After an over 100% stock rally this year, Peugeot SA (OTCMKTS:PEUGY) (EPA:UG) slipped close to -10% today. The French carmaker suffered a major slide after news that the company could be increasing capital up to €3 billion through Chinese manufacturer Dongfeng and the French government. The company has not confirmed the news yet and it will be subject to regulatory and shareholder approvals, so nothing is final so far.

General Motors and Peugeot on rocky grounds

Apparently the market did not like several things about the capital increase, including the added control of the French state and the possible drawbacks of larger collaboration with Dongfeng. A few of the major issues that Peugeot has suffered through include an increasing tendency to burn cash and also continued weak sales in Europe, its major market. According to H1 earnings, the company is set to burn another €2 billion through the rest of the year

Barclays’ Kristina Church and others write that while it is not clear how the deal will be structured, this much is evident—that it would toughen the existing relationship with General Motors Company (NYSE:GM), which has a 7% stake in the company. GM has already indicated that their partnership would get rocky if Peugeot furthers relationships with Dongfeng.

Short interest in Peugeot

We have mentioned several times how  hedge funds have bet against the European car market and of those negative bets, many are against Peugeot. Earlier this year short interest in the French company was close to 20% of outstanding shares—however the company’s relentless rallies forced several shortsellers to cover.

Some noted hedge funds who are still betting against the company are Odey Asset Management. Odey’s short amounts to 2.2% of the company’s shares. Peugeot SA (OTCMKTS:PEUGY) (EPA:UG) was the fund’s worst performing short in August. Meanwhile other European hedge funds that have bet against the company are Marshall Wace, in which the fund has a 0.73% short, and Adage Capital 0.6%. D.E Shaw is also shorting 2.09% of Peugeot’s shares

Take a look at other short bets of Marshall Wace in France.

Peugeots’s competitive advantage

In case of a capital increase, GM’s ownership in Peugeot SA (OTCMKTS:PEUGY) (EPA:UG) will be diluted and seeing from that perspective the development could also be negative for other existing shareholders. Citi’s Philip Watkins recommends caution until the news is confirmed, and he notes that a larger partnership with Dongfeng would allow the Chinese company access to Peugeot’s technology, which could reduce its competitive advantage. However there are also some positives in this development, it could increase Peugeot SA (OTCMKTS:PEUGY) (EPA:UG)’s expansion to Asian markets and reduce reliance on European sales. Watkins is overall upbeat about the French automaker; he says that the company’s cash flow is improving and it is determined to minimize its losses.

Goldman Sachs Group Inc (NYSE:GS) notes that €3 billion would equal to approximately 60% of the automaker’s current market cap and if the new capital is issued with a near-zero discount rate it could dilute GM’s ownership to 4%, whereas Dongfeng and France would hold 20% each. Goldman Sachs also comments:

The deleveraging of PSA’s balance sheet and a more comprehensive partnership with Dongfeng, in addition to the ongoing progress in reducing operational cashburn, could continue a re-rating of the PSA equity story against the background of stabilizing/improving European car sales.

 This was one good day for shortsellers, amid a seemingly unstoppable stock rally.