Issue: Oct 2006


Investors seek defensible positions, reliable cash flows



by Charles Faulkner

Private equity firms investing in the automotive sector are dramatically shifting their focus from component suppliers to the aftermarket, as they seek more defensible positions which traditionally generate reliable cash flows, according to a new report issued today by PricewaterhouseCoopers LLP.

As predicted by PwC in 2005, there has been reduced private equity interest in the manufacturing side of the auto business. Rising material costs have made it more difficult for these capital-intensive businesses to generate the cash needed to service debt. This is particularly evident in the components sector, where private equity-backed deals now represent just 15 percent of the total value, down from 30 percent in 2005 and 61 percent in 2004.

The report also looks at how the automotive industry has experienced the re-emergence of trade buyers. Following an all-time low level of interest in the previous two years, trade buyers have returned to the market looking for bolt-on or specialist acquisitions. They made their most triumphant return to the components sector, accounting for the five largest deals in the first half of 2006. While this return helped drive deal numbers up 20 percent in 2005, average deal size actually fell slightly.

However, this does not mean a return to the days of the mega-merger. Instead, major vehicle manufacturers are using M&A to restructure business through bolt-on acquisitions and sales of non-core activities.

"Vehicle manufacturers see vehicle design, manufacturing and distribution as core functions but all other activities are up for sale at the right price," said Paul Elie, automotive transaction services leader for PricewaterhouseCoopers. "In this new climate, private equity buyers have gone from being viewed with caution to being the buyers of choice."

Emerging markets, which are fast growing and hungry for new technical expertise and customer relationships, are likely to become significant players in the U.S. and Europe before long. Cash-rich Indian vehicle manufacturers have been using their ability to source components more cheaply than Western rivals to gain a competitive advantage in bid situations. Overall, deal numbers are steadily increasing, particularly in mid-sized deals where Chinese firms are focusing on American assets, while Indian firms look to Europe. While these deals are currently small, this is expected to change in coming years.

Hedge funds have been taking advantage of the distress of many components companies to buy into the sector. Fund managers have been snapping up bargain debt and distressed equity from banks and becoming catalysts for change in some cases.

"Hedge funds have already spurred debt and equity write-offs in some automotive firms," noted Philip Wylie, automotive corporate finance leader for PricewaterhouseCoopers. "Judging by their actions in other industries, we could see them drive more radical management changes by bringing in turnaround specialists or even forcing the break-up of some businesses."

Key regional markets:

U.S.


The U.S. has seen lower corporate M&A activity because of well-publicized problems at the big three manufacturers. Distressed M&A in the U.S. components sector is likely to be the growth area, as several of the industry's big names restructure. Korean, Chinese or Indian players could emerge as real movers and shakers.

Europe

Europe remains the most active region for M&A, as the large manufacturers focus on core activities and look to divest non-core assets. In the UK and more widely across Europe, consolidation in the retail sector is expected to continue. However, the more fragmented nature of the continental European retail sector is likely to mean that volume will remain fairly modest for the next five years or so, despite an increase in deal numbers.

For more information on PricewaterhouseCoopers automotive practice and to download a copy of Auto Insights, visit http://www.pwc.com/auto .

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