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 In The Daily Deal Gary Silberg, a partner at KMPG LLP's Chicago office analyzes private equity deals trends within the automotive industry. The U.S. automotive industry is suffering from a long list of well documented issues that include high labor and post-retirement costs, shrinking market share, overcapacity and regulatory challenges. Yet, the industry has become a popular destination for private equity investors, a trend that is likely to continue.
Private equity firms remain interested in automotive companies for several reasons. For one, private equity is willing to invest in riskier or more uncertain situations in exchange for the opportunity of a higher return. Also, using their financial sophistication and expertise, private equity firms can manage these complex businesses in a way that may allow them to grow and ultimately achieve profitability.
A KPMG LLP study reveals that private equity firms that invest in the automotive sector usually employ one of several acquisition strategies: "Integrators" focus on combining entities on the supplier end of the value chain and hope to benefit by economies of scale. "Balance-sheet fixers" focus on restructuring the balance sheet of the target companies and are mostly looking for opportunities that exist in the Tier 1 and Tier 2 suppliers. "Operations champions" take a longer-term perspective and seek to engage in a major restructuring of existing operations. Investors with this strategy tend to focus on the large Tier 1 players, original equipment manufacturers and the retail end of the value chain. As M&A transactions continue to be more competitive, the study indicates that those firms that can bring "operations champions" skills to the transaction will be the ones most likely to succeed in creating value. The U.S. automotive market is experiencing one of the most trying times in its history. Detroit's Big Three -- General Motors Corp., Ford Motor Co., and Chrysler LLC -- have seen their U.S. market share drop from 83% in the 1980s to 63% today. Automotive suppliers also are suffering. Since 2001, automotive suppliers that collectively accounted for more than $72 billion in sales have filed for Chapter 11 bankruptcy protection. Despite these troubles, the automotive industry has been a tempting place for private equity investors. In 2006, there were a total of 261 reported M&A transactions in the North American automotive industry, up from 211 in 2005. And even in the challenging market of 2007, 231 deals -- valued at over $26 billion -- were completed. The private equity deal gaining the most attention was perhaps Cerberus Capital Management LP's purchase of 80% of Chrysler for $7.4 billion in August. But according to KPMG's study, most private equity funds interested in the automotive industry have primarily invested in Tier 1 suppliers, including two of the largest, Delphi Corp. and Dana Corp., both operating under Chapter 11 bankruptcy protection. A total of five private equity firms, including hedge fund Appaloosa Management LP, have announced plans for an investment of $2.5 billion in Delphi. Meanwhile, Centerbridge Capital Partners LP has committed to a $500 million investment in Dana. That Delphi and Dana are both operating under bankruptcy protection is no coincidence. First, these companies relied almost exclusively on Detroit's Big Three as customers and, since their fixed costs were high, were adversely impacted when the domestic manufacturers' market share declined. Second, many suppliers were adversely impacted by increases in prices for commodities such as steel and copper and were unable to pass those on to their customers. Finally, labor costs, including post-retirement costs have been growing exponentially. With new private equity owners, these suppliers now may be better able to resurrect themselves by presenting a more "hard-nosed" approach to the industry's problems. The private equity-owned suppliers may be more pragmatic when negotiating with their customers and employees and may not be as willing to give Detroit's Big Three some of the discounts that they have historically enjoyed. Moreover, look for them to use their "operation champions" skill sets to drive higher productivity and profits. The next wave of investments in this sector is likely to focus on Tier 2 and Tier 3 suppliers, which consist largely of automotive components suppliers and subassemblers. Some of these Tier 2 and Tier 3 suppliers could wind up in bankruptcy, a process that could result in additional opportunities for private equity investors. The most attractive targets for private equity firms again may well be suppliers that are emerging from bankruptcy with restructured balance sheets and operations. Although the automotive industry has been suffering from a myriad of challenges, there seems to be no shortage of private equity investors who perceive opportunities and are willing to tackle the tough issues in the hope of outsized returns. The evolving state of the industry, which includes more flexibility from the United Auto Workers union, and the number of automotive companies in the bankruptcy process indicate that this trend is likely to continue. The next stage of the industry and its economics will likely be written with substantial input from the private equity community. Categories Deal Video
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