Malaysia's national carmaker Proton must overhaul itself and forge an alliance with a foreign partner if it is to arrest declining sales, return to profits and remain a viable business, analysts say.

The troubled 20-year-old firm is running out of time to turn its business around before facing an onslaught of low-cost, high-quality foreign competition as import duties are whittled away.

But Proton remains dogged by a reputation for poor quality and is failing to counter the advance of Japanese automakers Toyota and Honda, and South Korea's Kia and Hyundai, by introducing attractive new models at competitive prices.

"The future does not look bright for Proton," said John Bonnell, director of Automotive Resources Asia, a Bangkok-based automotive consulting firm.

Alarm bells began ringing louder when Proton shocked the market last month by announcing a RM12.35 million (US$3.28 million) net loss in its first quarter to June, compared with a profit of RM166.47 million a year earlier.

Malaysian brokerage ECM Libra said that as well as revealing the first red ink in six quarters, the balance sheet showed Proton was bleeding cash reserves and faced running into debt by the 2007 financial year.

"Strategic vision of the group was clearly lacking, and it is clear Proton is in a holding pattern until a foreign partner, namely Volkswagen comes in," it added.

Afta in 2008

Malaysia's biggest carmaker has been rudderless since July when chief executive Mahaleel Ariff left under a cloud after eight years in the top job.

"They must find a chief executive officer to steer the company during these troubled times," said an analyst with a local brokerage firm, who declined to be named due to the sensitivity of the issue.

"Time is running out for Proton. It must come out with new models within a shorter span of time. We also have to be mindful that the auto liberalisation comes into effect in 2008," she said.

Under the Association of Southeast Asian Nations (Asean) Free Trade Area (Afta) agreement, Malaysia cut import duties on Asean-made vehicles to 20 percent on January 1, 2005.

But it will delay reducing duties to the mandatory level of below five percent until 2008, when the fierce competition will really begin to bite.

Already Proton's share of the domestic car market - one of the region's biggest - has fallen from 67 percent in 1999 to 44 percent in 2004 as car-mad Malaysians embrace the smart new imports, and the outlook is poor.

Proton had pinned its hopes on the 1.2 litre Savvy (photo), which went on sale in June as its first new model in 16 months, but it has been shunned in favour of the MyVi produced by more nimble Malaysian competitor Perodua.

In what has become a typical tale for Proton, the Savvy was launched later than the MyVi, with no automatic version available nor test drive vehicles, and the finish and features were inferior to its competitor.

In the face of the flood of imports as well as home-grown alternatives, Proton is aiming to improve its bottom line by exporting at least 100,000 vehicles annually by 2008, from just 17,000 in 2004.

But Bonnell said that strategy is doomed because Proton does not have a brand presence in the international market, making it virtually impossible to bolster overseas sales in the face of aggressive competition.

"The auto industry in Asia now is extremely competitive. We now have China producing cars and selling at 10,000 dollars a unit," he said.

No shutting down Proton

Most observers believe that however bad things get, the government, which has a 42 percent stake in Proton through the state investment arm Khazanah Nasional, will not allow the automaker to fold or be snapped up by a foreign player.

"I don't think the government will shut down Proton. It is a question of national pride," Bonnell said.

But he said that if Proton sells a controlling stake to either of its reputed suitors, Volkswagen or Hyundai, it could address its core problem of poor quality and use the credibility of a foreign brand to improve public perception.

An alliance with a foreign auto giant would help Proton roll out new models quickly and help the company achieve economies of scale in an environment of high steel and oil prices, Bonnell said.

Proton has been in talks with Volkswagen since last October when it announced it would assemble and sell VW cars locally and abroad as part of a "long-term strategic partnership", the details of which are still being thrashed out.

Hyundai is also reportedly interested in a tie-up with Proton's assembly plant and platforms.

But Bonnell said that neither Volkswagen nor Hyundai is likely to rush to join forces with Proton, given the considerable problems it faces.

"I think they will remain cautious. They will want to take a majority stake in order to control the company. I don't think they will settle for a minority stake," he said.

Three options

A newspaper report last week said a deal with Volkswagen could be signed within months, but that rather than taking a controlling share in the parent company it would buy a 51 percent stake in the manufacturing and engineering units.

Lim Kit Siang from the opposition Democratic Action Party said Proton has to form an alliance with a global automaker to become an international player.

"It cannot just depend on the Malaysian market as it has done in the past 20 years. It cannot expect Malaysians to continue subsidising the company," he told AFP.

Lim said the government has three options for Proton: to form a strategic alliance with a foreign maker, to sell its stake, or maintain the status quo with the public underwriting its operations by paying high prices for its cars.

Even former prime minister Dr Mahathir Mohamad, the architect of the Malaysian national car scheme who remains an adviser to Proton, has warned that his pet project faces oblivion if it does not adapt to the new environment.

"If labour cost is high, maybe we may not be able to compete and maybe we will say goodbye to Proton," he said recently.