Bankruptcy & Consolidation in the Global Automotive Supply Industry

A PRTM Study of the Winning and Losing Auto Suppliers

Table of Contents
Executive Summary...1 Industry Backdrop...2 Regional Factors...2 Winners and Losers...4 The Road Ahead...11 Study Methodology...12

Authors:

Dietmar Ostermann, Barry Neal

a prtm study of the winning and losing auto suppliers

Executive Summary
This report highlights the results of a recent PRTM study of more than 350 global automotive suppliers. Based on more than 20 financial and qualitative criteria, Bankruptcy & Consolidation in the Global Automotive Supply Industry assesses trends within the sector and identifies possible winners and losers (see sidebar, page 12). The study reveals that the economic crisis and the resulting downturn in the global auto industry have caused a significant shift in the automotive supply chain. Our findings indicate:
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Global 100 European suppliers and Chinese suppliers will be among the top global consolidators. Several large Global 100 North American suppliers are currently at risk of going bankrupt. Only one U.S. supplier is among the top 10 potential global consolidators, while two Chinese suppliers are on the list. The chassis and electronics sectors will experience the strongest bankruptcy and mergers and acquisitions activity. Chinese suppliers will play a top role in consolidating within the interior systems segment. North American and European suppliers will be the biggest consolidators in powertrain systems.

The number of automotive supplier bankruptcies has grown significantly since 2007 and is continuing to grow. These bankruptcies will be followed by a period of consolidation, which will intensify as the global credit markets continue to loosen within the next 12 months.

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bankruptcy & consolidation

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global automotive supply industry

Industry Backdrop
The financial crisis has left an indelible mark on the automotive sector. The housing bust, followed by a severe worldwide recession, has resulted in mortgage defaults, a tight credit lending market, massive job losses, reduced compensation, and a drop in consumer spending. Without cash and borrowing clout, consumers have stopped buying high-ticket items like cars in an effort to limit cash outflow. Current and predicted global vehicle sales volume paints a clear backdrop of how badly car makers have been hitand how they must adjust planning and supply chain processes to account for continued weak demand. To date, sales volume in several major geographies, except for China, has dropped about 40% from 2007. Although the economy may be improving, PRTM predicts sustained lower vehicle sales volumes for most regions going forward, particularly in North America, where it is estimated that longer-term light vehicle sales volumes will mature around 13 million units per yeara far cry from the 16.5 million units that were common during the earlier part of the decade. However, there is another side to this picture. China and emerging markets like Brazil are experiencing an uptick in auto demand. Chinas vehicle sales, for example, are estimated to increase by more than 50% from 2008 levels of approximately 9.5 million units within the next five years. Given the incredible growth during the last few monthsmore than 30%its possible that this progress may be realized much sooner. The sharp disparities in business conditions have left automotive suppliers on shaky ground, and in the last year, have forced many into bankruptcy. As the industry begins to assess the impact of restructurings and bankruptcies, sizes up near-term demand and production capacity, and refocuses on emerging markets, PRTM anticipates even more bankruptcy and M&A activity among the global auto supply base. To better understand what is happening in the industry and to identify which companies may fare better or worse than their competitors, PRTM studied more than 350 global suppliers from North America, Europe, South America, China, India, Japan, and South Korea. Our analysis shows several scenarios likely to unfold in the coming quarters. The most significant scenarios point to:
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An accelerated pace of bankruptcy filings An industry-wide consolidation led by large European and Chinese suppliers A noticeable shift in winners and losers on a regional level

Regional Factors
European and Chinese suppliers will be the major industry consolidators. Based on our analysis of various financial and qualitative criteria, companies from these regions scored, on average, the highest and are in the best position to become buyers (Figure 1). By contrast, North Americas Global 100 suppliers fared worse than the population overall, and will constitute the largest percentage of bankruptcies and divestitures. Regional growth may explain, in part, why some geographies have better-performing companies. Chinas auto suppliers grew at an average compounded rate of about 20% from 2004 to 2008more than double the rate of Indian, Japanese, and European suppliers, and nearly seven times that of North American suppliers (Figure 2).

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a prtm study of the winning and losing auto suppliers

FIGURE 1: Supplier Scores by Region

Region
Global Global North America North America Global Europe Europe Japan Brazil India China South Korea Total/Average of All

Number of Companies
93 31 30 38 52 97 10 33 24 35 355

Buyer
5.4 4.9 5.1 5.5 5.1 5.0 5.0 4.5 5.2 4.5 5.0

Seller
3.2 3.3 4.1 3.4 4.0 2.9 3.0 3.7 3.6 3.2 3.4

Divest
4.1 4.6 3.7 4.1 3.7 3.1 3.6 4.1 4.2 3.3 3.7

Fail
4.2 4.8 4.2 4.5 4.4 3.3 3.3 4.1 4.4 3.8 4.0

FIGURE 2: Supplier Financial Results by Region sales

CAGR 0408
Global 100* North America Europe India China Japan South Korea Brazil 8% 3% 9% 8% 22% 9% 8% 19%

ebitda
CAGR 0408
6% 4% 5% 10% 37% 10% -3% 16%

Avg. 2008 ($B)

$17.2 $9.9 $12.4 $0.5 $2.0 $6.7 $0.9 $0.4

Avg. 2008 ($B)

$1.9 $1.1 $1.5 $0.1 $0.2 $0.7 $0.1 $0.1

EBITDA % of Sales**
11% 12% 12% 15% 10% 10% 15% 15%

* Global 100 companies also counted in regional numbers ** Average sales per company compared to average EBITDA per company

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Winners and Losers

By all indications, the next several quarters will mark an increase in bankruptcies, divestitures of non-strategic business, and supplier mergers and acquisitions. As a result, the winners and losers on the worldwide stage will also change. Winners are defined as companies that have the financial wherewithal to lead consolidation and buy weaker companies or competitors assets. Losers are companies that will file for bankruptcy, divest assets because of financial troubles, or go out of business.

Winners: European and Chinese Suppliers

Our study found that large European and Chinese suppliers, on average, will be the biggest winners. They will be in a dominant position to lead consolidation globally, which will gain momentum as credit markets loosen. Various European companies, particularly German suppliers, appear on PRTMs top 25 potential global buyers list (Figure 3). Companies such as ZF Friedrichshafen AG (transmissions, steering), BASF SE (paint), Hella KGaA Hueck & Co. (lighting), and Benteler AG (body and chassis) are the most likely consolidation front-runners. Chinese suppliers, operating in a booming market and, in some cases, benefiting from central government support, have consistently improved their global market share in recent years and are displaying improved profitability. Some are now strong enough to acquire other companies. Guangzhou Automotive Components, a division of the highly profitable 51% state-owned automobile manufacturer Guangzhou Automobile Industry Group Co. in Guangzhou, China, and Weichai Power Co. Ltd., a state-owned diesel engine manufacturer in Weifang, China, are considered to be among the top 10 potential global consolidators. A third Chinese supplier, FAWER Automotive Parts Limited Company, the parts maker partially owned by state-owned auto maker First Auto Works (FAW) in Changchun, China, is in the top 30. Guangzhou and FAWER are the components divisions of two of the largest state-owned automobile manufacturers. Chinese suppliers have already taken steps toward consolidation, suggesting they will continue down this route in the immediate future. Guangzhou has actively been buying automotive assemblers and suppliers. It

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a prtm study of the winning and losing auto suppliers

FIGURE 3: Top 25 Suppliers by Consolidation Score

10.0

US-based companies
8.0

China-based companies

Other

Consolidation Score*
G ua ng zh ou Au

6.0

4.0

2.0

0.0

has also formed joint ventures with Toyota Motor Corp. and Honda Motor Co. Ltd. in China, giving it more influence with and access to key modern manufacturing and product development capabilities. Likewise, Weichai Power recently bought Moteurs Baudouin SA, a French maker of diesel engines and gearboxes. And FAWERwhich last year changed from a state-owned company to a holding company recapitalized at one billion Chinese yuan renminbi (about $146 million) is a solid profitable company. It has access to modern technology via FAWs two established vehicle assembly joint ventures with Volkswagen AG and Toyota, as well as one recently-formed joint venture with General Motors for light trucks. North American suppliers, longtime industry stalwarts, generally did not score as well as potential buyers.

to m G obi ro le up To yo De ns ta Bo o sh ok Jo u hn so Z n M F at th ey SK F BA SF W ei ch PP ai G Po Ta we r ta G ro u Ai sin p Se iki H el Cu la m m M ag ins Ai na ch In iM tl ac hi N ifc ne o In du st ry N S TS K Te c Be h nt el e D r Al uP ps on El t ec tr To ic m kin G s Fe en de te ra l-M x og ul M ah le

*Potential of company to make acquisitions, on score of 010. See Study Methodology.

Only one of the top 10 potential global buyers is from the United States: PPG Industries Inc., a Pittsburgh, PA-based diversified glass and paint supplier. Four other U.S. suppliers also rank among the top 25 potential buyers: Cummins Inc. (diesel engines), El DuPont de Nemours (paint), Gentex Corp. (exterior, electrical), and Federal-Mogul Corp. (powertrain and seals). Japanese suppliers are also not expected to be consolidation leaders, even though they have strong buying scores. Eight Japanese suppliers made the top 25 potential global buyers list, several of which are Toyota Keiretsu companies lead by Denso Corp. and Toyota Boshoku Corp. Based on their histories and our industry experience, however, we believe they will not engage in mergers or acquisitions in any significant way.

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Losers: North American Companies

The study also found there is likely to be an increase in bankruptcy filings and divestures of nonstrategic business units. These events will add greater risk and instability to the automotive supply chain over the next few months. Bankruptcies. The number of supplier bankruptcies is accelerating (Figure 4). The filings in 2008 were roughly double the number seen in 2007. And, by our estimate, 2009 filings will surpass 2008 levels significantly, since 2009 year-to-date bankruptcies have already reached prior-year levels. We anticipate that large North American suppliers that are part of the Global 100 suppliers will constitute a larger percentage of bankruptcies, since the downturn in the U.S. auto industry was so much stronger than in most other regions and, according to our analysis, many of the North American suppliers are in weaker financial positions. Prominent large North American suppliers currently in bankruptcyVisteon Corp., Metaldyne Corp., Hayes Lemmerz International Inc., and Lear Corp.also appear on PRTMs list of top 25 global bankruptcies (Figure 5). On the basis of our analysis, we believe these companies will go through reorganization, will be auctioned or sold, or will divest certain businesses. The North American suppliers that face potential bankruptcy risk include: American Axle & Manufacturing Holdings Inc., ArvinMeritor Inc., TRW Automotive Holdings Corp., Flex-N-Gate Corp.,

FIGURE 4: Automotive Supplier Bankruptcies, 20052009

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Number of Bankruptcy Filings

30 25 20 15

Actual bankruptcies Projected bankruptcies

40

10 5 0

35 30 25 20 15 10 5

2005

2006

2007

2008

2009

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a prtm study of the winning and losing auto suppliers

Tenneco Inc., and Shiloh Industries Inc. These companies all have three things in common: they provide capital-intensive subsystems, have close ties to the former Detroit Three automakers, and maintain a U.S.intensive footprint. Divestitures. Several North American and European suppliers may try to escape the threat of bankruptcy by divesting certain assets or businesses (Figure 6). According to our analysis, electronics firms that have financial difficulties stemming from the downward slide in consumer electronics purchases may decide to shed their automotive businesses. This includes companies such as Clarion Co., Ltd., Alps Electronics Co. Ltd., and Koninklijke Philips Electronics NV.

Schaeffler KG, a German producer of bearings and many other components, is a special case. Previously in good financial health, Schaeffler encountered financial difficulties as a result of acquiring Continental AG. It is likely that Schaeffler will try to divest several businesses, like Contis tires or rubber products, to mitigate the situation. Major Developments by Vehicle System Within the six main vehicle systems (exterior, interior, chassis, electrical/electronics, powertrain, and body), two segments face the greatest consolidation pressures. Based on the number of total suppliers by vehicle system and the number of possible strong

FIGURE 5: Top 25 Suppliers by Bankruptcy Score

10 9 8

US companies Others Supplier currently or recently in bankruptcy

60

50

Bankruptcy Score*

7 6 5 4 3 2 1 0

40

30

20

10

D e er lph ica i n Ax l H ay Vis e es te on Le m m er Ac z er Ku m tec bo Ti r D Ch e ia m as on ys d El ec tri c Le a Br r em b C o Ar lar vin ion M er it Sc Fa or ha ur ef e fle cia r/ Co W nt ilh i el m TR Ka W rm an n Ci e Au Fl ex t -N o Ka -G sa ate iK o M gyo et al dy Te ne nn ec o Sh ilo h Va le o Be hr ED AG Am
*Company's risk of bankruptcy, based on score of 010. See Study Methodology.

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FIGURE 6: Global 100 Selected Winners and Losers

9.0 8.5 8.8 7.5 7.0 6.5 Toyota Boshoku Denso ZF Hella

Top Buyers

Top Divestors

Top Sellers

Top Bankruptcies

Strength as a Consolidator

6.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0

TS TECH Federal-Mogul Magna Intl Du Pont Hyundai Mobis BASF SKF Saint Gobain Magneti Marelli PPG NSK Benteler JTEKT Bayer Marne TI Group Auto. Eaton Alsin Seiki Timken Alpine Electronics Cummins Freescale Semiconductor Sumitomo Electric JCI Brose Linamar Clarion Behr Flex-N-Gate Metaldyne Valeo Schaeffler Conti Mahle Wilhelm Karmann TRW Tenneco Faurecia Lear Martinrea International Hayes Lemmerz ArvinMeritor Visteon American Axle

Delphi

FIGURE 7: Potential Supplier Consolidation by Main Vehicle System

120

Number of Suppliers

100 80 60 40 20 0 Chassis Electrical Interior

Companies in sector Companies in strong acquiring position

Powertrain

Exterior

Body

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a prtm study of the winning and losing auto suppliers

FIGURE 8: Automotive System Sensitivity to Volume Risk

40 35 30 Sensitivity Score 25 20 15 10 5 0 Chassis Powertrain

Risk Level

High

Medium

Low

Interior

Body

Exterior

Electrical/ Electronics

buyers in each of these systems, PRTM forecasts that the intensity of bankruptcies and consolidation will be strongest in electrical/electronics (wire harnesses, switches, door systems, etc.) and chassis (brakes, steering, axles, suspensions, etc.) (Figure 7). Electrical and Electronics. The electrical and electronics vehicle system has a large number of total suppliers and strong possible buyers, which suggests the segment is ready for consolidation. The M&A activity will take place among system-level players and across systems. In the latter category, suppliers from main vehicle systems will look to buy electrical and electronics companies to increase their electronic content know-how. This trend will be driven by the increasingly important role of electrical and electronics components in system-level configurations. In 2010, electrical and electronics will account for 40% of a cars overall value, up from 25% in 2000. Chassis. This segment is ripe for consolidation, with 120 chassis suppliers of relevant size globally and 24 strong potential buyersM&A pressures will almost certainly increase in the future. Capital-intensive

chassis systems providers have been severely affected by declines in demand, so companies in this sector will have a hard time meeting performance expectations in the current market (Figure 8). Of the most recent wave of supplier bankruptcies, roughly 30% were chassis system suppliers, including Metaldyne, Hayes Lemmerz, CONTECH, and J.L. French Corp. Within the main vehicle systems likely to experience a high degree of consolidation of the supply base, M&A activity will take place unequally. For example, within the chassis system, the suspension, axles, and steering subsystems will undergo the greatest amount of consolidation. Each has relatively high numbers of suppliers and several strong potential buyers (Figure 9). The specific consolidation scenarios that play out will be very closely tied to the following factors: strategies of the specific companies, product and technology portfolios, customer bases, manufacturing capabilities, and so on. In steering systems, for example, 68% of the volume is controlled by five large suppliers, and most auto manufacturers generally have a go-to supplier. This has created an unusual

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FIGURE 9: Forecasted Consolidation Within the Chassis Subsystem

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Companies in sector Companies in strong acquiring position

Number of Companies

30 25 20 15 10 5 0 Fuel Tank Suspension Axle Steering Pedals Wheels Brakes Exhaust

degree of stability on the M&A front in this subsystem. However, key new trends are emerging: the rapid growth of Indian and Chinese players; the development of low-cost country steering subsystem manufacturing footprints by several participants; a near-term shift from hydraulic to electrical power-steering; and a mid-term shift to steer-by-wire total chassis control systems. These trends will encourage suppliers to form new partnerships with other companies. Suppliers will use these alliances to fill in gaps in their technology portfolios and more closely link steering to braking, acceleration, and suspension control.

Two of the weaker companies in the steering subsystem have already begun the consolidation process. Delphis Saginaw Steering System was sold into a GM temporary trust in July, but will soon be back on the block as part of Old GM assets (assets being sold in the GM bankruptcy proceedings). Metaldynes chassis business was similarly purchased by private equity firm The Carlyle Group as part of the troubled companys Chapter 11 restructuring in August. Strong potential buyers include Chinese firms like Guangzhou Automotive and FAWER, as well as Sona Group Ltd., Indias largest steering subsystem supplier.

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a prtm study of the winning and losing auto suppliers

The Road Ahead

Over the next few quarters, the global automotive supplier industry will come under greater pressure to consolidate. The current number of suppliers engaged in the six main vehicle systems could be reduced by 25% or more. Supplier bankruptcies constitute the first wave of restructuring and the rate of bankruptcy filings will continue to accelerate in the near term. As credit becomes more widely available and companies are able to secure liquidity, there will be a wave of M&Athe next phase of industry consolidation. In our view, European and Chinese suppliers will gain ground during this intense shakeout and emerge as top potential buyers. North American suppliers, however, will have to watch their already weak footing; several more are likely heading towards bankruptcy and divestiture. The chassis and electronics segments are likely to face the most intense bankruptcy and M&A pressures. The high number of total suppliers and number of possible strong buyers reinforces PRTMs expectation of increased activity in these areas. As part of the study, PRTM identified the consolidators and distressed suppliers for several subsystems, predicted bankruptcies, and developed consolidation scenarios on a vehicle subsystem level. The more probable divestitures of financially-troubled suppliers and the potential buyers are shown in Figure 10. In the tires subsystem, for example, Schaeffler will need to shed assets to generate cash after purchasing Conti. Potential buyers include Pirelli & C. S.p.A. and the Michelin Group, both of which have shown interest in Conti tires in the past, or Veyance Technologies,

FIGURE 10: Top Divestors and Potential Buyers

Subsystem

Thermal

Lighting

Wipers

Automotive Components Division

Front-End Modules

Wire Harnesses

Chassis

Tires

10 8

Divestor Score

6 4 2 0

Delphi

Visteon

Valeo Guangzhou Automobile Group

TRW

Faurecia Hella, Behr, Omnium (HBPO)

Lear

ArvinMeritor

Schaeffler/ Continental Pirelli

Potential Buyer

Behr

Hella

Mahle, IAC

Yazaki

Benteler

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Inc., which is a good fit for ContiTech. In the thermal subsystem, Delphi, emerging out of Chapter 11 U.S. bankruptcy protection under new ownership, may decide to focus its business activities even further and shed its thermal division. Behr GmbH & Co. KG and CalsonicKansei North America, Inc. are potential buyers, using those assets to expand their geographic and customer reach.

The automotive supplier industry is in the early stages of what will prove to be a major industry restructuring. Companies that understand how they rank vis-vis their competitors will be well positioned to prevail in the years ahead.

Study Methodology

The 2009 PRTM study included 357 global suppliers from North America, Europe, South America, China, India, Japan, and South Korea. The study took into account more than 20 financial and qualitative criteria in eight main categories. Based on these criteria, a score was developed to rate each companys 1) risk of bankruptcy or 2) ability to acquire other companies. The categories are as follows:
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Size and criticality (the measure of the relative size of the supplier, in terms of revenue, and its OEM criticality, based on an assessment of supply chain and technology) Capital structure and health (a measurement of a companys short- and long-term capital structure, market solvency, and degree of corporate distress) Commodity structure (an assessment of the companys commodity portfolio) Business health (an evaluation of EBITDA growth, cash flow, sales and profits relative to assets, union participation, litigation, and environmental issues)

Business flexibility (measured against R&D and capital intensity and manufacturing flexibility) Customer base (a review of nonautomotive business, regional sales, business with bankrupt OEMs, and percent of revenue from car vs. truck business) Ownership structure and management (evaluation of the companys historic acquisitiveness, senior management strategy, and the favorability of structure to acquisition, divestiture, and/or sale) Pricing (EBITDA multiple and price/earnings ratio)

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