The China Shock Behind the Honda-Nissan Merger Talks

Three fundamental facts lie behind these moves. More than half of new cars sold in China today are either fully electric vehicles or plug-in hybrids. Three in five Chinese buyers are choosing a domestic brand, the highest ratio since the country emerged as the world’s largest car market.

And China’s passenger-car exports quintupled between 2020 and 2023, hitting 4.1 million vehicles last year, according to industry data. 

It is the auto-market version of the changes China’s rise has wrought in global politics and economics. The impact on cars took longer to come because China’s local carmakers, many of them state-controlled, were behind in technology, quality and design. 

Nissan 7201 23.70%increase; green up pointing triangle, Honda, GM, Volkswagen and other Western and Japanese brands for decades dominated and milked the Chinese market, while having little fear of Chinese rivals encroaching on their own strongholds. During the good times, GM relied on China to pad its bottom line by about $2 billion a year. 

The foreign brands were taken by surprise at how quickly EVs and their plug-in hybrid cousins took off in China in the span of four years. After Tesla ignited consumer demand for EVs in China, aggressive privately held companies, in particular BYD, emerged as leaders in EV batteries, low-cost manufacturing and connected-car technology. Now the Chinese companies are looking to capture markets in Europe, Southeast Asia and Latin America. 

BYD, the bestselling Chinese carmaker, is aggressively introducing low-price plug-in hybrids, such as the Qin Plus, which some ads show priced as low as $7,000 with the help of subsidies. The company is also investing in factories in Thailand, Hungary, Brazil and elsewhere.

The Honda-Nissan combination would be aimed at combating the Chinese push by combining the Japanese carmakers’ efforts in EV technology, autonomous driving and other areas where China is strong, analysts said.

While a combined Honda-Nissan would be poised to capture the No. 3 spot in global vehicle sales behind Toyota 7203 2.02%increase; green up pointing triangle and Volkswagen, Mizuho Bank senior researcher Jin Tang said he wasn’t sure scale would be enough. 

“Without significant breakthroughs in EV or smart-vehicle technology, I don’t believe the merger alone will allow them to compete, especially in key markets,” said Tang.

Honda and Nissan have already been inching closer this year, saying they would work together on electrification technologies.

At the beginning of this decade, the two carmakers relied on China for more than a third of their global vehicle sales. But this year, their China sales are running at about half the level of five years ago. 

Nissan’s woes go deeper because it is also posting weak results in the U.S. Last month, it said it would cut 9,000 jobs and reduce its global production capacity by a fifth. In November, Singapore-based Effissimo Capital Management, an activist investor, said it had built a stake in Nissan.

Investors in Nissan have welcomed the potential emergence of a partner on which the troubled carmaker could lean for support. Nissan shares closed up 23.7% in Tokyo trading on Wednesday. Honda shares closed down 3%.

Before Wednesday’s rise, Nissan’s market capitalization had fallen to the equivalent of about $8 billion, prompting speculation about the company’s future.

Foxconn, the Taiwanese company known as a contract manufacturer of Apple’s iPhone, has discussed making a bid for Nissan as it attempts to expand its nascent EV business, people familiar with the matter said. They said Foxconn had a particular interest in the Japanese automaker’s car manufacturing and design assets. Nissan declined to comment and a Foxconn spokesman didn’t reply to a request for comment.

A person familiar with the discussions between Honda and Nissan said they were vexed by the scope of the new technologies to be tackled as they continue to pump out millions of gasoline-powered vehicles each year that need regular upgrades. Analysts said it was hard for a single company the size of Honda or Nissan to stay abreast of advances in intelligent vehicles and electrification. 

Still, a merger would raise its own issues, including possible culture clashes and competing product portfolios. Honda and Nissan get most of their sales from the same markets—the U.S., Japan and China. Both are mass-market Japanese carmakers with similar types of vehicles, such as Honda’s CR-V sport-utility vehicle competing with Nissan’s Rogue.

And a combined Honda-Nissan would face the same dilemma of whether to try to recover market share or retrench around their shrunken position.

Volkswagen has made clear it intends to invest and rebuild in China, its biggest market, even as it pursues painful cost cuts at home. Over the past year or so, Volkswagen has been shifting to use more Chinese components obtained from local suppliers to cut development time and expense. It is also investing billions of dollars in local companies to get its hands on cutting-edge Chinese technology.

Yang Jie in Tokyo contributed to this article.

Write to Yoko Kubota at yoko.kubota@wsj.com