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Friday, October 3, 2014

In For The Long Haul

The original for this post is at TheTruthAboutCars.com, which in turn draws upon a post by Alexander Dawejko done for my Economics 244 course. I have added another paragraph here.

ZF Friedrichshafen is buying TRW; JCI sold its automotive business to Gentex and Visteon. Are we in a new era of supplier M&A activity? The previous wave didn’t work out well – Dana, Tower, Dura, Lear and others ended up in Chapter 11.

So how about Federal-Mogul? They too went on an acquisition binge in the late 1990s, including the British firm T&N. In the process they took on debt, with a $2.75 billion package just for the T&N purchase. As with others, they bit off more than they could chew. Federal-Mogul’s downfall however wasn’t operational issues but one T&N factory that had used asbestos. The accompanying $1 billion-plus in costs tipped them into Chapter 11, and it took until 2007 – 6 years – for them to emerge. So where are they heading?

Now back in 1999 Carl Icahn, a corporate raider, started buying shares in Federal-Mogul. The value of his initial holdings vanished in Chapter 11, but he also bought Federal-Mogul debt, a lot of it, and in 2007 emerged as the dominant shareholder in the new firm. Icahn’s modus operandi had been to acquire a majority stake in a company – the list includes Viacom, Marvel Comics, Blockbuster and Time-Warner – and then replace management with his own associates. They then would dismember the company in search of cash, with Icahn unloading his holdings as soon as practical, to make way for the next target.

Obviously 2008 was not a good time to unload anything automotive, and overall profits have since been spotty. But by 2012 profits were looking up, and Icahn split the firm into two pieces, separating powertrains (a $4.2 billion business) from aftermarket ($3.1 billion). This made sense only as a prelude to Icahn’s selling one or both of pieces. Consistent with preparing for a sale, he appointed an associate, Daniel Ninivaggia, as co-CEO of the aftermarket portion. [See a Sept 3rd Automotive News story.]

In a visit to a Federal-Mogul R&D center in Plymouth, Michigan we [Dawejko and the rest of the class] saw how focused their people were on designing and manufacturing new products. Most of the class had never heard of the test equipment we saw. Unlike the tribology labs, some of the products under development were self-explanatory, such as the corona discharge spark plug about which TTAC reported in 2011. What became clear is that Federal-Mogul is in fact a high-tech operation that spends 5% of revenue on R&D. They have been a PACE supplier innovation finalist 32 times, and an award winner 11 times. In the context of the automotive product cycle, however, technology is not a route to quick profits.

[In autos] technology is not a route to quick profits

Back to Icahn. The new co-CEO of the aftermarket half of Federal-Mogul may be an Icahn executive, but unlike the people Icahn installed on the board, Ninivaggia previously spent 6 years at Lear. He is an industry person, and not just an M&A specialist. In the same vein, Rajesh Shah, named CFO in 2013, has a long career working for auto suppliers, and came from another supplier rather than from Wall Street. Looking forward Ninivaggi noted, “There’s been a significant consolidation in the industry and as our customers have become very large companies, we need to do the same thing; we need to grow fast, improve our capabilities and expand our product lines”. It will take some years to show that the newly autonomous aftermarket operations are firmly profitable.

M&A may be a useful tool as major suppliers work to adjust their portfolio to match their global footprints, selling pieces that don’t fit to erstwhile rivals and buying similar operations from their competitors. Federal-Mogul is itself an assemblage of such pieces, cobbled together over the past 20 years. (An aside: one engineer the prof knows worked for five different firms, while never changing his desk at what is now a Federal-Mogul facility just outside Ann Arbor.) At the Plymouth tech center we were presented with their R&D roadmap, shared with their customers. They’re looking a decade down the road, 3 product cycles, for what future drivetrains will require. If they get that right, they will be one of 2-3 global players left in each of their product segments, with profits to match.

Pension fund managers operate on a 60 day cycle; the customers of hedge and restructuring funds take longer to get restive. Neither is compatible with the auto industry. History suggests that buying and selling automotive firms is not a quick route to riches for anyone but the lawyers and investment bankers who participate on a fee basis. Wittingly or not, Icahn is in this one for the long haul.

...there's irony when corporate raiders turn into stable shareholders...

Icahn isn’t alone in holding onto things; Wilbur L Ross with International Automotive Components has been “in” for a long while as well. Is there not irony when corporate raiders turn into stable, major shareholders, so that these firms look more like privately held firms investing across the business cycle than ones whose strategy is driven by the stock price of the moment?

By Alexander Dawejko ’17 and Michael Smitka, Economics Department, Washington & Lee University