Private Equity: Increasingly Important to Auto Suppliers

Auto Focus: Private Equity – Increasingly Important to Auto Suppliers
MiBizWest • March 24, 2003
by Jim Gillette

Trying to finance your auto parts com­pany? Good luck. Sources of available and reasonably priced funds are difficult to find.

The latest blow to the public equity mar­ kets came on March 3, when both Ford and General Motors announced their February light vehicle sales were below expectations. The seasonally adjusted annual rate was a disappointing 15.4 million units compared to 16.6 million during February 2002. Stock analysts seized the opportunity to down­ grade the auto industry triggering a 5.2 percent drop in the Dow Jones Auto Part Index and a 5.0 percent decline in the Dow Jones Auto Manufacturer Index the next day.

Public equity has dried up

Of course, this was nothing new, as the former index dropped about 34 percent and the latter 51 percent from April 2002. The equity markets see no upside to the traditional domestic auto industry in the near-term. We agree and remain concerned over a potential spate of supplier bankruptcies resulting from reduced production volumes and cash flows this year.

Meridian Automotive Systems pulled its planned IPO in late February citing “current market conditions.” It may be a year or so before suppliers can once again tap the public equity markets.

Banks are reluctant

Bank financing also remains tight, as most loan committees are still gun-shy after loose lending requirements of the mid- to late-1990s led to a cluster of defaults at the millennium. According to the latest Federal Reserve Quarterly Survey on Bank Lending Practices, there is no sign of easing lending policies for commercial and industrial loans. Twenty-two percent of loan officers re­ ported they are still tightening restrictions; none reported any loosening.

The one remaining source of funding for auto suppliers still highly active is private equity. According to a survey by PricewaterhouseCoopers, private equity firms have funded 27.5 percent of automo­tive component firm purchases over the past three years.

While there are scores of firms managing investment funds, some of the bigger names have dominated the news lately: Blackstone Group’s purchase of TRW Automotive; Questor’s acquisition of Teksid (with other partners), Aetna, and ASC; and Carlyle Group’s purchase of Edscha and Breed Tech­nologies. The most interesting, by far, is Carlyle.

Carlyle Group turns its focus to auto suppliers

Established in 1987, Carlyle currently manages over $13.9 billion for wealthy in­dividuals and large institutions. Most intriguing is the list of those associated with the firm including: former President George Bush, former British Prime Minister John Major, and former SEC Chairman Arthur Levitt Jr. to name only a few of the heavier hitters. Louis Gerstner, retired CEO of IBM, replaced Frank Carlucci, Defense Secretary under President Reagan, as Carlyle’s chair­ man in January.

Previously known for its forays into de­fense-related businesses, for the most recent four years Carlyle has focused at least part of its attention on the auto industry. (See box on this page.)

History of Carlyle Group Auto Supplier Acquisitions
  • March 1999 – Purchased 72 percent of German Honsel-Werke AG, a maker of aluminum die-cast products including trans­ mission casings, suspension components and engine blocks.
  • April 2001 – Took over bankrupt Key Plastics.
  • 2002 – Participated in bidding for TRW automotive business, but pulled out of the negotiations.
  • November 2002 – Purchased 77 per­ cent of German Edscha, a maker of hinges and convertible top systems.
  • December 2002 – Purchased Rexnord Industries of Milwaukee from Invensys. The company makes bearings, motor brakes and chains.
  • March 2003 – Purchasing troubled airbag maker Breed Technologies.

If there is a problem with this type of finance it is because auto suppliers’ custom­ers, principally the automakers, tend to look askance at private equity investors. “Finan­cial buyers,” as they are labeled, are often criticized as looking for the “quick buck.” There is a perception that they buy a com­pany at a distressed price, hang on until the equity market recovers, and then sell to the highest bidder. Automakers say they prefer to do business with “strategic buyers,” ex­isting suppliers seeking to make acquisi­tions to expand their capabilities and market opportunities.

Big Three automakers prefer “strategic buyers”

Gretchen Perkins of the private equity firm Long Point Capital agrees “that the OEM’s (primarily domestic ones) don’t con­sider financial buyers to be their first choice. This is due to the fact that when a financial buyer buys a company we always use debt (as much as we can!) as part of the purchase price. If the company wasn’t leveraged prior to the sale, the cash drain of the interest payments going forward means there is less money: 1) to pony up for Visteon, for in­ stance, to make the [cash up-front] ‘pay-to­ play’ payments; 2) to foot the increasing tooling investments; 3) to buy the latest machinery and equipment to make the parts at the always reducing price the OEMs want; and 4) to agree to big price cuts. In short, the OEM’s typically can extract more from an unleveraged company than a leverage done.

In the case of a strategic buyer, debt is not always a part of the acquisition structure, or if it is, maybe it’s not as much.” While it is true that Carlyle will likely sell some of its automotive holdings in the future for a handsome profit (according to one source, the firm has been averaging 36 percent annual returns for its investors), its apparent success with turning around the injection molder Key Plastics is a major step toward building cred­ibility with auto industry insiders. At this point of observation, it appears that Carlyle’s for­mula for obtaining the best price in the future is the same as a strategic buyer’s for building value over the long haul.