Friday, 7 March 2008

Micro-Level Trends – Industry Re-Integration – GM : Delphi : Goldman's?

Carrying on the PE vs Trade debate, perhaps the best example of the tussle for under par value is Delphi; both in its own right as a corporate entity and relative to the M&A opportunities that are emerging from, possibly forced, asset sales as the US supplier-base sector remains structurally and financially weak.

Having been under Chapter 11 protection for two and a half years, providing the breathing space to set a re-organised growth path, a US bankruptcy court has recently permitted a $50m payment to Delphi’s lawyers and financial advisors and supported a divisional divestment strategy that sees its steering mechanisms unit sold to Platinum Equity LLC, whilst the wheel bearings unit is bought by Kyklos Inc.

Quite obviously the company and its advisors seek to maximise divisional sale income from what are effectively low-value but high cost functions that specialise in what are in reality basic components that are readily available either off the shelf or as specified from BRIC+ regions at greatly reduced costs.

Delphi’s valuation and future funding quandary was ever present throughout 2007, required taking time to assess by potential lenders as the complexity of deconstructing, detangling and valuing America’s biggest Chapter 11 ‘case-study’ became ever more apparent. Latest calculations of capital injection requirements present a case for $6.1bn. Whilst the process of crunching the numbers has gone on, waiting and visibly acting has been a co-operative PE alliance, eager to see what potential the financially dissected enterprise actually offered. Led by Appaloosa Asset Management, the consortium identified value in Delphi and has bought-in throughout 2006/7.

The PE group consists of:

Appaloosa Asset Management (Lead Role)
Goldman Sachs Group Inc
Harbinger Capital Partners Master Fund 1 Inc
Merrill Lynch and Co Inc
UBS Securities LLC
Pardus Capital Management LP
Pierce, Fenner and Smith Inc

These PE investors together have stated that they are prepared to submit a $2.55bn injection package that will obviously intrinsically provide board-room voting rights and allow major influence on Delphi’s corporate strategy. Thus far, the influence desired is that Delphi continues to grow its customer-base well beyond the historically prevalent GM, critically gaining independence from what it sees as a politically franchised prime client that has always had undue influence over Delphi, able to often dictate component pricing and contract agreements, a situation that brought Delphi to its knees and if not dealt with now, at this crucial juncture, will always leave the company subservient to ‘The General’.

Obviously GM has recognised the subtle threat coming from the PE sector, so has obvious concerns that what it sees as its own, ‘friendly’ supply base could be threatened, which in turn of course poses worries about GM’s own re-bound, having come this far after positive UAW negotiations and FY07 financial results demonstrating that the company is near the tipping point of getting back into the black after so long. GM’s strategy and future turn-a-round projections undoubtedly rely upon the ‘efficiencies’ it has gained from its suppliers, Delphi being the priority. So understandably sees Appaloosa’s strategic plans for Delphi as an undoubted threat to future stability and traction. It ideally seeks the benefits of the close association it had prior to 1999 as it’s then parent, without the financial and legal responsibility; even though it does have to take on accounting ‘charges’ on its own books.

Thus as a counter-bid - as seen via an SEC filing late on 5th March and subsequent to an ‘assistance’ statement of 12th Feb. - GM has ‘affably’ stated that it will forgo a payment worth approximately $2bn from Delphi (of a $2.25bn debt) that was due from the $6.1bn leverage total, on-top of which it may lend another $0.83bn+ to assist. This would consist of:

a) $2bn first lien note
b) $825m second lien note
c) $175 cash loan

Unsurprisingly, its understandable agenda is to reduce, parts pricing. Given the ‘fixed’ UAW rates, this was always the next issue to be addressed to reduce its variable (manufacturing) cost-base, and the estimated $1.5bn reduction (based on 1999 contract agreement terms) would aid substantially.

So what next in the Delphi saga?

Undoubtedly, given the dynamics of the global supply-base network, an ever weakening $US dollar, acquisitive European, Asia (tho' less so Japanese) trade buyers and an expected US economic rebound in 2009/10 that should buoy the car-market substantially, Delphi continues to be a prime interest to Private Equity, General Motors, possibly other VMs seeking a major US supply chain (eg VW, Hyundai?) and of course other foreign Tier 1 and 2 components companies, especially Europeans such as Bosche or Continental. The latter examples perhaps prominant given the record € vs $ differential that makes Euro-US M&A so tempting at present and into the mid-term; especially so as Delphi divests of its low-end product portfolio and so begins to equate with the more hi-tech competencies of German peers.

Given VW’s interest in massively growing its share of the US car market, and recognising BMW’s present troubles in obtaining high quality parts supplies from the current US network, it could (given Piech’s high influence with German industrial circles & a unification sentiment within political spheres) endeavour to work with its European suppliers to grow a capability base with NAFTA (not necessarily only the US). This would underpin a localised product quality push that targets the Toyota quality benchmark that has been key to the Japanese company's US success.

Of course such a scenario may be the hidden agenda of the PE firms who recognise Delphi as being of great worth to foreign buyers, whether as a lean, singular core entity (the evolution of which we see today) or as functionally split amongst specifically aligned and identified European, Japanese, Korean and (highly likely) Chinese trade buyers.

At present, given the on-going re-organisational debates and “re-al politick” that engenders yet another request for Chapter 11 protection, the abovementioned idealised PE exit strategies, look a long way off. The PE consortium appears to be running out of patience with a threat to withdraw their support by the end of March if the $6.1bn hasn’t been obtained. That would seriously damage Delphi’s stock price and so Market Capitalisation and so credit-worthiness. Of course the possibility is that such a move could be used to by the PE group to buy-back in at a reduced price and upping the present hold to gain greater control over company direction. And of course the PE firm recognise that it has more than a modicum of power since its own investment is based on a template that dictates that Delphi can only take on additional debt if creditors are willing to take only a small risk premium, which of course puts-off potential other creditors, leaving the parts-maker open to hostile bids without GM support.

Hence the Delphi saga continues with a PE vs GM tussle.

There are of-course a number of possible outcomes in terms of the future ownership, shape and profitability model Delphi may take. But at this present time we wouldn’t be surprised if Rick Wagoner is engaging with Ferdinand Piech to discuss what may seem like an amenable dual interest in Delphi. Add the possibility of a GM-VW tie-up regards a refurbished leased or sold plant for VW to give VW US production entry and perhaps Wagoner could out-fox the PE boys. Then again they are undoubtedly doing the same thing amongst the foreign Tier 1 & 2s in Germany and beyond.

Quite obviously, for some time Delphi management has found itself caught between the proverbial "rock and a hard place" - a possibly invisible PE agenda versus the 'strings attached' help of GM. At present it seems that Delphi prefers the intentions of the devil it knows, apparently siding with its primary customer with subtely aired concerns about the possibility of the PE brigade's real intention of 'shorting' Delphi stock to make a quick buck. No one can say whether that's a geniune reaction to the news of a PE pull-out, or a machination to tarnish the PE offering.

Interestingly Goldman Sachs' has distanced itself somewhat from the remaining PE ideology that Delphi should de-couple from GM. Perhaps it's thinking of jumping ship, siding with the GM link and possibly raising the required funds from its own coffers or raising a new consortium?

With a $6.1bn requirement, $3bn offered by GM and 'only' $2.55 current PE offer, it leaves an effective shortfall of $0.55bn. Could Goldman's raise a new $3.1bn fund by April 15th? In 5 weeks we'll know!