TRW was attractive to ZF because of its presence in advanced driver assistance systems. Thus far, its a standout deal, but will this huge deal herald more major restructuring in the global automotive supplier sector?

TRW was attractive to ZF because of its presence in advanced driver assistance systems. Thus far, it's a standout deal, but will this huge deal herald more major restructuring in the global automotive supplier sector?

This month's managament briefing reviews the financial position of the global supplier automotive supplier industry. Part 2 highlights recent developments in industry structure, including M&A and IPO activity and corporate restructuring.

As outlined in part 1, despite generally favourable financial trends in recent quarters, suppliers continue to face a number of challenges that go beyond short-term demand trends, currency fluctuations, etc. Pressures to refine business models to meet the evolving demands of customers and stakeholders constantly demand considerable management time, with appropriate allocation of capital (encompassing capex, M&A, dividends and share repurchases) high on the list of priorities.

For most suppliers, fine tuning of business structures is an ongoing process, reflecting the constant need to maximise returns on invested capital and to position companies for future growth and success. For some, this can go beyond fine tuning to encompass fairly dramatic structural change demanding substantial capital commitments.

Recent supplier sector news has been dominated by ZF's acquisition of TRW, the first major M&A development in the sector for some considerable time, although perhaps the real news is that such a deal remains very much the exception rather than the rule, the supplier M&A scene being dominated by fine tuning rather than major structural upheavals. ZF's move has been heralded as perhaps the first step towards a more widespread wave of major deals, especially as the internal financial resources for many suppliers have been bolstered in recent quarters (and access to external capital has eased), but, in reality, there appears to be little appetite for shifting capital allocation in this direction. Many suppliers, more than a few of which continue to look nervously over their shoulders at influential shareholders, appear to remain wary of committing to major bolt-on deals that go beyond reinforcing existing businesses and which are not earnings accretive in the short term.

Despite this cautious and measured approach to corporate development and growth by individual suppliers, in aggregate, the sector is still seeing significant evolution, and at a quickening pace. With higher levels of liquidity on balance sheets, improved access to external capital, and a heightened desire to pursue strategic initiatives relating to geographical markets, customer growth, technology advances, etc, key foundations for M&A growth are in place.

A recent PwC analysis (written before the ZF/TRW deal became public) has predicted that 2014 will see growth in the number of supplier M&A deals for the first time since 2011. The 2011 total of 303 deals declined continuously to just 186 in 2013, but was predicted to rise to 211 in 2014. With average deal values remaining low, aggregate M&A value of closed deals was estimated at US$15bn for 2014, up from US$12bn in 2013 but well below levels seen in previous years (peaking at US$35bn in 2007).

PwC also predicted that, on the acquiring side, North American suppliers will, for the first time in many years, overtake European suppliers in the number of deals done (32%, versus 30%), with Japanese, Chinese, South Korean suppliers contributing 8%, 5% and 9%, respectively. Conversely, main targets are predicted to (still) be European companies (36%), followed by North American suppliers (31%). PwC also noted an increased willingness of private equity firms to participate in deals as well as a concentration of activity in the powertrain and chassis systems sectors (driven by evolving emissions and fuel economy regulations) and the 'connected car' space, accompanied by an (unexpected) rise in deals in the exterior systems sector (driven by the additional electronics and safety content).

Recently announced acquisitions of note have included (acquirers and targets):

  • Panasonic - Ficosa (49% stake)
  • Shiloh Industries - Radar Industries
  • Aunde - Fehrer
  • Magna - Techform
  • Delphi - Unwired Technology
  • Linamar - Carolina Forge Company (hot forged product business); Seissenschmidt (66% stake)
  • Delphi - Antaya Technologies
  • ZF - TRW
  • Bosch - ZF Lenksysteme (remaining 59%)
  • Federal-Mogul - TRW (engine valve business)
  • Mahle - Letrika
  • Benteler - Wilco Wilken Laser (certain assets from insolvency)
  • Lear - Eagle Ottawa
  • Denso - Hefei Dyne Auto Air Conditioner (34%)
  • Halla Visteon Climate Control - Cooper Standard (auto thermal and emissions business)
  • Continental - Emitec (50% stake from GKN)
  • Federal-Mogul - Honeywell (friction materials business)
  • Visteon - JCI (auto electronics business)
  • Denso - EASE Simulation (72% stake)

Delphi's two recent acquisitions underline a typical current approach to corporate growth through M&A, the company's CEO Rodney O'Neal, having previously commented: "I'm not looking for anything transformational for Delphi. I'm already transformed. I'm looking to do a bolt-on where I bolt it on in the morning and I get the synergies out by nightfall and I've moved on." Delphi CFO Kevin Clark has also underlined that any acquisition has to meet tight strategic, operating and financial criteria, with areas of focus being in the company's electrical architecture (connectors; highly engineered electrical components), electronics and safety (infotainment and driver interface; active safety; software and services) and powertrain (fuel injection; alternative fuels) areas.

O'Neal noted when announcing the Antaya Technologies deal (expected to close in Q4 2014): "Antaya is an excellent strategic fit with Delphi, as it adds an important new connector technology to our already strong electrical connectors business ... This transaction is consistent with our strategy to allocate capital to growth opportunities that enhance Delphi's leadership position in automotive connectors." Similarly, O'Neal also noted when confirming the Unwired Technology deal: "Media connectivity is a high-growth segment as auto manufacturers respond quickly to consumers' increasing desire to integrate their smartphones and tablets in their vehicles. Unwired's products strengthen our overall electrical architecture and electrical connector offerings, which is supporting increased electronics content per vehicle."

Interestingly, although unconfirmed by the company, Delphi is also rumoured to be currently seeking an acquirer for its (relatively) small thermal systems business (for around US$1bn) as it increasingly sharpens its focus on its core Electrical/Electronic Architecture (E/EA), Powertrain Systems (PS) and Electronics and Safety (ES) businesses.

For some suppliers, significant structural reform of the business is being pursued in tandem with these acquisitions, Federal-Mogul being an obvious example. With leading shareholder (81% voting rights) and activist investor Carl Icahn a key driving force, Federal-Mogul has undergone a number of corporate changes through 2014, culminating in the September announcement that Federal-Mogul Holdings plans to separate Federal-Mogul Corporation's Powertrain and Motorparts divisions into two independent, public companies serving the global OE and aftermarket industries, respectively. Execution of the plan involves a tax-free distribution of the Motorparts division to shareholders of Federal-Mogul Holdings, the objective being to complete the spin-off of the Motorparts division in the first half of 2015. Icahn has noted this will create: "Two independent, market-leading companies that will be among the largest and strongest in their respective peer groups globally." The deal should also be, unsurprisingly, shareholder-value enhancing.

Intriguingly, in the same month this corporate spilt was announced, Federal-Mogul also announced an opportunistic purchase agreement with TRW to acquire the latter's engine valves business for US$385m in cash. This business will add around US$610m of annual revenue to the Federal-Mogul Powertrain division's top line once the deal is closed, which is expected to be in Q1 2015.

There is also recurring speculation that Visteon could seek a similar shareholder-value enhancing deal in the near future by splitting its business in two. Visteon has almost fully extricated itself from its former interiors business, while simultaneously boosting its electronics activities with the US$265m purchase of JCI's automotive electronics business. Current speculation suggests the company's management, believing that the two divisions add little value operating under the same corporate umbrella, may now seek to realise greater value by selling or spinning off the electronics unit in its entirety, effectively separating the business from the mainstream climate-control activities (majority ownership of HVCC). The expectation in such a scenario would be that the true value of the electronics business would emerge when its attributes become more clearly visible to investors.

Some suppliers have also sought to diversify their ownership structures and raise capital through initial public offerings (IPOs), although in one notable case - that of Chinese-owned steering supplier Nexteer Automotive - this took two attempts to complete and in another - interiors specialist International Automotive Components (IAC) - intent has yet to be followed by action.

Nexteer first attempted an IPO in June 2013 but stock market volatility forced a postponement. A second, successful, attempt was made in October 2013, the company finally listing on the Main Board of the Hong Kong Stock Exchange, resulting in net proceeds of US$273m for use in funding capex on new product programmes and machinery and equipment to increase production capacity, to strengthen R&D capabilities and supplement working capital.

In contrast to this success, IAC, which first announced on 14 June 2013 its intention to commence trading in its common shares (via an IPO) for the first time on the New York Stock Exchange, has yet to fulfil its ambition. As of mid-November 2014, the IPO had still not been launched and no details of the size or pricing details of the offering had been given. Private equity investors W L Ross Group (WLR) and Franklin Mutual Advisers (FMA) effectively control IAC, with stakes of 60.1% and 27.1%, respectively. IAC is currently a Luxembourg public limited liability company (société anonyme) headquartered in that country.

The latest successful supplier IPO was initiated by German, family-owned lighting and electronic systems supplier Hella in early November 2014. The bulk of the IPO comprised the placing of 11,111,112 shares at a price of EUR25.00 per share with selected institutional investors and others in a private placement, representing 10% of the enlarged share capital. The proceeds from the capital increase amounted to approximately EUR278m. A secondary component was also provided by the family and represented 4.5% of the post-money share capital. The family also made 750,000 shares available for a greenshoe option, taking the free-float to just over 15%. The Hueck family have committed to remain the holders of 60% of the post-placements share capital until at least 2024. The shares are now listed on the Frankfurt and Luxembourg stock exchanges and commenced trading on 11 November. The company has noted: "The listing and the private placements give Hella the opportunity to continue its successful growth strategy. With this important milestone, the company wants to continue expanding its international footprint and investing in innovation in order to keep offering its global customers outstanding and leading-edge products."

Hella's IPO also followed on from that of Mobileye, a lower profile, 'new-age' supplier that focuses on being a designer and developer of software and related technologies for camera-based Advanced Driver Assistance Systems (ADAS). Despite its lower-tier supplier ranking, Mobileye's products are integrated into car models from over 20 global OEMs including BMW, Ford, General Motors, Honda, Nissan and Volvo, albeit often part of first-tier ADAS units supplied by companies such as TRW, Magna, Autoliv, Delphi and Mando. Mobileye will also play a key role in developing technologies for autonomous driving and believes at least three technological innovations could be key, the first involving hands-free-capable driving at normal road speeds and in congested traffic situations. The company already claims design wins from two OEMs to launch these features in 2016, and is also in development programmes with an additional six OEMs for potential launch in 2018. The other two innovations, which Mobileye believes could launch as early as 2018, are the inclusion of minor road capabilities and city traffic capabilities.

Mobileye's IPO, completed in August 2014, comprised 40,927,350 ordinary shares priced at US$25.00 per share, with Mobileye offering 8,325,000 and selling shareholders 32,602,350. The aggregate gross proceeds of the offering were US$1.023bn. The shares are now listed on the NYSE.

Illustrating the ongoing evolution of the industry, 2014 has also seen the birth of a new supplier holding company - Metaldyne Performance Group (MPG) - which was formed in August 2014 through the merger of Grede Holdings, HHI Group Holdings and Metaldyne. The merger was designed to enable the three established suppliers to strengthen their market position across metal forming technologies, expand global footprints and leverage cross-selling opportunities that exist between the companies while benefitting from operational synergies. Immediately after the merger, 87% of MPG was held by private equity concern American Securities. American Securities completed its acquisition of Grede in a deal valued at around US$800m in June 2014, having acquired Metaldyne from the Carlyle Group for about US$820m in 2012 and HHI in the same year. Although MPG issued an IPO prospectus shortly after the August 2014 merger, and an updated S-1 in mid-November 2014, a share placing has yet to be finalised.

These corporate restructuring activities highlight the constant pressure to adapt to evolving challenges, whether they be from such things as customer and market demands, advancing technologies or pressures from key stakeholders seeking to maximise the value of their interests.

As indicated, as well as internal restructuring within the existing supplier base, a new group of automotive suppliers is evolving, the growth of these 'new age' suppliers often correlating with growth in new technologies, for example those associated with increased connectivity in vehicles. This competition from non-traditional automotive supplier companies in the vehicle space is emerging from new and relatively new, start-up entities (such as Mobileye, with roots dating back to 1999 and which became a public company on 1 August 2014) and from established businesses seeking to harness growth opportunities in, for example, automotive electronics.

In the latter category, Pioneer, a long-established supplier of general consumer electronics products (including in-vehicle entertainment systems) has recently developed new business strategies better harnessed to ride a wave of demand associated with in-vehicle connectivity and infotainment. In a strategy document published in mid-September 2014, the company stressed: "The car electronics industry has entered a phase of major change in terms of the market environment in which Pioneer operates, including an increasing ratio of products being installed in new vehicles as standard equipment or dealer options ... we therefore view the current situation as a major opportunity for future success. We aim to be an indispensable key supplier to automakers and their mega-suppliers, based on the expertise and customer confidence we have gained in the OEM market. In the consumer market, we will drive the car electronics industry as a pioneer in providing new value in the connected car life market, by being the first company to provide and expand world-first, cutting- edge solutions." To emphasise this commitment, the Japanese company also noted: "To achieve our management objectives, Pioneer will concentrate management resources in Car Electronics, and we will build a business structure that is centred on Car Electronics."

Conclusions

In summary, many suppliers face an evolving cocktail of issues that constantly challenge accepted business practices and structures. These issues continue to drive allocation of management and capital resources among many competing demands, the end game being to optimise growth and development based on perceived strengths and needs. For some, these changes are evolutionary while for others a more revolutionary strategy is necessary. As Takata has recently found to its cost, failure to meet the most basic of supplier requirements - product quality and performance - can have a major negative impact on reputation and costs. Failure to comply with accepted rules of business bidding and fairness, resulting in violation of anti-monopoly laws, can also ensnare even the most high-profile suppliers. But failure to evolve structurally, for example by not focusing on strategies targeted at reinforcing core strengths, can have even more dramatic long-term consequences.  

See also: Part 1 of the November 2014 management briefing: Supplier industry financial review (1) - (reviews the recent financial results of a sample of major global auto suppliers)

Recent Global Supplier Sector M&A Deals

Acquirer Target
Panasonic Ficosa (49% stake)
Shiloh Industries Radar Industries
Aunde Fehrer
Magna Techform
Delphi Unwired Technology
Linamar Carolina Forge Company (hot forged product business); Seissenschmidt (66% stake)
Delphi Antaya Technologies
ZF TRW
Bosch ZF Lenksysteme (remaining 59%)
Federal-Mogul TRW (engine valves business)
Mahle Letrika
Benteler Wilco Wilken Laser (certain assets from insolvency)
Lear Eagle Ottawa
Denso Hefei Dyne Auto Air Conditioner (34%)
Halla Visteon Climate Control Cooper Standard (auto thermal and emissions business)
Continental Emitec (50% stake from GKN)
Federal-Mogul Honeywell (friction materials business)
Visteon JCI (auto electronics business)
Denso EASE Simulation (72% stake)

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