Monday, 13 October 2008

Industry Structure – USA Auto Inc – Re-Structuring for the Road Ahead

Although Capitol Hill approved the $25bn worth of low cost loans to the US auto-industry, Detroit will be lobbying for second and possibly third rounds of equivalent contribution. But as with the $700-950bn TARP initiative, Washington will seek to be convinced that public funds will be best served with new thinking in Michigan and beyond, new thinking that sets out a far more stable and eventually prosperous road-map for the domestic auto-sector.

Much of this decade, especially he latter half, has witnessed a continuous and increasingly alarming sales decline for the Big 3 - first the once popular gas-guzzling SUV & its pick-up origins fell out of favour on the back of escalating oil, now the TIV severely undermined by the real economy's battering from the fall-out of the financial crisis. Stock prices depict the damage better than any number of now defunct adjectives – Ford recently at $1.99 and GM at $4.89 - pessimistically factoring-in market sentiment of dual enterprise bankruptcy, noting the cash-burn of all the Big 3.

To avoid that the lobbying will continue, but the necessity for a dramatic re-structure of the industry looks ever more likely. A call investment-auto-motives has made long before now, and one abetted by formal recommendation that Cerberus gradually start to dispose of the 3 divisions within Chrysler LLC to a well-matched (but for this post's purposes un-named) Asian buyer.

The situation faced today by the industry's senior executives and Washington politicos has been a long time brewing, its traces spanning back to the decade after decade of 'right-sizing' the Big 3 (& previously 4) have undertaken as their domestic market-share shrank. Periodic JV's & M&As such as AMC & Renault, Chrysler & Rootes-Matra, Chrysler & Mitsubishi & GM and Toyota have all played roles in stabilising the domestics and assisting profitable come-backs riding economic expansions, but those yesteryear situations were never as today.

On the back of the low-cost loans, it seems that the financial press have now started to appreciate the enormity of the situation, questioning the analysts community as to how GM, Ford & Chrysler might move forward, including major asset disposals of brands, plants and finance arms. The previous level of invisible concern perhaps now made visible by rumours of Ford's potential relinquishment of its 33% stake in Mazda, aswell as Volvo...sold as a volume-platform and technology affiliated compatible pair perhaps?

Beyond immediate revenue-earning, cost-reduction disposals apart for one company, the far bigger issue for Washington and Detroit must be that which questions the overall shape of the US automotive sector in the medium and long term.

The 5 options below provide a broad yet concise summary of possibilities:

1. Consolidation –
Demanding major upfront amalgamation costs to glean far-off returns, including UAW resistance given recent new contract signings and most importantly the lack of financing available in frozen credit markets, which even if thawed would presently require very high interest rate demands given 'junk' status of the auto-companies.

2. Sale –
Probably impermissible for GM & Ford given level of platform and global divisional integration, but Cerberus/Chrysler would be well positioned to divest of more easily disentangled brand-bases (indeed it would regain & strengthen individual brand character). [A timely full recommendation was made to Cerberus in August 2007, recognising the fall-out to come].

3. Industrial Reform Diktat from Washington -
Instigating cross-company JV's to create efficient operational workings from raw material & parts sourcing to platform engineering to production to dealer network agreements. Obvious problems with anti-competitiveness ideology & policy, especially from foreign automakers (transplants & imports) but that could be circumnavigated with off-setting subsidy, low-taxation and tax-credit agreements

4. Nationalisation / Part Nationalisation –
Viewing the auto-sector as a critical economic pillar that needs close monitoring and continued state aid. If seen as an adjunct to the TARP philosophy, the argument could be made that USA-Auto Inc is actually a long-term valuable asset that would actually be a Return on Investment for the American tax payer. Taking major equity stakes in what is perhaps the 20th century's epitomous icon of American Capitalism however could be seen as a step too far, and a failure of capital markets appreciation for US industry's acute value.

5. “Deconstruction for Reconstruction” -
Essentially the impartial, objective philosophical 'pull-apart' of the complete sector by not Washington, but Wall Street. This would create a new operationally efficient template that goes further than perhaps short-sighted governmentally imposed reform (see 3) by gaining GM, Ford and Chrysler's willingness to spin-out synergistic assets in the form of new Tier 0.5 enterprises; spiritual successors to Delphi & Visteon that could possibly include these Tier 1 corps to create a fundamentally strong Tier 0.5 industrial base that lifts the operational weight from the Big 3 to themselves move forward their own business models as eventually fully fledged 21st century Brand Enterprises avoid of heavy Capex demands and able to create high free cash-flow models that the new business order most definitely requires.