How MG-Rover became not worth saving

(this article was written in September 2005)

In the Tom Hanks film The Terminal, his character is making a transatlantic flight when his country disintegrates and he becomes stateless.

In a strange way, life imitates art and there's a new, shiny Rover 75 sitting in a car showroom in Kuala Lumpur. It's beautiful but no one wants it because whilst it was on the boat from the UK, the company that made it fell apart.

It was only a matter of months before the company imploded under what is for a car maker relatively small debt (less than GBP2 milliard), that Brooklands Motors in Malaysia took the step of becoming a large scale importer and distributor to reintroduce the formerly popular brand to a new generation of owners.

Brooklands did great things: it decided that MG-Rover's market positioning would be high-end - competing against its former owner BMW. And it invested in superb premises in KL and elsewhere, and branded them with the same corporate image as the best UK outlets. And it impressed: "Looking at the site and Brooklands Motors' plans for the new Brooklands Centre, this could well become the most impressive MG Rover sales and service facility anywhere in the world, said Mr. Russ Thomas, the MG Rover (UK) business development manager in December 2004. Less than six months later, MG Rover was in the hands of administrators and Brooklands was left with stock that had gone from potential darling to unwanted metal.

As one wag put it "you could open the sunroof and use it as a skip." Brooklands issued a statement telling would-be customers that it is business as usual. And, had Brooklands already sold lots of cars, that statement would have been entirely accurate. For selling cars is not where the money is, and MG Rover knows that.

Business model made company politically dispensable.

For MG Rover, the problem was one of timing, and one of changing history to meet the future. The biggest irony of the collapse was that, on any sensible basis, MG Rover should be seen as the automotive industry's comeback kid. Yet whilst Ssangyong has dragged itself out of the mire of debt and failed ownership, MG Rover died. Why did the government not step in to save the company, as it could have done even if just by guaranteeing soft loans?

Answer: because the company had not only re-engineered its product to be genuinely amongst the best in the world, but it had also - and fatally - re-engineered the way that cars are built. In doing so MG Rover had, to all intents and purposes, made itself non-essential to the local economy.

When MG Rover died, 5000 people lost their jobs. A quarter of a century earlier, the company's predecessor employed 250,000. At that level it was too big to be allowed to fail. But in a country with close to full employment, 5000 jobs (many of which may be taken up by other engineering concerns having problems finding technicians) MG Rover was not "mission critical" to either the economy or to the interests of the nominally socialist Labour government.

MG Rover had, in a word, made itself dispensable.

It outsourced almost all of its component production. It employed the most advanced manufacturing plant so reducing the need for people to assemble the final product.

But no one cries for redundant robots.

Is "just in time" viable for retail businesses?

In the dealerships, Rover's transformation from old fashioned metal-shifter to modern manufacturer has shown that the system's biggest strength is also its biggest flaw. It raises the question of viability of just in time consumer production.

Rover was at the head of the queue in custom-design cars. Back in the days when BMW owned it, when the new 75 was launched, there was great fanfare made of the fact that the car was not designed to be available from stock: the plan was elegant - customers would walk into a showroom where there would be a demonstration model and perhaps one showroom model. In the old days (still the current days for many manufacturers) the car maker made whatever models he had the parts for, and sent them to dealers who were obliged to take them. If purple paint was cheap, a purple "special edition" would be made and it was up to the dealers to sell them.

For the 75 the new principle meant no dead metal in showrooms, tying up capital, and for the company, equally importantly, no fields full of cars built to a standardised specification when the customer wanted "customisation," i.e. a car with the bits the customer specifies.

So standing at a computer terminal, the customer could specify anything: unlike in the past, there were not even restrictions on colour combinations for interior and exterior and if a customer wanted the seat finishing from a higher grade model than the base he was starting with, then it was no problem, so long as he paid the difference.

The idea was simple: in effect, MG Rover had become a retail business, not the manufacturer and wholesaling business. It was not an new business model: it's precisely what Dell computer had made its name doing.

A worthless warranty

But all this meant that, when the lines were stopped abruptly one Friday afternoon in April 2005, there were almost no cars in stock, either at the factory or at the dealers, and it meant that orders placed would not be satisfied. So dealers found themselves with one or two vehicles to sell, and in the case of new markets, like Malaysia, no large existing customer base to service and sell parts to. And, worse, those cars that had been sold were now subject to manufacturers' warranty but the manufacturer no longer existed. In effect, the cars were orphaned.

The legal position is simple: based on what is termed privity of contract, the rights and obligations of the contract are between the parties to the contract. The purchaser buys from the dealer. The dealer buys from the manufacturer. So the customer cannot go directly to the manufacturer, but only to his selling dealer. That's the law: but it's not how it works in practice.

In practice the purchaser of a car can go to any approved dealer for that brand and have warranty work done and that dealer, even though he did not sell the car, will do the work and bill the manufacturer. Often, it's not written down: it's a tacit agreement between dealer network and manufacturer and it provides immense support to the brand.

Dealers all over the world were left in a quandary. There remained the possibility that the brand would be maintained and manufacture restarted, either in Longbridge or in China and so dealers did not want to damage the brand by telling customers that they had to take their car back to the selling dealer.

PriceWaterhouseCoopers (they like to join all the words together and to use the grammatically questionable "PwC") were, appointed as administrators. It is important to see the difference between administrators and liquidators. Administrators run the company with a view to rescue or orderly disposal of assets which are retained in the company; liquidators have only a duty to shut it down in an orderly fashion, raising what they can for creditors. PwC's role, therefore, was not to presume the company's death but to see what could be saved.

PwC made their position clear - they wanted nothing to do with the warranty issue. In a statement made on the 13 April, PwC said "warranties continue in the first instance to be a matter between individual dealers and their customers." The statement went on to say that if a purchaser wanted to have independent warranty cover, they should buy an insurance policy."

PwC said it had to take this stand because the company did not have the funds to reimburse dealers for work undertaken under warranty. However, as a way to damage the brand, this was perhaps a devastating blow to a patient that was supposed to be under their care. But whilst this act was seemingly ham-fisted, the administrators were actively working to get some parts of the business producing product. And the administrators advertised for sale the MG Rover's own cars, some of which were new and others up to two years old - each with a third party insurance warranty.

And the fact that cars would become available soon was true: orders for the MG SV (more of a weapon than a car, it's so fast) was restarted soon after the administration began. This is the car that MG Rover wanted to build when it was owned by BMW, industry sources persistently reported prior to BMW disposing of the company. It was always said that it was a Beemer-eater and the reviews of the car showed that, given their head, MG Rover were capable of producing outstanding vehicles.

Government aid package

To aid UK suppliers and dealers, a GBP20 million fund was set up by the government for businesses that had a significant (more than 15%) dependence on business with MG Rover. But no aid was available to foreign businesses. Equally importantly, none of it was to aid MG Rover itself. The government had already decided that the company was dead and the money was to tide over suppliers whilst they found other customers and dealers whilst they found other franchises.

On 29 April, one of the MG Rover group companies, Powertrain, almost agreed with its suppliers to implement a scheme that would ensure production of engines and drivetrains for a period of four months. But a small but significant number of suppliers did not agree to the terms and therefore engine manufacture did not recommence.

By 20 May, several bids had been received. PwC had requested proof of funds and there were, the administrators said, three viable proposals for the MGTF (two seater sports car which shares its base engine with the Lotus Elise). As for the rest of the business, there were only two viable interested parties, they said. By June, the administrators had all but given up, reporting that there were no credible bidders for the business as a going concern. This may have been in part because, as the FT reported, MG Rover had "accidentally" contracted to sell its intellectual property to a Chinese company.

On 22 July, PwC announced "the sale of the assets of both MG Rover Group and its engine producer, Powertrain Limited to Nanjing Automobile (Group) Corporation". Nanjing Auto had been one of two Chinese companies that MG Rover had tied its hopes to for a life-saving joint venture. The other company, Shanghai Auto had pulled out of negotiations citing due diligence issues, and it was the removal of the hope of large Chinese investment that led to the immediate calling in of the administrators.

By that time, Lotus, for which the K Series engine accounts for up to 15% of world-wide sales (these days most Elises are powered by a more modern Toyota engine) had bought sufficient engines from the administrators to see them well into 2006.

Nanjing Auto's bid was subject to a last minute intervention from Shanghai Auto: but the administrators examined both proposals, and decided that Nanjing Auto's bid was the best all around. And they had a plan that seemed to meet many objectives.

First, there was money paid for the plant and assets: about GBP50 million. Admittedly, a huge chunk of that will go to pay the Administrator's fees and to preferential creditors, notably the UK Government, then the banks will take out their secured lending (their floating charges on the assets will have crystallised meaning that they must have agreed to the sale to Nanjing, which is almost certainly better than trying to sell the highly specialist assets at auction) and there will be little if anything left for the ordinary creditors, such as dealers wanting to claim under warranty claims.

Nanjing's Cargo

Nanjing will uplift Powertrain in its entirety and ship it to China where it will get one of the most advanced engine plants for bargain basement prices, and will hire UK specialists to ensure quality control remains every bit as good as it was at Longbridge. Some car production will also go to China.

But, and here's the news that MG Rover people on all sides have been waiting for, car production will begin again at Longbridge, although no dates have been set. The plant has been carefully mothballed by a team of 450 people: soon they will start to remove the covers. Nanjing announced that it was going to start recruiting, and - equally important for the brand - announced that it intended to keep design in the UK - it intends to keep MG Rover as a leader in design.

But just days later, Shanghai Auto tried to spoil the party: in a statement the company threatened legal action to prevent the Nanjing Auto deal going ahead, blaming PwC. "The process has not been handled fairly or in the best interests of creditors and employees. Our offer gave a firm guarantee of substantial employment at Longbridge," the company said. UK newspapers quoted union leaders as favouring the Shanghai Auto proposal, one calling it a "fantastic opportunity that has been missed."

The details have not come out at the time of writing but it is suspected that the issue centres around the up-front cash, something administrators always place at the top of their wish-list. But there is also a nagging doubt: was Shanghai shanghaid because it pulled out, precipitating the collapse, possibly as brinkmanship to pick up the pieces for less than the originally planned investment?

PwC says that there was a third bid - from David James who has a reputation of resurrecting corporate basket cases but, says PwC both the Shangai Auto and the James bids had conditions attached but the Nanjing bid was simple cash on the table.

In the end, then, cash talks and administrators walk. Shanghai Auto suspects that its bid was rejected in part because it could not demonstrate immediate availability of funds, although banking letters of intent were provided saying that the funds would be released when a contract was signed, Shanghai Auto claims.

There was, incidentally, an offer weeded out by the administrators to buy the company for GBP1.00 - and the proposer, purporting to be a well known fraudster, even sent the money - a postal order!

James' last minute (actually late) bid offered GBP45 million for both MG Rover and PowerTrain. He estimated the value of the R&D at a further GBP20 million and didn't want that. It may be that the fact that James did not want the whole package (what he really wanted was PowerTrain but PwC declined to accept bids on that business alone) was the reason his bid was not successful. It would have left the Adminstrators to sell the R&D division separately and their objective now is to get the money in the bank, pay themselves for the past four months' work, distribute what's left but keep some more back for their fees in doing that work, too.

But it is not yet clear precisely what Nanjing Auto have bought: the rights to some models have, it appears, already been sold to Shanghai Auto: amongst them the MG R series and the K Series Engines.

Investigations

And there's another twist: the Group's auditors, Deloitte & Touche, are now under investigation in relation to their professional conduct after it emerged that they acted as auditor at the same time as their associated business provided consultancy. The Accountancy Investigation and Discipline Board (AIDB) issued a statement on 17th August 2005 saying " "The AIDB has decided to investigate the conduct of Deloitte & Touche LLP as auditors and advisers to the MG Rover Group."

Deloittes has denied any wrongdoing, asserting that their work was carried out to the highest professional standards. But it's not D&T's only run-in with regulators recently: the UK's Financial Services Authority fined Deloitte and Touche Wealth Management, a wholly owned subsidiary of the accountancy firm, for breaches of compliance requirements.

The temptation to play both sides of the fence, as auditor and adviser are enormous. The UK's Daily Telegraph reported that MG Rover's parent company's accounts show that audit fees amounted to GBP500,000 in 2003. And that consultancy fees were four times that amount. Over a three year period, the newspaper says, MG Rover paid Deloittes fees totalling GBP7.8 million. Following the Enron scandal, US authorities changed the regulations to prevent audit firms and the related consultancies both working for the same company. If the AIDB finds that Deloittes did act improperly, it can apply an unlimited fine and / or suspend or revoke the firm's audit licence. No one is taking that latter prospect seriously.

PwC will be watching how the Regulator conducts the investigation for just a year ago a similar investigation was launched into PwC's conduct as auditor and consultant to failed bus manufacturer Mayflower. No public report has yet been issued in that case, the first of its kind. The Deloittes case is the second.

PwC will also be busy providing information and evidence to the Department of Trade and Industry which is conducting its own investigation into MG Rover's failure.

During the period, Honda exercised its rights over the Rover 45 (a model based on the Rover 200, first built before Honda sold the company to BMW). Having taken back its intellectual property (and, according to rumour, publicly shredding the technical specifications to ensure they could not be re-used), there are doubts over restarting production of the R45 and the MG ZS.

And there is question over the use of the Rover name. The ultimate rights to the name and the badge were retained by BMW when the Germans sold the business.

So, rather like Hanks who found that his country revived and then he could choose to go on with his journey or to go home, that car in the showroom in Kuala Lumpur may not be lonely for much longer. The primary question is what its new siblings will be called, and whether the much applauded showrooms can keep their existing logos.