, especially Toyota and Honda,” says one industry source.

Perhaps Proton will have more traction with the lower-cost Persona that will use the Iriz’s engine on a medium-sized sedan chassis. Realistically, however, its best bet will be the new Saga.

“How well the Saga is received will be the key. It has been Proton’s best-selling car. But if it can’t get good sales numbers, we will all be in trouble,” a vendor tells The Edge.

Despite delayed payments from Proton, he says most vendors have already invested in the necessary tooling and moulding machinery in order to supply parts for the new models.

It appears that the automotive vendors are more financially resilient than they have been made out to be. After all, if they can survive between six months and one year without getting paid by Proton, surely the situation is not dire.

One reason for this is that only a minority of Proton’s vendors are solely reliant on the company. Most have been supplying to other carmakers for many years.

Furthermore, the industry has been slowly consolidating over the past few years.

“When DRB-Hicom initially took over, some of the weaker vendors were let go. Then, as Proton’s sales got worse and it couldn’t pay on time, some began to merge. But as far as I know, no one has gone bust just yet,” the vendor explains.

This means that the vendor ecosystem has been adjusting to a weaker Proton, by diversifying and consolidating. Hence, the vendors’ competency should not be underestimated when it comes to working with a strategic partner.

Meanwhile, DRB-Hicom cannot blame Proton alone for its weaker financial performance. Despite a strong sales performance from Honda — up 8.95% y-o-y to 91,534 units — DRB-Hicom’s automotive distribution division (which does not include Proton) saw a 38.2% y-o-y decline in revenue to RM1.44 billion in FY2016.

The fall in DRB-Hicom’s share price to 90.5 sen, however, is starting to make it attractive, especially after the government bailout. The counter is currently valued at only 0.268 times net asset value, which has already begun to prompt buying activities.

It is a long shot, but if Proton really does get its act together and transforms its business model, DRB-Hicom will certainly be worth much more. Conversely, DRB-Hicom’s downside exposure to Proton is now much smaller. 

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