As is often the case in unsure times, generalist opinion differs whether the state of western capital markets and the auto-industry itself means that the balance of M&A ability and power is held by private equity funds or in-sector trade buyers.
The same question posed relative to the charging bull markets of BRIC+ regions.
Of course idealised answers are sought to assist opinion-forming regards one camp vs the other, to notionally assist advisory firms, deal-brokers and under-writers, but in reality although general assumptions can be ratified or dismissed by the quantitative analysis of automotive M&A trend surveys, it is the specific circumstances of individual M&A cases that matter. And of course each case will be different, with specific financial and strategic pros and cons, depending upon purchaser’s own strategic intentions.
Typically For PE they will be…
i) to turn-a-round target company performance via growth strategy and cost-savings
ii) to release potential via synergies with other portfolio companies (inc i )
iii) to divest the asset-base to ‘over-paying’ secondary buyers
iv) to sell-on a re-organised, efficient and part-proven ‘new’ company.
v) to leverage the balance sheet to improve ROE and re-build.
For a Sector Buyer they will be:
horizontal or vertical integration and value chain improvement
i) improved geographic or segment access to new customers
ii) improved geographic or segment access to new suppliers
iii) improved access to R&D
iv) synergistic product & service advantages (ie scale efficiencies)
Whilst the PE vs Trade question is an over-simplification, undoubtedly consensus forms behind well structured arguments for M&A theory relative to market conditions and respective business needs; so although both seeking ‘added value’ from an acquisition and may deploy similar tactics, the background business and financing contexts of PE vs Trade will invariably be different.
The results of such a difference were seen throughout ’05, ’06 and ’07. For western industry the heavily increased operational pressures on auto-suppliers, especially so in input costs, altered the PE stance on upstream buy-outs, preferring to seek downstream aftermarket and niche acquisitions that appeared to have greater B2B and B2C order-book and margin possibilities and enabling quicker pay-back periods. That left trade buyers less ‘harassed’ by competing outside firms to seek specialist ‘bolt-on’ buys to bolster and extend their own operations. However, remember that the growing band of restructuring specialists, such as distressed debt funds (eg Alchemy) are able to bridge that apparent PE vs Trade gap, and may yet prove a headache for the trade fraternity.
Set against the variability of a possible 3 pronged attack of Generic PE, Trade and (PE backed) Restructuring Specialists, it has been noted that the very nature of corporate complexity has had an enormous impact in on divestment issues. Complex deals that demand a level of continued co-operation after formal separation have become known as ‘Carve-Outs’, the deal transaction time required for full completion sometimes into over a year or possibly more. In the past divested units or complete businesses were far less inter-related with parent or sister businesses, hence providing simple M&A valuations and procedures, but as organisations have become more complex in their working natures (from cross-shareholdings to singular protected sourcing to shared contracts) so has the job of negotiating and extracting the core enterprise and associated peripheral functions.
Understandably, as advisors recognised the complexity growing. so they grabbed the opportunity to service the strategy implementation needs, the likes of Delloite and others have evolved their own services to specialise in this fruitful arena known as ‘Transition Services’. Generally assisting as an intermediatory in creating what are essentially outsourcing supply contracts of (typically): engineering services, testing services, procurement services etc, to maintain seller-to-buyer support integrity.
Detail, and the quid pro quo politics that accompany it, obviously takes what can seem an eon, so much depends upon the logical and emotional intent of the 2 parties. Ideally, if negotiations take place set against a bigger picture of additional down-the-road mutual interests, this can aid the ‘bon ami‘ and actually help form a greater working business partnership for the greater good. But of course that is not always possible. Two present-day examples demonstrate well: the reportedly distinctly different M&As of a amenable Jaguar/Land Rover-TATA deal vs the problematic Porsche-VW deal.
So we have seen how complexity and politics play major roles in implementing a ‘horizontally integrated’ M&A typical of auto-makers’ strategies, but what of the complimenting supplier-base?
Here we’ve seen 2 distinct plays:
A) extension up the value chain to improve margins and avoid ‘dog-fight’ lower cost competition
B) aiming to co-create a ‘cost-balanced’ high-value/low cost global enterprise.
Demonstrating play A, Germany’s Continental embrace Motorola and Siemens VDO in an attempt to extend beyond tyres and immediate technology into higher value business realms that surround complete vehicle dynamics focused electrical architectures. (see post dated 30.01.08)
And demonstrating play B, Canada’s Magna buy-out of the American firm Allied Transportation Technology and the Chinese firm Zhangjiagang Suxing Electronics demonstrates the opportunity, or perhaps defensive action, to amalgamate the best of western technology capable and eastern production capable synergies.
Such speedy integration of often 2 or more targets underpins conjecture that automotive supply base will continue to shrink through the balance of the decade, estimates of the reduction vary from as little as 50 percent to as much as 80 percent and more from 2000 levels. Whatever the exact figure, this consolidation is changing the auto supplier landscape significantly, especially so for commodity items.
Whilst the PE vs Trade M&A rate debate continues, we believe that industry observers should not discount the role and power of provate equity. The fall-out effects of the credit-crunch are indeed visible, and banks themselves have tended to retain cash to defend themselves against further fall-out, so restricting the conventionally available liquidity for specifically LBOs. But whilst that may be the case within the US and partially in Europe, liquidity is of course global, the US$ especiall so, and there’s a great deal of it on the balance sheets of Asian firms, the budget suplus accounts of national governments, the acruals of typically petro-dollar based Sovereign Wealth Funds and within Asian central banks themselves accessable by local capital markets looking at US based opportunities. Hence PE has learned to look beyond its conventional backers and onto new clients.
Beyond the liquidity question, is that of does PE have innate expertise to transform the supplier-base opportunities? (Especially as VM deals look rare in the face of a preferance for trade alliances) Although PE has had focus in other sectors, the fingers-burnt syndrome of 1990s venture capital firms taught the industry much. It perceived the supplier industry as ripe for consolidation 15 years ago and observed highly fragmented market segments (such as die casting, machining, injection molding, stamping, outside processors). Successful outcomes were varied, but it taught PE a great deal about how to change its approach for the next round of deal-making, consolidation and profit-taking…which may well be here for them.
Lastly, the PE vs Trade debate will continue, but ultimately it will hopefully be stringent strategic assessment, in thorough due dilligence and conservative expectations, that lead to plausible approaches, offers and acceptances, and not a rush to beat the sector competition or the 'other side'. Present times are not those in which to be rash, and investors will undoubtedly punish those that are.