It may have grown tougher to finance leveraged buyouts in recent weeks, but that doesn’t give industry experts reason to suspect private equity has cooled on the automotive sector.
“There are a lot of distressed auto suppliers out there, and these firms see it as a chance to buy on the cheap, fix it and grow,” says Daniel Cheng, vice president of automotive consulting firm A.T. Kearney Inc.
“There’s also a lot of automotive talent out there, so many of these firms have executives on retainer, or in their sphere of influence, that can come in and fix things.”
Plays by private equity, however, appear to meet with more difficulty these days. For instance, shareholders ofCorp. rejected a proposal from billionaire investor Carl Icahn to take the supplier private in a $2.9 billion deal. They thought the company was worth more.
And even the $5.6 billion grab of robustly healthy Allison Transmission fromCorp. by equity firms the Carlyle Group and Onex Corp. ran into financing trouble.
Investors reportedly became skittish over further fallout from the U.S. sub-prime lending debacle, a situation that ledGroup to sweeten the rates on term loans to help finance its buyout by Cerberus Capital Management LP.
Nevertheless, A.T. Kearney stands by its forecasts that private-equity ownership of North America’s top suppliers will grow to 36% by 2010, from 25% today.
“It’s definitely going to have an impact on the automotive space for some time to come,” says Cheng, co-author of the 11th annual A.T. Kearney Townsend study, which examines industry trends.
One reason behind the persistence of private equity is simply the number of struggling suppliers, which could increase given the right macroeconomic factors and industry trends.
Should commodity prices rise alongside tighter consumer spending and additional market-share losses for domestic auto makers, A.T. Kearney predicts a domino effect similar to the steel industry’s collapse. Given those factors, some 40%-50% of suppliers could file bankruptcy, the study says.
But given current flat commodity prices; steady consumer spending; and stabilized, or at least moderately declining, market share among Detroit’s Big Three auto makers, A.T. Kearney sees only about 1% to 3% of the industry entering bankruptcy by the end of the year.
That rate is comparable with the activity the industry witnessed between 2001 and 2004. “The companies emerging from bankruptcy are coming out faster than they’re going in,” Cheng says.
Looking ahead, A.T. Kearney expects private-equity firms to focus more on growth than restructuring. To this point, about 80% of private-equity deals have targeted under-performing suppliers.
The deals usually last three years or less, the study says. During ownership, the equity firm generally focuses on lowering operating costs; improving working capital to increase cash flow; addressing fundamental performance issues; and determining which products make the most money.
In fact, Cheng notes, it’s not uncommon for private equity to turn away business.
“It used to be that in order to be perceived as a good supplier, you would make money on some programs, lose money on others and just hope they balanced out,” he says. “Now, if it’s not going to make money, (suppliers owned by equity firms) are not going to (buy in).”
Private-equity ownership also appears headed away from the restructuring phase and into the growth phase, either with one firm buying a supplier from another that has completed reorganization, or the firm acquiring a group of suppliers to form a nucleus to grow the business.
About 20% of deals today are growth oriented. Ownership is more strategic, usually lasting between three and five years. Instead of shedding jobs to cut costs, the company hires additional workers to support growth.
The consolidation of several suppliers, meanwhile, provides the new business with scale, and complementary technology could be acquired to support market leadership. Typically, the new business also will expand its presence globally.
“We think that private equity (going forward) will focus on growth in addition to restructuring,” Cheng says. “You hear a lot about them becoming strategic investors, as opposed to financial investors, but how that plays out remains to be seen.”
Private equity, however, does appear on its way to shedding its reputation as a corporate raider.
During its courtship of, for example, Cerberus maintained it had no exit strategy in its plans, nor any intention to replace the existing management team. Rather, the firm’s chairman expressed faith in the auto maker’s turnaround plan and a deep affection for the U.S. domestic auto industry.
Indeed, A.T. Kearney claims, private-equity firms tend to create more value through their management discipline, financial expertise and access to capital.
“There is a perception in the public that private-equity firms come in as financial investors to strip down the company, flip it and cash out,” Cheng says. “But over time, as firms execute their growth strategy, they tend to add more people.”