Supplier profits boost M&A expectations

ERJ staff report (AN)

Detroit, Michigan -- A little over a year ago, Federal-Mogul Corp. was licking its wounds from several quarters of heavy losses. In December 2007, the suburban Detroit auto parts supplier had emerged from six years of bankruptcy -- just before the recession hit.

Today, it's sitting atop a pile of cash and looking for deals.

“We increased our already strong liquidity in the third quarter to $1.6 billion: $1.1 billion in cash and half a billion in an undrawn revolver" or revolving line of credit, Federal-Mogul CEO Jose Maria Alapont told analysts late last month. The reserve offers "excellent flexibility for acquisitions and other strategic action," he said.

Many suppliers boasted heady profits in the third quarter, reaping the fruits of deep cuts made during the downturn. Expanding profit margins and cash flows should serve as a lubricant for a widely anticipated round of mergers and acquisitions among suppliers, says Scott Merlis, managing director at CRT Investment Banking in Stamford, Conn.

The newfound profitability of suppliers has drawn the attention of investors of all stripes, from private equity and venture capital firms to foreign investors, Merlis said.

"New players are coming through the door like never before," Merlis told Automotive News. "I'm getting calls every week from new investors wanting to buy suppliers."

Most of the activity is happening below the radar. Private equity investors, burned by losses on big investments in recent years, have tempered their appetites and expectations and are targeting Tier 2 and 3 suppliers rather than large Tier 1 companies. They're settling for returns on investment of 15 percent, compared with double that a few years ago, Merlis said. "Private equity will spur consolidation, which the industry needs," he said.

The likeliest targets: smaller suppliers that might struggle to get financing as they look to increase production as volumes climb.

"The issue companies are having is funding the pickup in working capital that they require," Sun Capital Partners co-founder Marc Leder told Reuters last month. "That is creating opportunities for us."

As a result, the size of private equity deals is shrinking. The average private equity investment in the global automotive sector from January through October was $72.6 million, down from an annual average of $400 million in 2007-09, according to a CRT report.

Many industry pundits are awaiting a bigger shakeout. Only about half of the industry's excess supply went away during the cutbacks and bankruptcies of the past few years, said Jim Gillette, a supplier analyst at IHS Automotive.

"As long as you've got that overhang, it's difficult for suppliers to hold pricing when they go to customers," he said.

Still, some Tier 1s have said they're having trouble finding decent targets. Johnson Controls Inc. could spend up to $3 billion on a deal, executives from the Milwaukee supplier told Reuters last month.

"I just don't think there's a lot of opportunities to buy right now," CEO Stephen Roell told Reuters.

Magna International Inc. said this month that it acquired Resil Minas, a Brazilian seating supplier that expects sales of about $200 million this year. While North America's largest supplier is seeing fewer opportunities, it could spend a total of $400 million to $500 million next year on a handful of smaller deals, CFO Vincent Galifi told analysts this month during a conference call.

"I do think we're still going to see a number of companies getting into financial difficulties," Magna CEO Don Walker said during the same conference call. "So we might be able to get some good opportunities there."

From Automotive News (A Crain publication)