Tuesday, 29 April 2008

Business Opportunity – Tanfield Group – Creating the Spark of Interest in Taxis and LCVs

The road to successful ecological commerce isn’t necessarily an easy one, even if we are ‘green-washed’ into believing any venture with eco-exposure is expected to capture the public’s attention and take-off accordingly.

As Tanfield Group and it’s Smith Electric Vehicles division teamed-up with Ford, it undoubtedly hoped that City analysts would look favourably upon the partnership that integrates new generation propulsion with class-leading chassis and bodies. Unfortunately they didn’t, and the reaction to the showcasing of LCV ‘Ampere’ (based on the Transit Connect LCV) and the Faraday Mk2 was unfortunately negative, the important launch news completely out-weighed by under-performing EoY group results, and lack of near to mid-term impetus.

The main problem is the fact that these 2 new vehicles aren’t seen as adding much in the way of firm, immediate value to the Smith’s business.

The Faraday Mk2 will simply replace the vehicles of current clientele, so probably providing little in the way of additional sales, and the Ampere poses (for now) a distinct question-mark since its European and US customers tend to be smaller private businesses, who are understandably conventional in their buying habits due to reliability focus and the need to have secured depreciation charges allocated to the company van(s); well known when a conventional vehicle less so as an electric. In this regard the typical Ampere buyer would be the polar opposite of the big fleets (see below) who can afford to trial a limited number of Smith’s vehicles, particularly the Transit based Edison, given their large fleet size.

Sainsbury’s – Edison (Transit)
Royal Mail – Edison LWB
Southern & Scottish Energy – Edison LWB
CEVA Logistics – Newton 7.5T
TNT – Newton 7.5T
DHL - Newton 9.5T

[Interesting to note that 12 months ago Tesco decided to trial the Modec Electric Van, and continues to evaluate. Its sub 7.5T GVW compares to the Faraday, but looks far more futuristic]

Of course Tanfield and Ford recognised the Ampere dilemma some time ago and so have publicised the vehicle as the ideal city taxi-cab – previewed in New York – knowing full well that an Electric Taxi is aligned with Michael Bloomberg’s efforts to clean-up NY’s pollution and congestion, much of it created by Ford’s own aged Crown Victoria saloons used as the city’s Yellow Cabs. So the business case would be to demonstrate to hard-nosed small business owners the viability of Ampere from its almost ubiquitous appearance across the city.

London obviously pre-dated New York with deployment of the Congestion Zone, and taxis have been a central issue given their proliferation and associated emissions. At it’s here that investment-auto-motives believes that the taxi-cab business model will undergo a possible radical sea-change.

The introduction of TfL (London for Transport) private hire (Ford Galaxy) ‘black taxis’ means that a new breed of taxi sits as an interloper between classic ‘old fashioned Black Cabs’ (heavily regulated by the Public Carriage Office) and general mini-cabs (more lightly licensed conventional cars). This government-backed new breed has the might of the policy-makers on-side, and given that Ford is a favoured supplier, makes for the perfect launch-pad for latter-day introduction of the Smith Ampere, or its successor.

The fact that Tanfield has also signed an agreement to adapt the classic Black Cab – Manganese Bronze’s LTI TX4 (see previous post) – demonstrates that Tanfield looks to theoretically have a bright future.

Our interpretation of events is that in the years to come, as the regulatory impetus comes to pass to make London’s Black Cabs zero-emissions that the high-cost of buying an electric TX7 will be prohibitive to owner-drivers, who’ll also be weary of the technological implications/cost, and so only large taxi-lease fleet operators will be able to buy the products en mass and lease the electric vehicles to cabbies…much in the same way the trade worked in the 1910s and 1920s when the vehicles were unaffordable to the average cabbie. In due course again, it would make fiscal sense to eradicate the LTI TX7 vehicle for a suitable, standard electrically driven vehicle such as a Ford Transit Connect / Ampere.

investment-auto-motives believes that very few City analysts have even considered this latter day, big picture eventuality, but even for the few that have, that ‘pay-dirt’ is a long way off for Smiths and Tanfield group, and the probability is that as the reality comes to pass for electric cabs and electric light, medium and heavy logistics vehicles
Actually gaining market traction, Ford or perhaps another VM would look to an acquisition of Smiths or Tanfield. CEO Darren Kell undoubtedly has that far-off day in his business horizon. But for the moment, he is having to juggle City expectations whilst juggling the technical and contractual needs of his prime test-fleet clients; using the latter to convince the former.

Tanfield states that it build and shipped 260 vehicles in 2007, but states that 2008 will see production massively rise to 850-1100 units in 2008. As seen by the share-price fall (down 13% the day after disappointing results) analysts remain unconvinced that what should be a ‘good-news’ green gravy train is fulfilling the rhetoric. Observers also appear unconvinced at the synergies they’d hope to have seen develop between the electric vehicle division and Upright mobile platform acquired in 2006. The rationale is clear, targeting utilities companies with integrated products and equipment, but the order book, especially in that specialist arena ripe for efficiencies, appears to look less convincing.

The primary (non-Board) shareholders are as follows:

M&G Investment Management Ltd
Lansdowne Partners Ltd
DWS Investment GmbH
Goldman Sachs
Oyster Asset Management
Pictet & Cie

All will be looking to Darren Kell and his team to create a strong 2008 story, one that sets out perhaps a more detailed path of growth and value-creation than seen thus far.

Tanfield’s divisional balance, between electric vehicles / work platforms / electric engineering services, obviously appears on paper to be a good inter-related and highly synergistic portfolio, and a probable targeting of utilities companies well planned given the level of investment interest and the point in the business cycle for that field. If Tanfield can continue to orientate itself to be in the right place (as it seems to be doing) vs competition relative to the cycles of electric-truck fleet logistics and electric-taxi and small delivery sectors, all should in time be well - the technological seedlings planted yesteryear to provide green pastures for tomorrow.

Since the disappointing earnings report price-drop, confidence further waned, dropping below the £1 psychological barrier, but finding a support base at approx 94p and rebounding by Friday’s closing & Monday’s opening LSE price at 96.75p, rebounding 3.75%.

Whether the price will be buoyed by present big investor groups or by those Directors yet to hold stock or by third parties we’ll have to see, but creating that spark of investor interest with detail and progress of its coherent strategy and visibility of a transparent order book will be crucial.

Friday, 25 April 2008

Macro-Level Trends – Chinese SSE Stocks – The Economic (Olympic) Flame Returns

It’s the starting gun that switches potential energy to kinetic, a demonstration of which will be seen in Beijing, Shanghai, Shenzhen in the months to come. But in China’s economic race, after a 6 month hesitation, the authorities have clearly pulled the trigger via a sharp turnabout in regulatory reform to set investors off.

As the financial press have well documented, Thursday’s (24.04.08) massive 66% reduction in equities’ stamp-duty (from 0.3% to 0.1% of tradable value) proved the ‘fiscal injection’ that a 6-month slipping market needed to surge; up 9.3% on the day. Less than a year previously, in May 07, the Chinese political and regulatory mandarins endeavoured to cool the apparent never-ending bull-market with the 66% trebling of payable taxation. After a 5 month lag that hurdle and ‘topping-out’ rumours finally brought the market slowdown and reversal.

But were Thursday’s events such a surprise; surely not? As the world’s glare stares ever more intently at all aspects of China, the authorities were always going to steer the capital markets in the run-up to the games to demonstrate the country’s ongoing fiscal strength, re-enforce the booming China story, provide global financial credibility to Chinese Banking brands and critically open the world’s eye’s to the ‘invest-ability’ of the nation. Investment through FDI, extended JV networks, a foreign push to access Shanghai and Shenzhen bourses or indeed have high-net worth individuals push their investment managers seek a way in via PE interests.

Critics, such as today’s FT editorial, highlight that such obvious direct and influential governmental action makes a mockery of what are supposed to ideally be balanced, efficient market dynamics, investors reacting irrationally to external influential drivers as opposed to sound valuation methods based on good fundamental analysis. But ironically, unlike the ripple-effect of rumours and hearsay that can drive acquisitions and disposals, the previous night’s TV broadcast informing of the duty reversion could be said to be the theoretical fundamentals of EMH, so the massive SSE index jump only reflective of previously pent-up demand. The theorists will discuss for months to come, but the reality is, as any analyst knew, that the Chinese leopard was not about to change its interventionist spots, especially so at this juncture. It was only ever a question of exactly when and by how much.

The primer had come on Tuesday when the subtler action of slowing the market absorption of non-tradable stock (of mostly state asset companies) reduced the previous dilutive effect of certain stock-holders that had been taking place. That pricked-up the markets ears to the possibility of further ‘assistance’, especially since the avg p/e measure fell from near 50 in Oct 07 to ‘only’ 22 recently. Given the Chinese bias to traditional primary, processing and heavy industries, even that is more than double the value of similar western related indices with similar characteristics. Ford has just hit a 2010 p/e of 10, and that’s seen as optimistic against GM’s 5, so even now after the 6 month relaxation period, many will say a p/e of 22 is over-optimistic…but who is really to say when the NYSE and SSE operate in such vastly different economic, corporate, institutional and of course governmental contexts?

The true paradox is that the Chinese population has been switched-onto and into a level of Capitalism over a period of 5 or so years, when it took the USA over 100 years to reach the same per capita figures. Of course, aswell as the stock-market rebound, China has slowly been letting the value of the Renminbi rise against the US Dollar, both at America’s bequest but also for its own purposes as hopefully hordes of foreign tourists visit over the summer. The Rmb7 : $1 rate, and perception of the FX value to foreigners, will hopefully in turn drive up the volume of inbound foreign/US$ liquidity, so adding yet more to the foreign reserve account, and it is undoubtedly hoped partially slow the ongoing Dollar drop.

Back to stocks, and beyond highlighting the artificiality of China’s exchanges, Charles Dumas at Lombard Street Research, was quoted on 24th as saying “China is entering an unpleasant quadrant of the economic cycle where it has to cut back growth to stop inflation accelerating." Chinese officials have undoubtedly been keeping eagle-like eyes on US and UK press, and the Telegraph report of the same day hinted at the possibility of a rapid Chinese sell-off by those private investors lured in at the top-end of the 07 rise. Such reports may well have been the catalyst to settle and re-energise the local markets.

Given the ‘serendipity’ of the Beijing Auto Show this week, and so a heightened public and investor awareness in domestic autos, aswell as upbeat Q1 results from western VMs like Ford and VW what does the sudden Chinese stock hike mean for publicly listed automotive enterprises? investment-auto-motives will be taking a close look soon, but quite obviously the general upturn will give reason for auto CEOs to smile after what has been a rather tortuous ride. General market confidence will buoy MarketCap values and if that confidence can reign up to and beyond the Games, economic growth could even exceed the ‘slowed’ 9.5% of GDP rate, or at worst maintain that level. This in turn keeps commercial and consumer confidence high, even if the pushed-for pay increases don’t emerge as the labour-force hopes, so keeping the spending wheel spinning.

Those boosted MarketCap values greatly enable listed company CEOs to obtain even greater gearing from domestic and possibly part-foreign lenders, giving them the ability to implement what could be sector changing grand plans, probably endeavouring to appease government who’ve been pushing for consolidation for some time. Conversely, the booming economy drives more and more models to be introduced from ‘old state’, foreign JV and a whole crop of emergent new Chinese; some still to enter. The reported increase in available car models from 200 in 2007 to over 250 by end 2008 says much, but can such an influx really be viable given that even now margins on even newish vehicles are being slashed to sell. Probably not, as we’ve said before, there’s massive scope for consolidation on model-line, regional or value-chain rationale.

All CEOs, but perhaps those of Listed companies more so, will undoubtedly be looking for best-fit options as part of their M&A strategies, and they probably feel, like us, that now is the time to start trying to put those deals in place before the unknown economic after-effects of the Olympic Games come into being.

There’ll be a lot of schmoosing and a lot of corporate-sports analogies banded around in corporate hospitality boxes and local hotel dining rooms. Just as the Chinese athletes will be focusing on their future performance, so too will the auto-industry executives, hoping refreshed equities market excitement can be exploited to raise additional funds, whether fixed-income loans based on MarketCap, new SSE rights issues or even the confidence to list upon HKSE (next to Brilliance Corp) or even the NYSE or LSE to gain that all important foreign interest as the world looks on at this national highpoint.

And although it's been the car-makers who've had the spot-light, given the massive array of auto-maker clients (yet set for consolidation), it could well be the Tier 1 suppliers that take the baton and lead the pack.

Tuesday, 22 April 2008

Industry Structure - 'Old' vs 'New' Templates – Power begat Profit / Profit begat Power

The ‘shape & mass’ of a company is usually developed over years if not decades, theoretically honed to a specific structure that underpins the basic tenants of commerce – profit and power.
Of course changing economic contexts demand that its basic shape be malleable enough to shrink and expand as required, through either organic growth/contraction or ‘bolt-ons’ and ‘spin-offs’ to keep the company healthy and value creating.

Those 2 prescient elements of profit & power don’t change, but macro and micro level influences like globalisation, business process re-engineering, a broadening knowledge-based labour market and of course information technology has evolved operational trends and management science to alter the traditional relationship between profit and power, and critically the definition of the latter.

Commercial theory posits that Power can be defined in many ways, but the most elemental is control across the full-span of value chain, from beginning to end. Historically, this is how the great industrialists from Rockefeller to Ford built their empires, and it’s the very model that BRIC’s oligarchs and executives favour today. As part of their conglomerate’s growth, they have had to grow vertically and horizontally, indeed there could be said to be a ‘snowball effect’ of a growing business which naturally creates it.

However, the emergence of a diverse service economy, enhanced by the advent of globalisation, enabled the individual firm to reach-out across an ever more varied business landscape (made-up of ever more dedicated, area specific, enterprises and services). As the business world fragmented and globalisation grew the vast array of options, we could say that a first stage enabled the west to access low-cost, low-value Asian manufacturing and ‘brain-ware’. We are know witnessing the second stage of the process as Asian firms, having grown on the back of low cost products and services, now seek to access to ‘step-change’, world-class technologies and know-how - ideally via M&A, not JVs, as exemplified by TATA and Jaguar-Land Rover. This then demonstrates the modern interpretation of the conventional ‘Power’ through a massive tangable asset base, business (and possibly market) integration providing ‘Profit’.

There has also emerged a its polar opposite of this paradigm, the newer re-interpretation being that (calculated) Profit itself provides the leverage for Power. A power based not upon complete value-chain ownership, but the ability to orchestrate those others whom own different sections of the required network to create, from a blank page, a value-adding product or service. At its essence it reflects the ideology of ‘knowledge broking’ and depends greatly upon a massive network of business connections, commercial acumen and credibility.

Of course this is what the very well connected world of pro-active investment banking has been doing for over 150 years utilising the best minds to create industrial business models and of the development of new financial instruments and fiscal engineering.

But as the west becomes an increasingly post industrial economy and relies upon the new (non-tangible) cerebral asset base of a knowledge economy so industrial activity itself has evolved to the ability to harness intelligence and create value. This, from a historical process perspective, done backwards to conventional business practice - from inside an 'in-situ' plant-tied firm. Essentially a de-constructive and re-constructve approach of many other's assets and abilities.

The 1990s evangelism of Business Process Re-engineering (created by MIT’s Hammer & E&Y’s Davenport and quickly adopted across industry) called into question every activity within the generic firm’s internal value-chain, and prompted the elimination or cost-down of non and low value-adding processes. That in turn led to massive cross-sector re-organisations, especially of Fortune 500 and FSTE 100 companies, which with the help of large management consulting firms established additional, new IT and Admin-based facets to the previously aged and very industrial Support Services sector.

We could say that, that was the start of the devolution process and pretty soon the questioning regards “what is our core business and related activities” dug into link after link of that value-chain. The divestment of ‘non-core operations’ (open to definition and so the spark behind many a middle-management inter-departmental feud) allowed a firm to more intently ‘focus’, and so, increasingly the weak links of the chain, often based on a “complexity equals cost” argument, were removed. This was the basis for the likes of Delphi’s, Visteon’s, Magna’s etc emergence as massive Tier 1 players, able to more efficiently assembly sub-assemblies, which latterly became whole vehicle modules, that take complexity, time and cost out of a VM’s own production lines.

Take this to its natural conclusion, and we have the slow erosion of a VM’s traditional activities, preferring to actively outsource full production and act as Brand-Enterprises. Of course this has already happened with the production of niche vehicles such as GM’s VX220, low volume models such as Porsche’s Boxster and lower-volume local-production variants such as BMW’s X3, Jeep Cherokee and Chrysler Voyager and Mercedes 4WD vehicles. As a result we’ve seen the slow development of Tier 0.5 producers such as Magna Steyr. As the western auto-industry contracts due to economic and cyclical pressures, this trend to ‘farm-out’ production will continue, and the recent major shape-shifting of Detroit’s Big 3’s plants, [and in turn Delphi & Visteon plants] whether individually closed or contractually left open to spin-off, demonstrates that this decade’s ongoing re-structuring campaign is a modern watershed in the old fashioned ‘Power equals Profit’ formula.

As western procurement and manufacturing diminishes the bottom line so that formula has been questioned and re-orientated to ‘Profit equals Power’. Compelling, highly confidential, and increasingly stake-holder shared, business cases for vehicle projects or even whole divisions are the basis for multi-party shared risk-reward agreements. And as the whole playing field of vehicle design and marketing methods changes under the edict of global warming and the CO2 challenge, to include different powertrain types and new value-based (not price based) retailing methods emerge, so the once relatively simple procedure of developing a new vehicle (ie single model, heavy ‘carry-over’ replacement) becomes a far more complex exercise, requiring very different organisational thinking and abilities.

The ever deepening application of BPR has questioned what makes the foundation of tomorrow's new world auto-company? It has become more nebulous, more intelligence-orientated, more time-cost specific, and ultimately 'simply' ties financing to market opportunity using entrepreneurial skill and other parties' capabilities and assets.

From that basis the advanced thinking in the West seeks-out the ‘Profit begats Power’ idiom in the Brand-Enterprise ideal, whilst the East evolves the more conventional ‘Power begats Profit’ philosophy. But of course, although these 2 commercial / corporate belief systems cognitively appear worlds apart, they are could within 10 years be practical twins.

Coca Cola set-out the brand-centric, (bottling plan) asset divested, business model but who in automotive terms has that equivelency in sector power. We naturally look to Detroit with its history and slimmed but still massive asset-base and its Wall Street ties, but do GM, Ford or Chrysler have that Coca-Cola equivalency? Perhaps the recently globalised Chevrolet might?Toyota definitely does, but given general ongoing Japanese business conservatism, and Toyota's well-defined culture and core-competancies would it even wish to try?

The 'Profit to Power' formulae is in there, but it neccessitates a great deal of further examination by pro-active investors, financiers and auto-industry captains.

Monday, 21 April 2008

Company Focus – SAIC – The Return of the Octoganiarian Octogan

The auto-industry is half made up of yesteryear folklore and half consists of tomorrow’s new horizons, and there is perhaps no better example than the 80+ year old MG. Previously under NAC’s wing, the blame for a procrastinated gestation period and over-due ‘re-birth’ laid with SAIC.

The circumstances surrounding the UK sale of MG – Rover, whilst not forgotten, have subsumed and now all eyes are upon the consistently delayed return of the MG-TF mid-engined to the UK, European, Chinese and perhaps even US marketplace.

Those delays have been stated as initially project administrational problems, then SAIC-Nanjing organisational integration problems and latterly the desire to achieve benchmark product quality. All along industry observers have assumed that the Chinese would simply produce for their own rapidly enlarging and fragmenting domestic market, and employ the maintained portion of the former Longbridge production centre to assemble Chinese sourced CKD kits for the UK and Europe.

Production from both Chinese and UK sites is supposed to commence at the end of April and end of July respectively, but given the previous inability to meet self-set deadline targets, few are holding their breath, except perhaps those SAIC execs such as President Chen Hong.

Of course Hong and his team are endeavouring to match European quality levels with Chinese cost bases, much as Manganese Bronze are endeavouring with the TXI taxi. But there is a world of difference between the emotionally driven expectation levels of a premium branded sportscar buyer and the functionally driven requirements of a taxi-owner operator or his passengers. Perfecting the MG experience is what we, potential buyers and of course MG enthusiasts hope NAC and SAIC have been long deliberating

But what of the business-end of ‘market expectations’? Where exactly will SAIC try and sell the car? Given China’s obvious export ambitions and the global recognition of the MG marque, it would make complete sense if the TF were sold (ultimately) globally. To this end given SAIC’s entwined relationship with the able engineering consultancy Ricardo via their Ricardo 2010 alliance (for Roewe 750 & KV6), Chen Hong must have ordered the TF project team to investigate the costs of engineering a US compliant TF. NAC first muted the idea of MG returning to America back in 2006, indeed the potential for setting up a local manufacturing base in Oklahoma. Whilst this was undoubtedly used as a bargaining ploy versus Longbridge workers, the idea of a 2nd local manufacturing hub makes complete sense if the $US stays weak (as expected) and the Renminbi maintains its strength [presently at its highest level of approx Rmb7 :$1)

So the question is “has there been more behind the scenes re-engineering of TF than the ‘simple’ cost-down exercise first imagined?” Watch this space.

The fact is that SAIC recognises that the US has historically held MG close to its heart, seen alongside Alfa-Romeo’s (Duetto), as the quintessential European open-top sportscar. Given the massive success of the Miata/MX-5 there is undoubtedly a large market for such a car…a car with mass market prestige (ie read snobbishness) beyond the small Mazda. (Think of it as Miata meets Mini Euro-chic or some such). FIAT’s Marchionne will have recognises that the first to get a re-born Euro sportscar brand to the US market will obtain the press accolades and critically the aspirant consumers’ ‘share of mind’….after all many would like to re-live Dustin Hoffman’s ‘Duetto experience’ from The Graduate, or Ryan O’ Neil’s ‘TC experience’ from Love Story.

Auto-culture romanticism apart, and looking at the essential business issue of automotive project profitability, if investigated properly the MG-(T)F could well go down in auto-history as a possible contender as the most value-creating production exercise, as yet without an end. [ But then again, we have to state that there's been as much creative thinking in the investment and divestment philosophies of MG's quick-succession parent companies....a perfect blend of prudent, successful financial engineering and mechanical engineering!]

It was born from a Rover Group skunkworks project named ‘Pheonix’ & PR3, prompted by the 1989 Miata’s appearance and set very strict cost guidelines which were governed by a low-technology/low-cost philosophy. That in reality meant re-appropriating other vehicle structures and technologies that had been already amortised in production or were being developed by other project cost-centres, hence reducing to a minimum the apparent cost of the project, so as to gain Board approval at the 16-20K pa volume.

Hence given its ‘beg & borrow’(if not ‘steal’) engineering roots and the low cost tooling and generous supplier contracts gained by Rover Group, the first lifetime of the car that ran from 1994-2005 would have made the ROI and IRR figures look wondrous given auto-industry norms. Shift that tooling to China and obtain a much reduced BoM (Bill of Materials) with the advantage of greatly enhanced production volumes and even though the ‘old girl’ TF will be theoretically out of date compared to Miata 3, the business case fundamentals look impressive given that in reality SAIC will be focusing on 'second-life' China sales, less so European, and possibly look forward to yet another 3rd life-cycle in North America.

Thus the 'Phoenix' rose once before in the UK & Europe, again now in China & Europe, and possibly yet again in the future in the USA.

How FIAT & Alfa react to the USA dilemma will be interesting to see unfurl. It is looking into local production of Alfa’s in the NAFTA region to possibly combat SAIC’s Oklahoma plans. FIAT’s preferred spot is presently Mexico, and ironically it too could prove the lure for SAIC, and not only for cost reasons…for Mexico’s flag consists of a snake eating bird, very apt given the snake in Alfa's logo (derived from the Milanese coat of arms).

But ultimately much of MG’s and Alfa’s future lies in whoever will Graduate first in the US and re-create the European sportscar Love Story

Thursday, 17 April 2008

Company Focus – Manganese Bronze / LTI – Hailing a New Ride Eastward

In niche manufacture supply chain relations and dependency means everything, and such producers rely heavily on the supply and payment flexibility of said suppliers, so whilst there have been forays into low-cost production centres from as far afield as Essex to Tunisia and Tamworth to the CIS, UK specialists have historically stayed nation-bound, unless sold-off to foreign owners; as witnessed with TVR to the Smolensky’s – Blackpool to Russia.

These industry ‘minnows’ are the philosophical and operational polar opposites of their major VM counterparts, often dealing in the high hundreds of units on an annual basis as opposed to the hundreds of thousand or millions. However, aiming for a new position further up the output scale, lifting 3,200 units pa to an ambitious 20,000, is London Taxis International, and its conglomerate parent Manganese Bronze, the renowned makers of the iconic London Taxi Cab.

Whilst the niche auto-sector has had to look closer to home for assembly cost savings, the theoretical ‘match made in heaven’ between the UK’s niche auto-companies and China’s low cost capabilities has long been recognised. But given the often UK localised, small scale supply-chain that feeds such businesses, and long relatively costly, transportation through China and over-seas, the logistical element can prove problematic unless volumes are raised to overcome the hurdle. Not may niche-makers can substantially grow their business-base over-night to take such advantage, and so have been caught between the Sino-promise and Anglo-reality.

Manganese Bronze and LTI are in the process of dispelling that paradigm, the volume-rise key to the business case delivering. LTI was for many years considered a relic of the trade, unchanged for decades with its core, long-running FX2/3/4 vehicles but the business at the time was very profitable thanks to long-amortised tooling and basic engineering that had been incrementally cost-shaved year on year. The high margins were protected by a virtual monopoly on the approved taxi business, as it ‘made hay under the blue skies’ of protectionism by the Public Carriage Office’s licensing specifications; so creating an effective regulatory barrier to new entrants.

Hence LTI was left alone inside its own eco-system, whilst the world of private passenger car design evolved. The FX - although a dinosaur - was practical and profitable for LTI and its cabbie customers.

The modern world started to encroach in the early 1980s when other specialist manufacturers were encouraged to replace the archaic FX, leading to MetroCab Ltd introducing their very geometric vehicle, a then very ‘modern’ package efficient vehicle. Outside of London it sold well, taking LTI market share thanks to price and running cost advantages, but inside the capital where the classic FX’s shape and history was a much loved attribute by tourists and Londoners alike, the MetroCab foundered. London cabbies knew that shape was a part of what earned their fares.

Although LTI was saved by circumstantial fortune the MetroCab affair shook the complacency of the company management who realised that ‘taxi-land’, even London’s ‘taxi-land’, may not be theirs for the keeping after all. That realisation, along with the massive (safety, comfort and emissions) design chasm that had emerged between the FX and cars demonstrated that the FX had reached the end of the road and needed replacing with another FX retro-styled vehicle. The mid 90s TXI was born, but whilst safer and nicer than the old cab has been the bane of cabbie grumbles, caught between the advantages of new MPVs and even the old FX. There major concern, beyond driver ergonomics of the seat and MPG, is the massive fall in residual values of the vehicle since, unlike the old FX that went-on to provincial territories, Manchester, Birmingham, Liverpool, Glasgow etc cabbies have kept with the MetroCab and its successor variants, and 2nd hand TXIs compare against new MetroCabs, let alone 2nd hand prices. So an enlarged used TXI market would be a London cabbies dream, and that might eventually come about for right-hand drive foreign markets such as Australia and South Africa, and remotely possibly Japan, if Manganese Bronze’s and LTI’s long-held international expansion plans materialise.

That 20,000 unit pa ambition is underpinned by a JV with Geely based in Shanghai, which although proffers amongst the costliest labour in China, does still look attractive even with a rising Rinminbi. Especially so as the TXI, although less labour intensive to assemble compared to the FX, still depends on substantial man-hour input – it was actually designed that way to avoid heavy tooling CapEx costs.

The JV provides the basis for a greatly improved niche vehicle business model, massively reducing the overhead, variable and stock-item costs to provide greatly enlarged margins and profitability. And importantly, room to inject a final product pricing elasticity that may be required when endeavouring to secure new international contracts from new clients that have in many instances been ‘locally loyal’ for decades.

But ultimately the product and service offering from LTI will need to be developed to be far more than the (first glance) apparent ‘icon vehicle’ that visually adds to the city-scape. It’s a good start and differentiator, but needs to be worked into the contextual background that’s being created by increasingly high profile City Mayors that have been given their head in more and more cities since Rudy Giuliani & Michael Bloomberg in New York and Ken Livingstone in London highlighted the power to transform. So TXI has to develop to fit within individual (and hopefully ultimately separately convergent) City politics and policies that would back a unique City Cab initiative. Thankfully for TXI there are very few regulatory bodies abroad akin to the UK’s Public Carriage Office that still essentially set such specific design standards.

[Paradoxically one might expect emergent countries to use such legal mechanisms to partially protect their own indigenous auto-sectors; however given that car-based taxi-fleets are such as corner-stone of an emerging market - esp with foreign JVs (eg China’s use of the old VW Passat/Santana) – such barriers have proven pointless].

However, as of today, LTI is under pressure to meet the initial 500 unit order of that ideal 20,000, as industry insiders watch to observe proof of the JVs operational integrity, both in the efficiency of completing the 1st order run and the level of Chinese (vs UK) product quality. But ultimately from a City analysts’ perspective the ‘proof is in the pudding’ and that pudding includes anticipated UK market fortunes. As the share-price drop indicated, unfortunately for Manganese Bronze the sentiment is conservative, since LTI is caught between the reality of a (possibly heavy) reduction in London/UK sales given the economic climate and the promise of its new ‘Chinese 500’ enterprise performing perfectly. [Privately we suspect the customers who’ve ordered the Chinese Cabs may try and find fault in the product, delivery, or contract so as to reduce their payment and LTI’s receivable invoice value].

However, that hopefully unrealised concern aired, this is indeed a new era for MB & LTI, the ambition has for so many years appeared as pure speculation, however as those who’ve been there know, Chinese negotiation and agreement is a frustratingly slow and painstaking process.

But the result is that the foundations have been set, and LTI needs to now shift into an enhanced world-view marketing mindset that engenders the ability to not only offer the classic London Cab design to the world but with a modicum of exterior changes, develop a range of city-specific products for capital cities and their over-shadowed 2nd & 3rd city counterparts who seek higher profiles nationally and internationally. If the firm can reach the upper echelons of influential key decision-makers (such as the re-emergent City Mayor) and integrate their TXI product and service with local public-private transport policy – through possible lobbying for change that MB/LTI can assist and mould to be sympathetic.

So in addition to the much needed ability to raise volume the firm should also take a lead in clean energy propulsion technologies to add a technical functional USP beyond its aesthetic one. And furthering that dimension, look to be part of an intelligent transport infrastructure, installing perhaps with client city assistance, networked telematic technologies from sat-nav and upwards so as to demonstrate itself as the vanguard of global taxi and private hire product & service providers.

If MB and LTI can strategise and implement effectively, the expected growth of private-public transport should be approached logically yet creatively; especially so in mature western consumer markets under where car usage is altering due to socio-economic and environmental reasons. But that is the long term, today is about managing the UK-China relationship, for that’s the first step of what could be a very long and productive journey.

Wednesday, 16 April 2008

Macro-Level Trends – US & W. European Contraction – Searching for the Economic Bed-Rock

US and European auto-makers and their suppliers spent much of 2007 (indeed much of the last 5 years) trimming and re-trimming operations to a lean condition to enable the battle against the ever growing headwinds. Labour negotiations and legacy costs have been dealt with, and all too briefly, there was a respite in Q307 with the possibility of profitability increases looking forward into 08.

At that moment, many observers were (to our minds) overly bullish in their projections of a flat US market at 15.5m units for 08. Given the real-world, market-centric effects (even pre-cursing the credit melt-down), investment-auto-motive’s projections were in the realm of a very conservative 14.5m (factoring-in a retail-end credit squeeze), demonstrating what work lay ahead of the US industry to re-balance in what were already testing times. However, although at that point in time we had the unhappy fortune of calling closest ahead of time, all formal forecasters reacted to the unwinding credit-bubble by Dec07, the Jan08 projection by CSM stood at 14.3m – a massive 1.2m units below Q307 mass consensus; and again recently down-graded to 14.1m. And that is with as yet to be fully identified and absorbed write-downs by the banking sector.

There is of course the school of thought that the massive ‘knee-jerk’ pendulum-swing in banking and retail credit-offer terms is infact “pulling the rug from under the feet” of what are legitimate, sound credit-risk consumers, and this in turn is creating the unwelcome spiral effect of reduced consumption; most obviously witnessed in autos.

March YoY figures for the US and Europe are looking dismal, down 8% and 9.5% respectively. In the US, even Toyota and Hyundai, the biggest winners of 2007 have seen the biggest falls of 17% and 15% respectively, thereby putting pressure on domestic aswell as Asian VMs and their supply-bases to re-think their exactly how they can move forward under such harsh domestic conditions. These figures will have major ramifications across the global supply-chain, the Japanese and Koreans demanding more cost-downs from domestic and Chinese parts-makers, whilst the US Big 3 will have to push for greater access to massive volumes of Sino-derived low-value parts.

The reality for much of the Tier 2 and 3 US suppliers is that their world has been changing rapidly throughout the last 5 years, but their own order-book ‘up-turn’ projections (based on economics figures and industry rhetoric) has had to be post-poned time and time again.

This is undoubtedly the period of great industrial ‘unwinding’ in the US. [Perhaps less so for Western Europe who’s supply chain was more consolidated and less reliant upon a massive network of long established, but unfortunately strategically trapped, family businesses]. Of course, given scale and economic impact, the main focus has been upon the Tier 1s, the likes of the Delphi, Dana, Collins & Aikman, Visteon, Tower, Wagon, American Axle etc many of which have been under the protective umbrella of Chapter 11 for a couple of years. That has attracted PE & activist share-holder interest from the likes of Wilbur Ross and Carl Icahn, creating new amalgamated enterprises (ie International Auto Components Group) to cherry pick the best of forced divestments to create a new addition(s) to the US’ big Tier 1 family, And given its name, and origins, they may well be sold-off to cash-rich Asian firms seeking a proper foothold in the US to both feed the Big 3 and ‘New Domestics’ aswell as the expected latter-day introduction transplants from China and India.

Bernard Simon of the FT reports that whilst the big stories (and allied industry conjecture) obviously take centre-stage, there has been a wave of antipathy that has swept the small operators, their proprietors finding that the business case their companies were founded upon decades ago has simply diminished. Too small and too unsophisticated to be of interest to local and international trade buyers, they’ve simply shut-up shop.

Ironically, in the ebb and flow of industrial change, the struggles of certain suppliers such as American Axle’s strikes, are undoubtedly helping automakers themselves to halt the assembly of over-capacity product such as in this GM’s Large Truck & SUVs; helping to reduce the over-stock of factory-held inventory. But of course the strikes themselves are largely related to the manufacturing reduction GM has been forced to undertake and that impact on their supplier-base.

The likes of Magna International, Tennaco and Lear Corp stand in the same firing-line for worker unrest as they will expectantly be hit by scaled back GM orders, now hitting cars like the Cadillac DTS & Buick Lacerne, not just obvious Large Truck assembly.

Quite clearly, the ‘given-ground’ offered by the UAW to the Big 3 set precedents that the US supply-base will simply have to follow. That means new entry-level labour pricing and very probably the VEBA model for pensions and healthcare to buoy company balance sheets and liquidity for a US rebound, itself much dependent upon the weak US Dollar that has assisted cross-sector exports in recent months.

So that downward economic spiral hasn’t quite finished its journey, and the working-man, watching his world apparently fall-down around his ears won’t believe the storm clouds are ready to shift soon. But look at the bigger macro factors, beyond the credit-crunch, and a cost-contained US industrial base married to the weak Dollar and undoubted external/ FDI investor interest from homeland activists, foreign trade-buyers, PE and SWFs should provide the all important foundation for growth.

As far as the currently fragile supplier-base is concerned analysts offer varied opinion on the level of, and speed of, stock and MktCap value creation, but the balance is shifting in favour of a rejuvenated sector over the next 8-12 months, itself tricking into the ‘real economy’ in 12-18 months.

But as ever, forecasting industrial growth and the consumer confidence lag in these - to quote Greenspan’s verb – “turbulent times” isn’t easy. Factor in the growing appreciation of ‘Black Swan’ effects and forecasting will become perhaps even more of a black art than the science it often endeavours to present.

Monday, 14 April 2008

Industry Structure – Low Cost Cars – But what is Low Cost?

Idealist sagas tend to run deep and run long in the auto-industry, idealised solutions that never seem to emerge given the complexity and, some might say, stakeholder interest.

Most basic is the corporate efficiency idealism offered by the generic ‘world car’- technologically conventional and ‘stamped-out’ in its tens of millions.

Starkly contrasting that theme of operational mass-conventionality is the high ideal of the long-mentioned HyperCar, a radically architecturally (BIW & P/T) altered vehicle and production process that makes today’s vehicles look very…well…early 20th century. The ‘World-HyperCar’ is perhaps the ultimate ideal, and theoretically not inconceivable, but given the required down-to-earth attitude by execs of “profit over prophecy” that dualistic nirvana is still some time away.

However, far closer to home, applicable idealism has been centred on the thesis of the ‘low cost car’ by old world and new world auto-makers alike, to serve the rapidly rising consumer-bases of BRIC+ regions. And powerful solutions have been proffered. The extremes possibly reflected by Renault’s (Dacia) B/C-segment Logan & TATA’s A-segment Nano. The first demonstrates the laudable 6% margin available from an amortised ‘old’ platform & supplier value-extraction. [Renault rightly sought good Euro NCAP ratings early-on to provide long platform lifecycles to enable extended application as a low cost car – 2 birds, 1 stone]. Whilst secondly, TATA’s Nano demonstrates what’s achievable with product champion will, a very broad corporate capabilities base and the promise of a massive volume business case.

The web-site just-auto has recently been questioning what essentially makes a ‘low-cost car’, and rightfully concludes that there are many variations of the theme, market relativity, segment type and auto-maker type important. Thus there is no singular correct definition; the world and the industry are simply too complicated for that.

The secret to developing a low cost car is about understanding and managing as many elements as realistically possible within the (‘cost-down’) value chain. But theory doesn’t necessarily deliver results given a firm’s real-world situation. So it must play to its own strengths, and possibly align its core abilities with the complimentary core competencies of others, so as to create its own low-cost car routemap. Of course the usual contributors of: volume [for CapEx amortisation and purchasing scale], part-count-reduction engineering, low-margin feature/options/accessories elimination, etc are a given.

So although definitely worthwhile, infact critical, to understand the operational and project-based routes to achieving a low-cost car we must also appreciate that the bigger picture that corporate context plays a vital role in enabling its creation. And the fable to the low-cost story will be familiar to any industry luminary. As initially played-out by Ford and GM in the 1920s/30s, then Japanese in the 1960s/70/80s, then the Koreans in the 1990s and today the Indians and Chinese, long and malleable industrial value-chains are key.

Powerful vertical and horizontal cross-industry structures enable cross-divisional (‘elasticised’) transfer-pricing and the opportunity for general financial engineering – especially under beneficial accounting rules. [A wonderful example of this is massive 21% stock-price rise of Hyundai Motor over the last month, even with tough ‘headwinds such as steel costs, thanks to legal omissions of subsidiary losses]

So, for financiers and investors, there’s much much more to be investigated behind the apparent panacea of the low-cost car. How exactly do you define low-cost? Is the Nano’s amazing price all of TATA Motors’ doing, or a result of heavy internal project and production subsidisation? Thus as the industry chases the pot of gold at the end of the BRIC+ rainbow – and it is undoubtedly there - how do the less keretsu/chaebol integrated companies even-out the playing field? Renewed VM shareholder interest in the re-structuring supplier sector? GM’s recent move for convertible loan-stock interest in an indebted Delphi might be the first clue? And the second clue? Pardus Capital’s insistence on 2 Board seats at Valeo for “full and proper representation” as it possibly seeks to consolidate the French parts-maker with its stake in Visteon.

Look at the timing of the re-structuring of the western supplier-base in regards to the timing and the broadening and sub-segmentation of the BRIC+ middle classes and we see that lower-cost (possibly ‘world’) cars could be in western VM’s portfolios by 2010 and beyond. If these VMs, with major Tier 1 supplier stake-holdings (Bought from the exit strategies of private equity sellers), use the best of the Renault ‘long-life’ platform stratagems and the best of Asian value-chain extraction practice, today’s primarily institutional investors (and reduced stock-holding PE) will be content indeed by 2012.

Thursday, 10 April 2008

Micro-Level Trends – Design, Production & Marketing – Volvo Assists the Mass-Customisation Ideology

The technology was first applied to flat-side vans and trucks for basic business name and pictorials, then skilfully developed for full vehicle body applications, initially taxis, then commercial delivery fleets. And latterly we’ve seen VMs and dealers utilise the technology to personalise re-born Beetles, Minis and now 500s; providing a possible hint of what was to come.

This week the phenomena matured to its natural, potentially very powerful, end-game with the introduction of – to our knowledge – the first manufacturer created full & part body graphics range for new private car sales. Volvo and the C30

The evolution of applied graphic films has come on a long way, especially over the last 5 years. The CAD technology that designed the first ‘2nd skin envelope’ for cabs has massively expanded its library of vehicle surfaces, allowing the tailoring of the technology to any car.

At first glance it seems like a natural evolutionary step, as indeed is, but look closer at it has massive ramifications for the industry. For car-buyers the traditional colour palettes mutate into full-blown design suites. For auto-makers, the high-cost, complex and time-demanding paint-shop can be simplified, reducing the spectrum of colours needed and the quality of paint finish – the 2nd skin film used to visually dress the desired finish.

The basic virtues of the technology application have been recognised by investment-auto-motives for many years, its ultimate raison d’etre suited to the mass-customisation and differentiation of ideally a singular basic generic model that can be dressed (and modified in function and feature) to suit the personalisation requirement of the buyer. It would be the automotive equivalent of dressing a standard mobile phone or I-POD with style/fashion jackets.

From a commercial perspective though – for film manufacturer and auto-maker - it doesn’t make business sense to wait to integrate the technology into an as yet embryonic business model. But don’t be misled by the fact that Volvo is the brand to release the service into the (at first Swedish) market. Parent Ford is undoubtedly behind the initiative to both expand the pricing margin via this option for Volvo and observe & develop the process aswell as see how the film fares in relatively harsh Swedish climate conditions. Volvo is thus acting as an improved revenue earning test-bed for the application. The endeavour makes total sense from a Group commercial perspective, but exactly how it will be viewed and adopted by C30 buyers is a pertinent question, the answer for which we shall have to wait.

Although the launch of this full-body graphics service has been relatively low-key, the impact upon operational build/finishing systems behind factory gates, and the brand marketing process on the web and dealer-floor could be potentially immense, if the potential of the accordant business model was developed fully – as previously intimated.

Without being overtly theatrical “this is one small step for Volvo….one giant leap for Auto-Man(ufacture) kind”. But then ultimately, is it not about a single person’s own theatrical effort to stake their claim in what many may think a barren automotive landscape? The beauty is, the innovation has been anything but rocket science to get there.

Wednesday, 9 April 2008

Company Focus – GM Vauxhall – a Faux-Hallmark?

The Vauxhall name is an undoubted stalwart of British motoring history, but over the years as the world of automotive choice grew and consumers’ mindsets opened, that once heralded marque of heraldic origins lost its way, a general decline market share since the 1970s with the Opel brand over-throwing Vauxhall debate a constant returning topic within Luton and Russelsheim.

The idea of broadening the Opel brand to envelope the UK was kept at bay by the UK car market’s upturn in the 1980s, Vauxhall’s “boats rising with a favourable tide”. But in real terms the decline (as with Ford) has only been reversed momentarily when market conditions have worsened and Vauxhall dealers have been able to out-play their peers in terms of product and financing; able to lean on the mighty GM to effectively ‘buy market share’. Other periodic reversals of fortune, as and when there been a new product introduction or the mix has offered a cyclical ‘sweet-spot’.

Such a time is now as Vauxhall gains just over 10% of the UK market, up from 8.3% a year ago. But is even 10% a tenable position to be in as a supposed major manufacturer on ‘home ground’? Look elsewhere around Europe and the globe (exempting the US) and the conclusion is not hard to reach.

GM’s management knows this and has once again tried to re-energise its brand with a newly introduced re-drawn logo that aims to provide a more upmarket, quality ‘look & feel’. The problem is that that re-drawn graphic is hardly earth-shattering. Yes it cleans-up the Griffin & Banner pictorial but the public and Vauxhall buyers are so cognitively removed from the detail of the badge that there will in reality be little reaction

In truth the time and cost of such an exercise, including very costly dealer frontage renewal, should commercially deliver greater results than simply treading water.

But of course Vauxhall & GM management face the perennial problem of a supposed high-recognition brand that holds little true brand equity. That’s why year after year decade after decade what are announced as major re-imaging efforts have simply been tinkering at the edges instead of the much needed sensitive yet radical revolution.

Even the name ‘Vauxhall’ has no contemporary relevance; it hasn’t since the Edwardian era when the Vauxhall Iron Works moved from London’s Vauxhall to Luton in 1905, along with the firm's earliest 1903 car. The same lack of relavance for the logo, derived from the original aristocratic shield of Fulk le Brent (who gave his name to Fulk’s Hall located in the latterly known Vauxhall). So its here by (very) historical twist rather than modern virtue. Yes, the Griffin holds the ‘V’ Banner, but so what? Ask anybody but a Vauxhall salesman or devotee and virtually no-body could recount or draw the details of the Vauxhall badge.

In a world where other’s automakers recognise the need for immediate cognitive recognition (visually and phonetically) GM’s UK brand falters on both points. In comparison simply look at the simple, nameplate and letter-centric logotypes of:

Toyota’s stylised ‘T’
Volkswagen’s (iconic) VW
Suzuki’s stylised ‘S’
Honda’s ‘H’
Hyundai’s stylised ‘H’
Hummer’s ‘H’

Others have opted for basic symbols such as: Mercedes’ Tri-Star, Audi’s 4 Rings, Citroen’s double Chevrons (stylised helical gear teeth), Renault’s Diamond, Ford’s Blue Oval with clean Script etc. Others again have amalgamated initials and pictorials the most obvious being Bayarische Motoren Werke’s reduction to ‘BMW’ (without full wording) and stylised propeller roundel.

Highly detailed badges that derive from geographic origins (like Vauxhall’s) only work on premium cars such as Milan’s Alfa Romeo and Stuttgart’s Porsche. In the 1910s and 1920s Vauxhall did make high-line cars but the memory is long lost.

And so the badge is in effect a relic, and the name Vauxhall given its recognition based on the market power precedence of GM over the years.

We live in a sophisticated, brand-savvy consumer environment where brands must have resonance and simplicity (such as Apple & I-Pod) appear to reign. Of course that is an over-generalisation, each brand lives within its own environs and peer group…and that’s Vauxhall’s central image problem…it is a milieu of different elements (“heraldry for the masses”?) and doesn’t cognitively ‘fit’ into today’s ‘brandscape’.

That was precisely the problem Rover faced through the downturn late 70s, aspirant 80s and effective death-throws of the turn of the century. It was a mainstream brand derived from more glorious, premium days. And throughout the “slings and arrows of outrageous fortune” it tried to massage its detailed logo from the last original application on the 70s SD1, to the line-drawn interpretation of the Metro & Montego to the re-born classic badge of the R75 to the latter-day ‘halfway-house’ re-simplification of the most recent R25 & R45.

As with Rover’s Viking Longboat, Vauxhall’s Griffin & Banner presents a logo recall problem (the very opposite to Opel’s simple Lightning across Roundel).

Vauxhall does indeed face an image problem, and it won’t go away even if management try and pretend that temporary increased sales (due to a favourable market environment) was promoted by an identity refresh.

In truth it hasn’t gone far enough and the efforts of the in-house design team (undoubtedly given a restricted brief to undertake a basic design audit and effectively ‘clean-up’ the logo) reflects the difference in thinking and practice between automotive vs brand identity design management.

When a buyer, user or the public view a car, perception is gained via 2 main inputs: the car’s visual appeal and the cognitive brand association of the manufacturer. (Its why in pre-launch design clinics new cars by mainstream automakers are often rated higher before their ‘average’ badge is revealed). That dualistic mix is critically important and no matter how good GM Europe’s cars are stylistically (an they are handsome) they and specifically Vauxhall is let down by the barely relevant graphic, poorly defined brand values, poor logo recall and ultimately general perception

The brand may have a modicum of phonetic brand power given its centrality to UK motoring history, but day by day that relevance is eroded…as we’ve seen in historic market share. Of course the problem looks to locate Vauxhall in the ongoing dilemma of being “between a rock and hard place”, but whilst it tinkers tactically with the badge, it must also keep looking at sensitive, radical and meaningful graphic options for the years to come if the nameplate is to survive. That will mean an intelligent amalgam of the core identity elements (NB not simply core graphic elements) with a very modern, future-proof twist….otherwise it may be yet another automotive case of the “boiling frog syndrome”.

The Griffin is indeed a hybrid creature (half eagle, half lion), but up-coming hybrid technology is product attribute, not brand integrity…that comes from more than the sum of its parts.

Monday, 7 April 2008

Macro Level Trends – Eastern European Production – Battling Declining Conditions

Since the fall of the iron-curtain in 1989, throughout the decade prior to the new millennium (and the dawn of BRIC+ traction) auto-maker’s strategists and Boards were focused on the more easily obtainable promise offered by Central & Eastern Europe. Access to a massive population and low-cost production base spread across the new European entrant countries and Baltic states, demonstrated the shoots of new growth as Western European demand and capacity declined.

Thus VMs scoured Central & Eastern Europe to seek the best locations for trans-plant factories, requiring the right mix of: labour (skilled and non-skilled), component supply streams, local market (demand trends), geography (distribution networks), economic stability (good governance), taxation policy, any FX differential and of course economic aid via local government: either stemming from Brussels – in the case of European entrants – or ERB, or possibly the World Bank. Needless to say, each of the countries was keen to attract Foreign Direct Investment and so laid out their respective stalls to do so. For many the investments made by car companies represent the largest inward investments ever made, and had major trade policy consequences when seeking EU entry (ie Poland and European Commission)

Since those early days, we have seen the evolution of Eastern Europe as a new automotive production powerhouse come into play over the last 10 years of so, either via:

a) the green field factory developments of foreign VMs…
- Toyota-PSA (Czech Republic),
- Hyundai-Kia (Slovakia),
- Fiat-Ford (Poland)
b) the adoption and nurturing of local marques and factories…
- VW-Skoda (original in Czech Republic plus Sarajevo, Bosnia & India),
- Renault-Dacia ( Romania)
c) the creation of Joint Ventures…
- Renault Nissan-Avtovaz (Russia),
- ?-Zastova (Serbia)

[The forerunner of the business template perhaps being VW with its case study nurturing of Skoda]

From a governmental perspective, there was always a preference for FDI as independent ‘greenfield’ development (as with Toyota-PSA’s effort) since this was considered to attract funding for regional and state economic growth without divesting of state automobile assets. But in truth, those looking to invest (such as VW and Renault) considered M&A the only way forward both financially, politically, socially and commercially. Governments wanted to independently re-juvinate their own marques with technology transfer from western VMs, but that was only to be ultimately through integration

A recent report from Vienna’s Institute for International Economic Studies states that FDI within the 10 new EU countries rose from €24.5bn in 2000 to €61.7bn in 2007. Primary focus has been in locales such as the Czech Republic that to date has offered the right FDI criteria mix, but a mix of factors is starting to strain FDI fund levels and indeed starting those who previously invested as to whether to “twist” (carry-on investing), “stick” (hold-back) or even “leave the table” (look elsewhere). Those critical factors effecting Central and Eastern European industry are:

1. Emigration trends
2. Labour based Cost-Push Inflation
3. General Growth & Inflationary Pressures

Much of the workforce, not only the youth, keeps heading west seeking better pay (either for short or medium stays) or indeed new lives for themselves and children.
This has put a great pressure on indigenous and foreign firms when seeking additional or replacement labour. Indeed the old practice of replacing whole sheaves of the workforce after 2-3 years in order to contain costs is gone, instead firms having to offer job security and consistent pay-rises to try and keep labour as inflation rises.

Labour Costs
But the ‘inflation plus’, and beyond, salary offers simply aren’t useful when there’s an increasing shortage of workers to offer it too. And those that are skilled are consistently moving onto better paid work [Ironically, the short-termist attitude toward labour has been adopted by western industry as it seeks to depress costs vs the BRIC+ nations]. So the new EU countries are caught in the dilemma of facing a depleting workforce and increasing labour costs which undermines their FDI rationale…and foreign companies and ventures, like Toyota-PSA, are feeling the pinch and questioning their next strategic moves.

Growth & Inflation
Toyota-PSA has seen labour costs at its plant spiral 40% since the plant’s opening in 2004 on the back of an improving economy and labour constraint. Both initially wage-price inflation push and now the added headwind of rocketing food and energy prices are denting the new economies and seriously undermining both governmental and FDI confidence and sentiment. The IMF and S&P are both warning of a “hard-landing” in the Balkan and Baltic regions, especially so as the much needed FDI monies are greatly helping to off-set budget deficits that illustrate good fiscal governance. Without that, the newcomer EU countries will not be able to join the EU party and so once again there’s a loss of FDI confidence.

Under such increasingly harsh socio-economic conditions companies have to seriously consider their options. They recognise that although there may be a short to mid-term slow-down in economic expansion of the region, that the area is still ripe for continued growth, and so are keen to stay where possible - trimming costs and increasing productive efficiency. Thus there is a growing trend for auto-makers to follow the history of their western operations in automating as much as possible and farming-out the more intricate and labour intensive production activities to Tier1 and beyond suppliers, whether locally based or in Asia.

Automation in such tightening conditions is key and well recognised by VW-Skoda, “growth without growth” is how a former Skoda V-P describes the ideology; looking to capital investment projects to raise capacity and the all important ‘vehicles per employee’ measure that highlights the level of plant productivity.

This, as we know, has been the central story of industrialisation throughout history – labour intensive activities will always seek out, when the FDI criteria mix is right, those areas with ‘work-force elasticity’. As pressures build in the new EU countries and neighbouring Eastern regions, so those next in line areas are the likes of Belarus, the Ukraine and other ex Soviet CIS states.

Automakers well recognise that there is a re-run of the Eastern European story evolving today further East, as growing independent (but inter-connected) CIS states grow, their economies underpinned by massive oil industry revenues and reformed agricultural policies. And the CIS governors of course in turn well recognise that they are very well placed to ease the energy and food worries that plague the global economy.

Accessing those markets will be key, Kazakhstan perhaps the most important given its geographical and population size and the massive oil reserves that will serve the economy. And that’s why western media created that comedic ambassadorial character and cultural link called ‘Borat’.

So car-makers will be questioning themselves about the lessons learnt over the last decade in tapping into the Balkan/Baltic markets and moulding a copy+ initiative for the CIS that brings-forth new potential for names like Skoda, Dacia, Zastava, Lada etc etc.

Thursday, 3 April 2008

Company Focus – Valeo SA – Pardus Capital vs the Hinduja Bros

The newswire keeps crackling with the emerging clash between PE and Trade proponents of the automotive parts sector as Valeo SA is put under the spotlight for value extraction.

Valeo could be said to be typical of the large, broad-based, multi-systems parts makers that are currently under re-alignment pressure. As we saw with Continental AG recently, there is a need to both create higher-margin innovatory product-lines through M&A and organic efforts, as well as the requirement to relocate low-value manufacturing. Given the massive growth potential of ‘low-end’ systems (eg alternators, starter motors, etc) in developing markets, parts-makers are loathed to simply divest of those divisions, instead preferring JVs – like Valeo-Minda.

That’s very probably the strategy preferred by Karim Samii, President and Chief Investment Officer of Pardus Capital Management based on Madison Ave. He’s keen to create links with Asia’s light engineering base, and mesh its 19% share in Valeo with a 18-20% stake in Visteon obviously seeking great vehicle systems and administrative synergies between the two auto-parts makers.

[Hedge Funds such as Pardus have undeniably been hit by liquidity contraction, but that may be temporary as Middle-Eastern & Asian SWFs, PE and financial institutions look to invest their massive petro-dollar and retail saving holdings. Whilst western banks are following the UBS lead in restructuring their illiquid SIVs to regain helathy balance sheets, it is at such times that private equity can attract foreign finance when strategies prove compelling – as we see with KKR, Blackstone et al in property funds, and undoubtedly the 'value' potential of auto-parts. PE and Hedge Funds have been touting the re-alignment potential, as described above, to a myriad of potential clients, from Japanese Banks to Asian National Pension Funds].

With Valeo and this contextual backdrop in mind, the Hinduja Brothers know that they have to broaden the integral value chain of Ashkok Leyland, and are keen to chase the likes of TATA who’ve set the Indian international M&A pace, before they and Ashkok are left behind. Like Pardus Capital, they too recognise the potential and know they probably only have a small window in which to act before the Pardus dimension of Valeo regains power - with injected liquidity - and so are pushing pushing pushing!