The rebound of capital markets over the last few years have been fertile ground for a resurgence in M&A activity. Though of course press coverage highlights the major events such as the G20, ESF, DAVOS and geo-political unrest, those unaware of the M&A stories have been asleep at their laptops.
Activity has not (unsurprisingly) been on a par with 'pre-crash' levels, yet during this opportune period, CEOs & CFOs have been re-assessing their own company's capabilities, devolving typically non-core divisions/sections and re-structuring to suit the new era: one that presently sees a trend of 3-speed global growth across Asia, the US and Europe. The likes of FIAT perhaps the most high-profile of cases, whilst many others Tier 1, Tier 2 and Retail cases take place 'under the radar'.
A major part of such industrial re-alignment across sectors and companies is of course the requirement to 're-shape' the product (and service) offering. 'Bolt-on' acquisitions of synergistic companies have typically been the norm – especially during such economic cyclical troughs - given the 'growing pains' of alternative organic expansion, which is better undertaken during a less frenetic, steady income, era.
Hence with the intention of creating stable and strong business models, company board members and their bankers scour their respective sector nationally and internationally for suitable matches, these target companies typically rated by a lists of various important criteria to arrive at what on paper look like good matches. From then on of course is the 'mating game. This ideally undertaken on friendly, mutually rewarding terms between like-minded boards. However, even at these capital conscious times, the amalgam of internal corporate cash 'war-chests' and the investment banking desire to create M&A activity for fees and economic resurgence, means that the day of the hostile takeover – so often seen near the top of the cycle – is far from dormant.
As for the automotive sector, even throughout the financial crisis private equity players such as WL Ross were wrapping their hands with joy, especially in the US, well appreciating how the Washington Bail-Outs of GM and Chrysler would have downstream impact on their and the more general American supplier base. However, unsurprisingly given the de-leveraging of capital markets, it has been trade-buyers that have been most active.
Hence at the Tier 1 level the speedy ongoing formation of entities such as IAC (International Automotive Components) controlled from Luxembourg with global reach and important US grasp, with the intent to compete head to head with the likes of Magna International.
Magna International itself evolving as its founding family's (James Stronach et al) hold on the company is slowly released, as seen by the swap of his/their Magna control for its horse race-course assets; recognising that the separate demands of sports-entertainment versus auto-parts manufacture do not make for a merry mix for external shareholders, even if originally co-created for personal and corporate entertainment reasons.
Of course IAC and MI are but two high-profile and relatively young companies, yet re-structuring activity has of course been ongoing with names of older, well engrained traditional supply base companies decade after decade, themselves the core of trade-buyer M&A in the auto-sector
One recent announcement was long-lived American BorgWarner's acquisition of the 'Traction Systems' division from the Swedish Haldex Group. Auburn Hills made and agreement with Stockholm for $205m, the deal strengthening the technology base of the US entity,and effectively freeing the Swedish to concentrate on its primary operations.
The BorgWarner name (itself derived from combination) is renowned for powertrain & drivetrain parts and systems manufacture, most notably transmissions/gearboxes, but also in relation to clutches, engine valve-timing, turbo-charging, exhaust gas recirculation, radiator fans & shutters, cold-start systems, coils, and tire-pressure monitoring systems; these under the 'Engine' division.
However, increasingly over the years the important theme of 'vehicle dynamic capability' has become a core aspect of BorgWarner's own VM client's concerns, and so one it must seek to address by strengthening its 'Drivetrain Group' which comprises of 'Transmission Systems' & 'Torq-Transfer Systems'. This division focuses upon the method by which engine-power is transmitted through gearboxes and drive-shafts to ensure the desired level of ultimate vehicle traction control. This ranges from: the challenges of 'wheel-spin' and 'wheel-lift' in performance driving at corners, to those set by road-surface water & ice, aswell of course various off-road environments ranging from rock to sand to mud to ice, all set on varying slopes.
The span of the topic alone is immense, let alone the ability to integrate into into the demands of mass manufacture of various vehicle architectures, hence BorgWarner's interest in the expertise and proficiency of Haldex.
For all VMs and their suppliers alike the once fringe demand for 4WD/AWD of some 30 years ago became mainstream with the consumer adoption of SUVs, whether truck-based as in the US previously, or car-based as seen at first in Japan and soon after Europe. The SUV softened into the SAV and has today become a mainstream variant of all global volume manufacturers, and so integrated into new product programmes.
So although 4WD or on-demand AWD was first seen as part of the aspirational-set with Land Rover, Jeep, Toyota and Mitsubishi, intrinsic to 'gentry farming' & safari/jungle adventure, its capability has trickle-down to now pass beyond those esoteric psychologically motivated lifestyle statements of European car buyers and become what is seen as a rational consumption choice. For many the AWD advantage is tangable, the loss of seasonally adjusted car-prep participation (such as snow-chains) and adverse experiences such as recently increasingly severe winters - which can make even urban roads impassable without AWD – all support a trend for such vehicle specification demand in Europe, the US and Japan. In short they expect their cars to be capable even in heavy winter or rural environments, because the expectation over 20 years has been slowly but strongly created, even if only ever used for a few days or one week of the year.
Conversely in fast growing EM regions, there is a strong argument that the real-world driving conditions of BRIC+ nations range from near perfect on newly laid interstate roads to utterly atrocious in suburban and rural areas with little or no tarmac laid. And even in many large city centres, the old road has crumbled into fissures and pot-holes that put great demand onto the suspensions of conventional cars. This is why for years the major VMs created alternative body strengthening and suspension set-ups for what were termed the developing regions – the basic Euro, US or Japanese car itself was adapted to cope with the adversity.
Thus although seen as modern per se by their prime symbolic cities, large portions of EM regions do still necessitate an alternative type of more robust, more capable car – hence the SUV characteristics of FIAT's new B-segment car - the Nouvo Uno – designed by Brazilians for South Americans.
The evolving business interest for BorgWarner and its clients, lies within the product and consumer 'intersection' of these 2 previously disparate 'Advanced' and 'Developing' commercial worlds. Combine the US/Euro/Japan consumer preference for the 'rest assured' AWD feeling (with periodic use) and the BRIC+ consumer need for AWD and there is a convergence of what was separate regional demand into a unified 'glocal demand' for smaller AWD technology packages.
Yet this too poses a major technological challenge for VMs and their suppliers alike, since AWD vehicles intrinsically are less energy/fuel efficient than 2WD counterparts given additional mechanical weight and the parasitic losses through the extra hardware on-board. So the VM-Supplier challenge is to create AWD systems that can also meet the ecological demands set by ever more stringent regulation; such as CAFE-type demands on the auto-industry itself, aswell as consumer-relative eco-demands such as vehicle purchase and use taxation demands relative to CO2 and NoX emissions.
Thus for BorgWarner, given the mass-market reward of small AWD set against the technological development challenge, the best solution was to buy-in the capability and so bolster internal advantage before either a competitor did so. Also likely was a case for VW Group to acquire the division as part of its own large investment programme – which has seen other small companies snapped up in Europe (eg Karmann and Guigario) - and given that VW, Audi, Skoda, SEAT, Lamborghini, Bugatti all use Haldex systems; and importantly the company also sells to VW's competitors: GM, Volvo, Land Rover, Saab.
Thus the BorgWarner board must have viewed its own drivetrain technology capabilities as becoming potentially uncompetitive and indeed increasingly unrequited had it not bought 'Haldex Traction'.
As for Haldex, the Swedish name is renowned in auto-engineering circles as being at the forefront of drivetrain-control development and manufacturer, with special expertise in increasingly 'intelligent' (ie on-demand) four wheel drive systems. In the last 15 years its prime offering is an AWD system designed specifically for front-wheel-drive architectures. Known as LSC – Limited Slip Coupling- it has been through various generational iterations, and sits as the primary sales product in conjunction to the traditional rear-wheel-drive based layouts which today sits under the XWD title; this offering traditional mechanical and newly developed electro-mechanical packages. These FWD and RWD systems created so to match the prevalent trend of developing 'cross-over' 4WD vehicles from typically standard FWD drivetrains of C-segment and B-segment vehicles.
Moreover, given its national roots Haldex is invariably seens as an AWD transmissions provider to 'homeland' Volvo and SAAB. Yet these companies' previous ownershipp by Ford and GM meant increased US & international supply contract competition for Haldex, which though off-set by VW Group & Hyundai-Kia contracts internationally, meant that domestic manufacturing demand would continue to diminish. The unwillingness of Sweden's government to 'save' Volvo and SAAB, instead respectively sold to China's Geely and Holland's Spyker (with probably intent to sell on to a Chinese auto-maker) was the effectual 'nail in the coffin' for large scale homeland production.
To help combat this contextual headwind and sector competition, the company has sought to also climb the value chain by offering development assistance and manufacture of 'niche' 4WD systems for the supercar segment. Notable contract wins with VW's Bugatti & Lamborghini given the VW Group association, with the Siesto Elemento concept at the Paris Motor Show underpinned by its system, even if PR touted as Lamborghini's own.
Yet 'Traction Systems' is the smallest of Heldex's 3 divisions, compared with 'Vehicle Systems' and 'Hydraulic Systems'. Given the 'dislocation' of its AWD manufacturing geography and growing competitionn from both established and newly emerging AWD systems peers, it seems that Haldex's Swedish management thought it fit to hive-off the section given the 'headwinds' of AWD manufacturing sector trends when set upon focus on the 2 prime divisions which deal with commercialvehicless and the growth potential of supply to Truck producers and Agricultural and Construction equipmentmanufacturerss, at the start of the new apparent economic upturn.
Recognising the macro-trends of the auto-sector and the importance of EM regions, Haldex built factories in China, Brazil, Mexico, India and Hungary, to compliment US and German plants. These obviously span the 3 operations, but also provide a sound geo-strategic basis for buyers that reaches far beyond the typical 'window dressing' seen by sellers, so making the 'Traction Systems' division very attractive to trade buyers.
At first glance the $205m agreed for the division – its capabilities and the goodwill of the Haldex name (if also sold) - appears to be rather cheap. Yes, Haldex Group like others within the supply chain had been suffering through 2008/2009, but the contraction of its group income stream of about -33% between 2008-09, was not reflected in the Traction Systems division which itself saw only -17% YoY drop, giving SEK 850m in 2009 (approx $119m*) compared to SEK 1,021m (approx $143m*) in 2008. [NB* FX rate used: 1 SEK = $0.14 over last year average].
Of course as an external observer, one cannot see the details of the 'closed-book' deal, that BorgWarner would have perused, able to disentangle 'Traction' from 'Group' figures. But one would expect that the semi-specialist division should have offered an operating margin that was substantially higher than the Group figure that wavered over preceding years. A 6% operating margin even in 2009 and could grow to 8% in potential good years not too far away.
So using that Op Margin average of 6% on 2009 income should have seen $7.14m profit, and on 2008 income sees $8.6m. If we expect a nominal 20% improvement for 2010 so matching car-demand return we see 2010 income rise back to $143m, which at 6% margin gives $8.6m.
Thus the $205m represents a price paid multiple of x24.
This may be notionally high compared to typical stock-market p/e ratios, but shows the willingness of the buyer to pay a notionally premium price in a distorted market period for something it sees as critical to its own future, aswell as also recognising the competitor-peer threat which took the effective 'auction' for Haldex so high.
But BorgWarner also recognises that with a global client base and burgeoning X-over vehicle segment with great EM potential, it has its inherent scale and global marketing reach on its side, so able to open new doors at Ford, Renault-Nissan, PSA, Toyota, Daimler, BMW, FIAT-Chrysler, Honda, and especially so in China with a good in-house or JV proposal. It can now leverage an offering which comprises of efficient pricing models (ie multi-buy deals) for new customers that the small largely Swedish team at Haldex under divisional V-P Ulf Ahlen simply could not.
Thus it has commercial and cultural leverage that it rightly sees as well justifying the calculated x24 p/e price. BorgWarner's press release highlighted that the division was purchased for less than its estimated FY2011 sales revenue figure -
ie thus to CEO Tim Manganello's eyes (and those of investment-auto-motives)gained at a bargain price given its potential.
With its new parent able to 'offer the world' Haldex Traction will undoubtedly be under R&D pressure to advance its LSC mechanism both in terms of performance and cost – possibly creating 2 separate design paths to do so for Triad vs EM regions, to advance the applicability of its XWD package and to encourage concept development and new-client uptake of its electro-rear axle technology so as to gain market traction and confidence.
In summary up until the last few years Haldex Traction has not quite sat on its laurels since 1998, developing its core product all along, but also enjoyed the ride created by its momentum. Now it must ready itself for scale-up whilst maintaining quality at a cost, and additionally create a new buzz by targeting relative niche product in the hybrid drivetrain world.
As for that possibility, Toyota and Honda are the best established, well-ahead in the eco-tech game but in Toyota's case has for the first time in its history started to look at externally adopted technology. Honda given its smaller size and mindset may not be so pliable. But the set of eco-tech followers within the realms of other VMs should convert to good new client prospects and opportunities.
The promise is most definitely there for the Traction division to play a vital new role within BorgWarner. Doing so both culturally as an innovation inspiration within the corporation, and presumably able to offer a disproportionately positive income contribution to the Group in due course.
It seems the BorgWarner board has recaptured the company's "spring in its step".
