Friday, 21 August 2009

Industry Structure – EU Supplier Sector – Re-Forming the Sector

Although August & September are typically a quieter period for capital and money markets, they are also the time of the summer & fall conventions; a European notable being the Frankfurt Motorshow with adjunct conferences.

For global auto-industry investors, the associated heavy focus on US Autos and its supplier base has momentarily switched to Europe. North America has seen much its sector M&As and acquisitions given the activity highs between 2004-07, with the latter 07-09 financial fall-out pulling more suppliers into bankruptcy which has allowed PE to cherry-pick below-value enterprises that should benefit from GM and Chrysler's quick-routed Chapter 11 emergence, and the first to benefit FMC..

Thus, now US investment eyes have crossed the water to Europe.

Recognising that the EU supplier sector has lagged the US in its downturn due to latter-day credit-crunch shock-effect , more disparately placed car manufacturers and the now waning support of government to offer yet further 'bail-out' funds to individual companies beyond those already publicised.

So increasingly, EU member governments are looking to Brussels to take on the burden of 'supportive reform', thus the EIB (European Investment Bank) has stepped into the fray to offer bridge financing to the systemically important vehicle manufacturing and parts supply players as an interim step to the re-building of Europe's car and light commercial vehicle industry. And as such takes on the role of partial arbiter for the sector's future.

[NB. the EIB will be acting as a self-interested agent of change given that it must itself be seen to invest in companies with sound long-term fundamentals that underpin EU prosperity and thus so its own 'Loan Book' & Capital Ratio can support its own triple-A credit rating. (It's 'mission' as “The Bank Promoting European Objectives”)

Unfortunately, automotive/personal mobility per se does not seem to appear as an RDI (Research, Development & Innovation) focus for the EIB. investment-auto-motives prompts the EIB to encapsulate this highly economically important arena ].

Thus at present industry observers and the investment community alike now watch over Europe.

Just as it did with the North America and its regional sector collapse. That NA process is still of course ongoing, its own decline starting as early as 2004 with listed and privately held companies bitten by the contractual – and for some sole supplier - leverage that Detroit's Big 3 had over them; those 3 themselves in turn caught in a spiral of value-destruction created by legacy costs and an unforgiving marketplace.

For Europe, although EU members are often thought to act in concert, the 'Brussels reality' is unsurprisingly somewhat different; especially so during such decisive, watershed times as these. The 'beggar thy neighbour' reaction of individual members to the banking crisis, and more recent 'back-door' subtle protectionism enaction, shows that Europe still has broad economic policy frailties stemming from member states of diverse economic foundations, sizes, specific industrial sector 'GDP generators' and resultant attitudes.

This complex context is the terrain that today both supplier company board chairmen & directors and private equity industrial portfolio & fund managers must appreciate in detail if they are to respectively compile their futures. And given that today's only partially thawed liquidity that is preferably done as collaborating agents, given PE's effective ownership of allocatable financing capital and what should be in-depth board-level knowledge of their own company.

Presently PE – much US based - is looking at the European supplier base to both obtain synergistic 'bolt-on' capability to currently held enterprises in North American and as eco-tech enablers with migrational prospects into the US, Canada and 'down the road' Mexico – as part of NAFTA pact trading conditions. Thus PE is looking typically for the near age-old idioms of manufacturing & geographic market scalability and technical competitive advantage – 2 basic tenants of enterprise. (The recent Obama espoused Modec-Navistar/International JV offers an examplar of the latter trend.)

Thus the Aug-Sept conference season sees the SupplierBusiness conference in Frankfurt on Sept 17th. Executives from Tier0.5, Tier 1 and Tier 2 supply companies along with banking representatives and big hitters from the PE world – Wilbur Ross of WL Ross & Co a key-note speaker, as is Philip Wylie, now with boutique investment bank Houlihan Lokey.

The conference will typically be 'abuzz' with conjecture as to potential sector consolidation deals and where exactly the EU supply-sector sits today in a tri-sected arena of ICE, Hybrids and EVs, vs a very forward looking Japan, re-surgent S.Korea, the giants of India and China, the capital flows into Taiwan etc etc.

The Modec-Navistar venture will set a tone regards the tech-transfer of EU capability, but the segment as a whole must maintain its view and momentum forward; even if major “value-curve M&As” such as the Schaeffler-Continental amalgam are suffering heavily at present.

investment-auto-motives highlights the EU potential, possibly via the EIB, to follow Berkshire Hathaway's lead with BYO – an enterprise created from 'conjoined twins': an electronics producer and automotive manufacturer. An example that highlights the present and future need for cross-sector pollination.

Thus at this time Brussels (with the assistance of CLEPA) should be creating a broad EU Supplier Sector Roadmap, a guidance template of sorts that states to the world the aspirations of the EU for its multiple Tier levels, incumbents and possible & probable new entrants.

Private equity has had its fingers burned to a degree in the US because of the combination of a less than rounded and detailed industrial policy, now greatly exacerbated by the previous seizure and now cautious dynamic of capital markets. The EU must take heed and learn, perhaps indeed sensitively using the US experience to its own advantage in seeking locally appropriated funds and FDI for a new era.

In the meantime, expect the investment community at the SupplierBusiness conference - titled “A New Direction for Suppliers – A Radical Industry Reconfiguration?” - to be wandering the hall with compiled lists of the key financial ratios of each company at hand, balance sheet numerics of core assets (ie without intangibles) vs liabilities, privately critiqued corporate strategies and importantly SWOT analysis of incumbent management

Futhermore, regards hot-topic 'bar talk', the recent WSJ press report that hedge-funds may be short-selling VW given its Porsche related dealings, which if ultimately occurs puts yet more pressure on VW and its EU suppliers. In such a move the hedge funds would be acting as 'cats' amongst EU supply-base 'pigeons'; which could in due course net useful 'pigeon pie' for PE.

Given Frankfurt's role as a major European financial hub, financial analysts should already be running “what if” scenarios that will be priced into the FSE listings – even going so far as to question of VW's sustainability in the DAX.

Definitely a case of “watch this (sector) space” until the industry chatter resumes on September 17th.