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UK-DONGFENG-PEUGEOT:Dongfeng deal buys time and new blood for Peugeot
Reuters Employees assemble cars at a production line of Dongfeng Peugeot Citroen Automobile factory in Wuhan, Hubei province, February 13, 2014. REUTERS/Darley Shen

By Laurence Frost and Gilles Guillaume

PARIS (Reuters) - PSA Peugeot Citroen and China's Dongfeng have agreed a 3 billion euro (2.4 billion pounds) capital tie-up that buys the French carmaker more time to turn its business around, brings in new management and ends two centuries of family control.

Peugeot Chief Executive Philippe Varin and former Renault executive Carlos Tavares, who will replace Varin when the deal is finalised, must now explain how the fresh capital can be used to improve the bottom line, analysts said.

"Expectations are running high," London-based ISI Group analyst Erich Hauser said in a note. "PSA (Peugeot) needs to show a new equity story to keep investors interested."

Peugeot and Dongfeng <0489.HK> have signed a non-binding outline agreement, two sources with knowledge of the matter told Reuters before an official announcement set for Wednesday.

Both companies declined to comment.

Under the memorandum of understanding signed on Tuesday, Dongfeng Motor Group and the French state will each pay about 800 million euros for a 14-percent stake in a reserved share sale and a rights issue, sources have said.

Existing shareholders will get warrants entitling them to more stock at the same 7.50 euro price as the reserved issue, a 40-percent discount to their market value, raising up to a further billion euros.

The Peugeot family will see its 25.4-percent stake and 38 percent of voting rights diluted to parity with Dongfeng and the French state, ceding control of the company it founded in 1810 as a maker of tools and coffee mills.

The rescue deal and a new lending partnership with Banco Santander will help Peugeot survive the expiry next year of 7 billion euros in state guarantees keeping its lending arm afloat, sources say.

It will also reinforce the Peugeot and Dongfeng Chinese joint venture with increased production, a new research and development centre and expansion into Southeast Asian markets.

Under Peugeot family control, the carmaker has been slow to adapt to competitive threats and missed opportunities to deepen partnerships with BMW , Toyota <7203.T> and Mitsubishi Motors <7211.T>, insiders say.

Analysts say Dongfeng's cash buys time but does not address the European problems behind much of Peugeot's 3 billion euro cash burn and 5 billion net loss in 2012.

The company needs to scrap another plant and freeze investment to return to profit in the region, Max Warburton of Bernstein Research said on February 14.

While the remedy would be "risky, disruptive and stressful", Warburton said, "there's still a chance Peugeot can trade its way out of its current difficulties".

But the French government, which stopped last year's closure of the Aulnay factory near Paris, has already warned it is unlikely to accept further significant plant cuts in its new role as a major shareholder.

Further closures "are not on the agenda", Industry Minister Arnaud Montebourg told France Inter radio on Tuesday. "The restructuring has already happened, and it was painful enough."

Peugeot is expected to meet existing commitments to build at least one new model at each French site and produce 1 million vehicles domestically by 2016, Montebourg said.

Peugeot shares were down 1.3 percent at 1530 GMT. Dongfeng had closed 1.6 percent lower on Monday before trading was suspended pending the announcements.

Dongfeng is the latest Chinese carmaker to take a significant stake in a Western peer after Zhejiang Geely Holding bought Sweden's Volvo Car in 2010 and SAIC Group acquired South Korea's SSangyong.

Besides putting some of its 24 billion yuan $3.96 billion (2.36 billion pounds) of cash reserves to work, some sceptics have questioned what the Chinese carmaker and its own Fengshen line of vehicles stand to gain from the tie-up.

According to people with knowledge of the agreement, the carmakers will roll out technology including Peugeot's fuel-saving HybridAir transmissions - which store recovered energy in a compressed gas cylinder - under both companies' brands.

The deal, which follows months of talks and remains subject to a Peugeot shareholder vote, is likely to be signed formally during Chinese President Xi Jinping's visit to Paris in late March, sources say.

(Additional reporting by Chine Labbé in Paris, Sophie Sassard in London,; Samuel Shen and Kazunori Takada in Shanghai; and Norihiko Shirouzu in Beijing; Editing by Louise Ireland)