PARIS/LONDON French carmaker PSA Peugeot Citroen (PEUP.PA) took a 1.1 billion euro ($1.52 billion) writedown at its ailing overseas operations and won General Motors (GM.N) backing for a tie-up with China's Dongfeng.
Peugeot and GM also lowered savings goals for their scaled-down alliance on Thursday, as the Paris-based carmaker acknowledged it was pursuing a deal with Dongfeng Motor Group (0489.HK) underpinned by a capital increase.
One of the worst casualties of Europe's economic slump and six-year car sales decline, Peugeot is cutting jobs and plant capacity in an attempt to halt losses within two years.
The company's shares tumbled on the writedown and after a source told Reuters the board had approved the outlines of Dongfeng deal with a 3.5 billion euro capital increase at a discount of as much as a 40 percent.
"No matter how the deal is structured, we cannot see anything positive in today's news on Peugeot," London-based Barclays analyst Kristina Church said.
The stock could eventually begin to recover after a capital increase, Church added in an investor note.
"But this assumes Peugeot is able to use the 3.5 billion potentially raised for future growth ... whereas in reality we worry it will be subsumed purely by operational cash burn."
Peugeot and Dongfeng have been in negotiations to extend their existing Chinese partnership to other Asian markets, backed by a share issue in which the French state and Dongfeng would take matching Peugeot stakes.
Discussions are at "preliminary stage", with no guarantee of a successful outcome, Peugeot said. "There is no agreement on the terms of a potential operation."
According to a source familiar with the matter, Peugeot's board agreed on Tuesday to enter final talks to sell 20 percent stakes to France and Dongfeng in a capital hike likely to be priced below 7 euros per share after the Chinese carmaker made an indicative offer of 6.85 euros.
Peugeot shares were down 7.8 percent at 10.61 euros as of 1509 GMT, after dipping as low as 10.20 euros in heavy trading earlier in Thursday's session.
However, the manufacturer and its founding Peugeot family still hope to negotiate a higher price from Dongfeng, two sources with knowledge of the matter said.
"A price of 7 euros or below is out of the question," said a person close to one of three Peugeot cousins who head the family's business interests. "I'm not aware of any price being proposed - but no lower limit has been set."
Dongfeng, based in the central Chinese city of Wuhan, declined to comment on the tie-up talks.
"We're still in touch," spokesman Zhou Mi said. "There's nothing more I can say."
France would support new industrial pairings for its biggest carmaker, Finance Minister Pierre Moscovici said.
"We want this company to be able to conclude strategic partnerships that will enable it to achieve the renaissance that it deserves," he told reporters.
A Peugeot-Dongfeng deal would be "looked upon favorably" in Paris providing it protects domestic sites, a government source added. "At some point the finance ministry will have to say whether the state will take a shareholding.
Representatives of the French government, Peugeot and Dongfeng met on November 30 and December 7 in Beijing along with their advisers to discuss the transaction, according to one source.
Names of famous painters were used to designate the main parties, several people said. Peugeot's code name was Picasso and Dongfeng's Degas, while GM was referred to as Gauguin and the French government as Fragonard.
Peugeot's impairment charge, which follows a similar 4.7 billion euro hit on 2012 earnings, reflects weaker currencies and sales outlooks in Russia and Latin America, Chief Financial Officer Jean-Baptiste de Chatillon told reporters.
The company's plant in Kaluga, Russia is among production investments "whose book value is no longer covered by future cash flows", Chatillon said on a conference call. "This will impact group operating income."
The auto division recorded a 510 million euro operating loss in the first half, before one-off gains and charges. Peugeot nonetheless reiterated its 2013 goal of halving last year's negative 3 billion euro operating cash flow.
Peugeot and GM also slashed their 2018 savings goal from a troubled European alliance plan announced early last year.
They now expect an evenly split $1.2 billion in annual benefits by 2018 - 40 below the initial target - after scrapping a small car program in October.
But joint development of compact and small minivans will continue, the companies said, and GM will back a third-party investment in Peugeot as the French carmaker's 7 percent shareholder. A delivery van program is also being considered.
The likely discount on the planned capital increase reflects worsening conditions and currency headwinds for Peugeot, which hopes to announce a Dongfeng tie-up by February, one of the sources said.
Under its outline terms, Dongfeng and the French state would each hold about 20 percent of Peugeot after a reserved share sale to the French state and Dongfeng, accompanied by a rights issue to existing shareholders.
The Peugeot family would lose control as its stake was diluted from 25 percent to 15 percent even after acquiring some new shares in the rights issue, the source said. The effect would be even more dilutive for GM or any other shareholders that do not buy new stock.
In a move that may help secure the new funding from Dongfeng, Peugeot last week named former Renault No.2 Carlos Tavares as its next chief executive.
(Additional reporting by Gilles Guillaume, Blaise Robinson and Leigh Thomas, Elizabeth Pineau in Paris; Sam Shen in Shanghai; and Edward Taylor in Frankfurt; Editing by Astrid Wendlandt and Anna Willard)