General Motors scaled back cooperation with Peugeot months into their alliance and later turned down a government-backed merger, leaving China's Dongfeng <0489.HK> as the French carmaker's last hope, people familiar with the matter said.
GM took a 7 percent stake in PSA Peugeot Citroen after the carmakers announced what was billed as a broad-based alliance in February, 2012.
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Yet the pairing hit obstacles within eight months, when GM revealed its Chinese partner SAIC <600104.SS> would veto key plans including for larger cars, said the sources, who declined to be identified because the matter was confidential.
"We never found out whether GM had known that all along," one person said.
By June this year, Peugeot had won French government approval for a restructuring tie-up with GM's Opel division, but the U.S. carmaker turned it down, citing CEO Dan Akerson's likely succession by early 2015 and political sensitivities, people said. GM is still 7.3 percent U.S. government-owned.
The series of setbacks with GM has forced Peugeot Chief Executive Philippe Varin to look elsewhere for a cash injection amid mounting concern over the company's finances.
Peugeot shares fell 9.1 percent on Monday after Reuters reported the company was preparing a 3 billion euro ($4 billion) capital increase in which Dongfeng and the French state would buy matching stakes of between 20 and 30 percent.
The move would reduce GM's stake in Peugeot and give the Chinese state-owned carmaker access to its French partner's technology, in return for help in potential new markets, according to people with knowledge of the talks. Peugeot and Dongfeng already have a Chinese joint venture, DPCA.
But the size and timing of the planned capital increase, and the government's readiness to contribute, are driven by financial concerns that have lately resurfaced despite Peugeot's assurances in July that it would surpass 2013 cash goals, sources said.
"The government is worried about Peugeot's financial state, which is one reason why such a big share issue is imminent," said a person familiar with the matter.
"There's an awareness that the cash situation will not pick up in the way that had been set out," another person said. "The slight improvement we've seen so far cannot be sustained."
Peugeot, which had said it would beat its target of halving industrial cash consumption to 1.5 billion euros, will give a progress update when it publishes third-quarter revenue next week, a spokesman said, declining further comment.
Peugeot ended the first half with cash of 7.71 billion euros, excluding listed subsidiary Faurecia , and is set to consume about 2 billion this year as restructuring costs increase net industrial debt to 4.8 billion.
Together with 2.4 billion in undrawn credit lines, that will leave about 8 billion in available reserves - but the real cushion is closer to 5 billion because Peugeot needs the difference just to operate.
Peugeot's dependence on European sales and exposure to Mediterranean markets has made it the worst casualty of the region's auto slump, with a 5 billion euro net loss last year.
The company, slashing jobs and plant capacity to pursue a return to profit in 2015, had announced plans for at least five joint vehicle and powertrain programmes with GM soon after their alliance was unveiled last year.
The two carmakers have since held unsuccessful talks about a deeper combination.
Peugeot and GM are pushing ahead with joint purchasing, logistics and three programmes to develop small cars and two minivan families, for introduction in 2016 through 2018.
"We started out with about 40 potential projects," Peugeot programme chief Jean-Christophe Quemard said last month.
"There are things we would have liked to do but can't," Quemard said, citing technical incompatibilities between vehicle designs. "It's very frustrating and takes a great deal of time."
LEVEL OF INFLUENCE
The future of the alliance could be affected by Dongfeng's level of influence in any expanded partnership with Peugeot, GM Vice-Chairman Steve Girsky told Reuters last month. A GM spokesman declined further comment on Monday.
Under a "change of control" clause in their alliance agreement, GM has the right to pull out if any third party acquires Peugeot stake of more than 10 percent.
"It's clear to us that Peugeot's existing alliance with GM would be at risk following such a transaction," Barclays analyst Kristina Church said in a note to investors. "The need for a 3 billion euro cash injection reveals how dire a financial situation the company finds itself in."
French Finance Minister Pierre Moscovici declined to confirm or deny that the government was preparing to commit fresh funds, in addition to a 7 billion euro state guarantee granted to Peugeot's financing arm last year.
"I'm not going to comment on that kind of thing," Moscovici told France Inter radio. "The government is not going to remain indifferent to Peugeot ... After all, we're talking about the future of a major listed company that employs almost 100,000 people in France."
The carmaker has lost more business to competitors in recent months and its European market share fell to 9.7 percent in August from 11.3 a year earlier. In September its slice of French sales tumbled 3 points to 27.7 percent.
Unveiling cutbacks last year, CEO Varin said his recovery plan assumed a steady return to a 13 percent European market share.
Renault , itself 15 percent French government-owned, declined to comment on the possible injection of public cash into its domestic rival. But insiders said privately that the reported capital increase plan was met with relief.
"Everyone here has been worried for months about our mutual network of suppliers crashing if PSA goes bankrupt," one said. "If this capital increase does happen, Peugeot gets more time and more cash they can use to pay off suppliers, and that has to be a good thing."
(Additional reporting by Gilles Guillaume in Paris and Ben Klayman in Detroit; Editing by David Holmes)