Global Trend Toward Banning Internal Combustion Engine and other Technology Disruptions to Accelerate Spin-offs and Mergers and Acquisitions in 2018 for Automotive Suppliers
Disruption caused by several emerging trends had a major impact on automotive suppliers in 2017 and will continue to send shockwaves throughout the supplier sector in 2018. Starting last February, Norway became the first nation to ban the internal combustion engine (ICE) and it intends to allow only the sale of electric vehicles by 2025. Over the course of the year, India, France, and the United Kingdom all made similar announcements as the trend towards the adoption of zero emission vehicles or battery electric vehicles (BEV) has started to accelerate around the globe.
Since, stock analysts have started downgrading the long-term outlooks for even the world’s best suppliers that have significant involvement in ICE ecosystem, as automakers confront intense pressure to completely shift vehicle propulsion from ICE to electric. Analysts are not suggesting that this shift will occur overnight, but they do expect it could create significant risk to many suppliers’ earnings trajectories. Understanding these headwinds and the competitive challenges ahead, suppliers such as Delphi announced in 2017 a spin-off into two separate businesses, and Honeywell, Continental and Autoliv have announced similar spin-offs considering similar strategic concerns.
But this will not only impact large suppliers like Delphi, Honeywell, and Continental. The supplier content for engine, transmission, exhaust and fuel systems is roughly $4,000 USD per vehicle. This content is made up of countless mid-market suppliers who supply forgings, castings, hoses and machined components for these critical systems. In a global market today, that produces approximately 100 million vehicles, this is a $400 billion market segment that will be significantly disrupted by this shift in propulsion technologies.
Today, countless suppliers produced machined components for the ICE ecosystem. It is widely understood that approximately 70 percent of the machined components going into the vehicle are tied to the ICE. This shrinking market will create excess capacity and will have a significant impact on this supplier universe. There will be a significant number of strategic issues for these component suppliers to consider:
How will excess capacity affect pricing and profitability for these components;
What new business opportunities will be available from EV components or alternative markets; such as, aerospace or other industrial markets; and
What will be the best strategy for the organization going forward?
The tipping point for electrification may yet be a few years off, however, these headwinds and competitive challenges will have a significant impact on the value of all ICE suppliers as the market shifts increasingly to electrified vehicles. This is why large suppliers like Delphi and Honeywell are making significant strategic decisions today.
Thus, considering this fast-changing landscape, it is clear that for 2018, the top five most important stories affecting global auto suppliers are:
1. China will announce the ban of the ICE by 2030; Germany will follow.
In early September, Xin Guobin, China’s vice-minister of industry and information technology, told a forum of automakers held in Tianjin that the government would ban the production and sale of fossil fuel cars. Most Chinese automotive insiders believe this ban will take place starting in 2030. BAIC Group’s chairman, for example, said the company’s goal is to stop sales of its conventional fuel-powered cars in Beijing by 2020 and stop their production and sales nationwide by 2025.
You can expect Germany to follow quickly with its own ban of ICE, as it strives to shift to electrification to retain technological leadership to protect the German automotive industry.
2. More automotive supplier spin-offs.
As technological advancement creates new products and business model opportunities, suppliers will continue to refocus their product portfolios away from some of their traditional mechanical products and expand their electronic/electrical offering to position themselves for the new future. Other suppliers will follow the lead of suppliers such as Delphi, Honeywell and Autoliv who have completed or announced spin-offs, due to:
The different pace of technology advancement in their two business segments;
Different market needs driving investments for growth and innovation;
Different skill sets of people throughout the organizations (leadership, engineering, sales);
Different sales growth rates over the near and long-term with limited customer or operational synergies; and
A potentially different shareholder profile due to the timing of returns.
Expect these challenges to potentially drive spin-offs from companies such as Valeo who has a portfolio of both traditional mechanical products and new electrical, electronic or software related products.
3. Mega-mergers will continue, led by the new tech entrants.
With the advent of connected and automated cars, the consumer and industrial electronics giants and new entrants from the semiconductor industry view the auto industry as an attractive growth market. Companies such as LG, Panasonic, Samsung, Toshiba, Mitsubishi and Hitachi are bringing expertise in high-volume production of lithium-ion batteries from the consumer and industrial electronics sectors, giving them the critical scale needed to compete.
And with this market alone having the potential to grow to over $100+ billion by 2030, expect more large-scale acquisitions of traditional suppliers by these tech players in 2018, such as Samsung’s rumored interest in acquiring Magneti Marelli.
But this type of M & A activity will not be limited to the new entrants. Consolidation strategies will be used where the primary focus is to create financial synergies and competitive advantage and leverage in these changing markets. An example of a recent large transaction includes Dana’s acquisition of GKN Driveline (which was originally planned to be a spin-off from GKN). The merger will combine GKN's Driveline division with Dana in a deal worth $6.1 billion and the resulting combination will have annual sales in excess of $13.4 billion.
4. Private equity firms increasingly will dominate automotive mid-market merger and acquisition activity.
As technological advancement creates new products and business model opportunities for larger suppliers, mid-size and smaller suppliers who lack global reach and scale will be continually disadvantaged in a fast-paced environment that requires increasing investment and significant business transformation. These mid-market companies lack resources required to make the necessary strategic shifts in new product/technologies to remain competitive.
For example, one can question how a traditional mid-market manufacturer of ICE components can deal with an industry disruption like the ban of the ICE and the shift towards battery electric vehicles. This type of business transformation will require significant investment and the development of new core competencies and new products over the next several years.
Many suppliers faced with this situation will opt out and exit the business instead of taking on the risk associated with transformation. In this environment, the investors likely to have the appetite to take on these challenges will not be strategic investors but will increasingly be financial investors like private equity firms.
5. Investor activist activities will increase within the automotive supplier space.
In late 2016, stock analysts had already started downgrading the long-term outlooks for suppliers that have significant involvement in the ICE ecosystem, as automakers confront intense pressure to completely shift vehicle propulsion from ICE to electric.
While this shift will not occur overnight, analysts expect it could create significant risk to many suppliers’ future earnings trajectories. Understanding these headwinds and the competitive challenges ahead, Delphi and some other major suppliers have already undertaken strategic spinoffs to proactively address investor concerns.
Other suppliers that are not already making strategic shifts – including many of the top 100 auto suppliers – will likely face increased pressure from activist investors who seek to unlock value and raise stock valuations.
Overall, it is clear, the automotive supply chain will see more challenge and change in 2018 than the industry has witnessed in the previous 50 years.
Information for this article was submitted by Paul Eichenberg, Paul Eichenberg Strategic Consulting. Paul manages his own automotive consulting firm called Paul Eichenberg Strategic Consulting. Paul’s clients include hedge funds, investment banks, private equity investors and automotive suppliers. For more insights, visit www.chief-strategist.com.
Paul will be making a presentation on this topic at the September 11-12 Forging Industry Technical Conference, visit the event webpage.