Over recent months the
investment community has watched as a number of major
auto-manufacturers have undergone various internal ructions and
publicly aired sector concerns. The latest of which has been GM's
apparent rebuff of FCA Group's intent to further consolidate the
auto-sector, itself as a primary actor.
A Snapshot of Current
Affairs -
The formal departure of
Ferdinand Piëch from the
official top perch at Volkswagen came with little warning, although
he (as effective patriarch of the Piëch-Porsche
clan) obviously retains massive shareholding influence. At Renault
there may be possible future frustrations for Carlos Ghosn after the
French government's raised near 20% share-hold, which with regulation
imposed increased voting rights, raises the issue of 'politicising'
the efficiency rates of domestic plants. (Previously,
investment-auto-motives highlighted the case that promised plant
efficiencies at Renault and Peugeot would simply be delivered on the
back of improved sales on a per unit basis).
More apparently
pro-active is the ongoing push by Sergio Marchionne of FCA Group for
yet greater broad-based efficiency seeking within the sector.
An Ever Ongoing
Contextual Debate -
Under the title
'Confessions of a Capital Junkie: An Insider Perspective on the Cure
for the Industry's Value Destroying Addiction to Capital'' (dated
29.05.15), he recounted to analysts the sector's need for
consolidation. Whilst also explicitly refuting that the timing of the
speech reflected: FCA's present investment position (“in the food
chain”), the possibility of an FCA sale, a revision of the 5 year
plan, any presumption about him seeking a last 'big deal'.
His prime plea is for
mergers, acquisitions or partnerships as the costs of developing and
selling vehicles invariably rises, with specific focus upon the costs
of research and development, stating that the auto-industry creates
less value for customers and shareholders than most other industries.
In short it “has not earned its cost of capital over a cycle”. It
was presented as a dispassionate, objective view of the sector, from
the outside, using insider understanding, and “choosing between
mediocrity and fundamentally changing the paradigm”
Presentation Summary -
[with
investment-auto-motive's comment]
The first slide
demonstrated the rise in capital expenditure and research and
development for the major mainstream and premium manufacturers, from
€76bn to €122bn, with a compound annual growth rate of about 12%
for mainstream and 10% for premium makers.
[However, this in itself infers little. Reflecting simply a relatively stable and strong return of general business confidence from the extreme post-crisis lows of 2009/10. Those lows then were historically off-trend and an anomaly. The success of US economic QE re-inflation (much assisting GM and Chrysler), with similar central bank actions followed by Japan and Europe, plus ongoing faith in various EM markets, has then expectantly seen what appears a substantial rise in CapEx and Research-Development].
[However, this in itself infers little. Reflecting simply a relatively stable and strong return of general business confidence from the extreme post-crisis lows of 2009/10. Those lows then were historically off-trend and an anomaly. The success of US economic QE re-inflation (much assisting GM and Chrysler), with similar central bank actions followed by Japan and Europe, plus ongoing faith in various EM markets, has then expectantly seen what appears a substantial rise in CapEx and Research-Development].
The second slide was
more telling...with the sur-title “and going forward, new technical
challenges will continue to raise the bar on capital requirements”.
[This critique of the investment costs relating to [regulatory] a) emissions, b) safety and [customer] c) car-connectivity, were all obviously wholly valid].
[This critique of the investment costs relating to [regulatory] a) emissions, b) safety and [customer] c) car-connectivity, were all obviously wholly valid].
Slide three offered a
the perspective that...”product development costs are consuming
value at a much faster rate than other industries”. A comparative
calculation spanning different auto-cos and other sectors was
provided, showing what appears a valid viewpoint: the number of years
taken in which Enterprise Value is swallowed by CapEx and R-D. EV is
typically used an alternative 'full sum' and fulsome perspective to
simply MarketCap. It is conventionally calculated as: [MarketCap +
Debt + (minority interest and preferred shares)] – [Total Cash +
Cash Equivalents].
[As ever though direct comparisons may be unintentionally misleading. Because of their inherently different histories, business dynamics and point in their own business cycle, different sectors are viewed very differently. Some with overt over-speculation or expectation, so artificially boosting MarketCap, whilst others (ie providers: food, utilities, building materials and construction) often take on far greater leverage given 'staples' nature, that debt essentially based upon assured business income, so raising their EV value. (Remember that the banks' business is to lend, and since EV includes debt, the value of a business or sector is simplistically seen as greater). Also, as known, newer high potential firms with much publicity tend to be speculatively “equity heavy” so boosting MktCap, whilst socially engrained firms tend to be “debt heavy”. Critically, as seen new autos are seen as highly consumer cycle dependent, so whilst notionally 'socially engrained' are also absolutely foregoable as a discretionary purchase. Thus the sector doesn't enjoy either the speculation boost on its EV, nor the debt boost. (Through investment-auto-motive's own 'Coupled Ratios' analysis, autos tend to have lower level of leverage vs their cash positions). As a maturer industry, the typically well attuned analyst and institutional investor tends to be rational about their valuations approach to autos and so conservatively value its participants. Thus whilst the slide's 'take-away was that “the average across (combined) other industries is about 20 years for CapEx and R-D to reach EV levels compared to Autos' approximate 4.1 years”, that conclusion, whilst a probable truism, is very much overly generalised].
[As ever though direct comparisons may be unintentionally misleading. Because of their inherently different histories, business dynamics and point in their own business cycle, different sectors are viewed very differently. Some with overt over-speculation or expectation, so artificially boosting MarketCap, whilst others (ie providers: food, utilities, building materials and construction) often take on far greater leverage given 'staples' nature, that debt essentially based upon assured business income, so raising their EV value. (Remember that the banks' business is to lend, and since EV includes debt, the value of a business or sector is simplistically seen as greater). Also, as known, newer high potential firms with much publicity tend to be speculatively “equity heavy” so boosting MktCap, whilst socially engrained firms tend to be “debt heavy”. Critically, as seen new autos are seen as highly consumer cycle dependent, so whilst notionally 'socially engrained' are also absolutely foregoable as a discretionary purchase. Thus the sector doesn't enjoy either the speculation boost on its EV, nor the debt boost. (Through investment-auto-motive's own 'Coupled Ratios' analysis, autos tend to have lower level of leverage vs their cash positions). As a maturer industry, the typically well attuned analyst and institutional investor tends to be rational about their valuations approach to autos and so conservatively value its participants. Thus whilst the slide's 'take-away was that “the average across (combined) other industries is about 20 years for CapEx and R-D to reach EV levels compared to Autos' approximate 4.1 years”, that conclusion, whilst a probable truism, is very much overly generalised].
Slide four highlighted
that... ”high operational leverage amplifies profitability swings
across the cycle”, this inferred by a cross-comparison of
mainstream vs premium auto firms and other sectors' EBIT Margins once
again. Here mainstream VM producers are seen to have a lower EBIT
Margin obviously compared to premium makers, but critically also
lower than a number of other sectors.
The sectors illustrated
are (in ranked order) Pharmaceuticals, Consumer Products, Aero and
Defence, Chemicals, Packaging, Telecoms, Building Materials. It is
shown that it was only Autos which experienced negative margins
during the post-Crisis lows of 2009, whilst Premium Autos is on par
with Chemicals and Telecoms since 2010, whilst Mainstream Autos
under-performs against all.
[Once again, it must be recognised that such a comparison is distinctly not 'apples vs apples', but this is not Marchionne's absolute point, simply the relative EBIT. Again, it must be recognised that the autos environment is very different to those illustrated. Unlike cars, the Pharma sector has a distinct three tier structure across commodity drugs (retailed), conventional drugs (prescribed) and break-through drugs (high margin), each of which has various yet comparatively high levels of margin. Consumer Products are a broad range, but the effective commoditisation of the invisible electronic hardware thanks to its massive volume, easily adaptable, low-cost nature, plus ability to re-locate to international sites offering low cost workers has driven down the per unit cost of production: from smart-phones to flat-screen TVs to toasters. Thus brand, general design, interface and software availability have maintained price ceilings with a plethora of goods have allowed older (well amortised) specification products with low brand awareness products to lower price floors yet still gain appreciable per unit margins. Aero and Defence, viewed as 'specialist' is relatively protected by a somewhat secure pipeline of contract orders which even in the event of cancelled orders will invariably find alternative buyers at a slight discount in the global marketplace; furthermore whilst apparently “research rich” and so costly at the front-end of specific projects requires far less heavy plant and tooling than its Autos counterpart. The others, similarly have sector-specific traits, with perhaps most simplest Building Materials typically extracted from the earth and often only 'part-processed' at a relatively low cost per tonne before offered to the retailer and end user. Moreover, many of these sectors are typically not reliant upon B2C influenced consumer credit, but have are B2B facing, hence their ability to maintain earnings through the post-crisis downturn in which 'big ticket' consumer items were worst hit. Nonetheless, when compared to a broad array of other disparate sectors, Marchionne does indeed have point about the “high operational leverage” impact because of the cost of CapEx and R-D].
[Once again, it must be recognised that such a comparison is distinctly not 'apples vs apples', but this is not Marchionne's absolute point, simply the relative EBIT. Again, it must be recognised that the autos environment is very different to those illustrated. Unlike cars, the Pharma sector has a distinct three tier structure across commodity drugs (retailed), conventional drugs (prescribed) and break-through drugs (high margin), each of which has various yet comparatively high levels of margin. Consumer Products are a broad range, but the effective commoditisation of the invisible electronic hardware thanks to its massive volume, easily adaptable, low-cost nature, plus ability to re-locate to international sites offering low cost workers has driven down the per unit cost of production: from smart-phones to flat-screen TVs to toasters. Thus brand, general design, interface and software availability have maintained price ceilings with a plethora of goods have allowed older (well amortised) specification products with low brand awareness products to lower price floors yet still gain appreciable per unit margins. Aero and Defence, viewed as 'specialist' is relatively protected by a somewhat secure pipeline of contract orders which even in the event of cancelled orders will invariably find alternative buyers at a slight discount in the global marketplace; furthermore whilst apparently “research rich” and so costly at the front-end of specific projects requires far less heavy plant and tooling than its Autos counterpart. The others, similarly have sector-specific traits, with perhaps most simplest Building Materials typically extracted from the earth and often only 'part-processed' at a relatively low cost per tonne before offered to the retailer and end user. Moreover, many of these sectors are typically not reliant upon B2C influenced consumer credit, but have are B2B facing, hence their ability to maintain earnings through the post-crisis downturn in which 'big ticket' consumer items were worst hit. Nonetheless, when compared to a broad array of other disparate sectors, Marchionne does indeed have point about the “high operational leverage” impact because of the cost of CapEx and R-D].
Onto the fifth slide
and the mention of the previous impact...”resulting in structurally
low and volatile returns”. This illustrates how – against the
same comparative sectors – both mainstream and premium auto-makers
suffered far greater volatility in the Return Of Invested Capital
(ROIC) through the post 2008 down-cycle. It states that the Weighted
Average Cost of Capital (WACC) across all combined sectors has been
approximately 9% over the last decade, as as such mainstream makers
have over-whelmingly failed to meet that base-line with the exemption
of immediate post crisis period – unstated but when artificial
sales incentives were created by governments - with premium makers
previously just under the base-line, while over the last five years
comfortably surpassing it. The conclusion then is that given the raft
of higher return investment opportunities elsewhere, mainstream
auto-makers current inefficient business models are destined to fail
to continue attracting investors.
[Once again close attention needs to be paid to the reality of the WACC per sector, and specifically the details of each sector's typical corporate capital structure (critically the cost of equity and cost of debt). As stated, various of the sectors used are indeed of the “defensive” variety which invariably attract high investor demand and so lesser costs of equity and debt. As a “cyclical” entity, mainstream auto-makers will suffer by comparison, especially soon after a calamitous period. However, given the fact that auto-makers must endure the disadvantages of heavy fixed costs and demand cycles, compared to distinctly simpler, less exposed business formats, Marchionne maintains a valid point].
[Once again close attention needs to be paid to the reality of the WACC per sector, and specifically the details of each sector's typical corporate capital structure (critically the cost of equity and cost of debt). As stated, various of the sectors used are indeed of the “defensive” variety which invariably attract high investor demand and so lesser costs of equity and debt. As a “cyclical” entity, mainstream auto-makers will suffer by comparison, especially soon after a calamitous period. However, given the fact that auto-makers must endure the disadvantages of heavy fixed costs and demand cycles, compared to distinctly simpler, less exposed business formats, Marchionne maintains a valid point].
Slide six asks...”Why
did this happen?”...and answers...[because] “OEMs spend vast
amounts of capital to develop proprietary components, many not
discernible to the customer”. Here we see two diagrams with %
breakdowns:
1. Typical Vehicle
Development Costs:
a) vehicle R-D = approx
40% [spanning wide specifications spectrum and high IT content]
b) vehicle tooling =
approx 35% [presumably mix of VM + OEM supplier funded]
c) power-train R-D =
approx 15% [utilising std mid and low-cost casting/machining
processes]
d) powertrain tooling =
approx 5% [typically marginally altered std components]
e) other = approx 5%
2. New Vehicle
Programme – Developments Costs Split
x) differentiating
products / technologies = 50% - 55%
y) 'beneath the skin'
components = 45% - 50% [“indiscernible to customer”].
[As a basic % cost guide, little actual 'systems detail' can be gained, beyond the obvious intimation regards the component complexity of the modern vehicle, the heavy financial burden of the conventional pressed steel “Budd system” and the increasing toll of R-D in electronic hardware/software. Likewise belief must be placed in the calculated development and provision of customer 'visible' items vs 'invisible' parts development costs. This template conforms to the general historical norm. However ultimately both the visible and invisible aspects of customer perceived “component contribution” are obviously heavily dependent upon the associated variant or sub-brand: vital in premium markets but also in portions of mainstream, seeking to use knowledge about their 'invisible engineering' to persuade the customer of differentiation and thus purchase initiative. However, even though specifically informed or knowledgeable target customer are swayed (by sway-bar thickness and such), it appears very likely that the majority of modern mainstream car users are not concerned about being informed about engineering details].
Slide six expounds
that... “one industry solution focuses on reducing the number of
active platforms and increasing scale”. We are shown in one diagram
how since 2004 the number of platforms for the global top 10
auto-firms has reduced from 22 to 18 in 2014 (though disingenuously
including the few platforms for vehicles produced at 2k units pa).
Accompanying another diagram showing how the number of 'top hats'
[car style variants (ie upper body internals, mono-sides, closures, etc)] has risen from 2.5 in 2004 to 3.3 in 2014. This then the
conventional 'in-house' strategy for reducing complexity and overall
core platform multi-model development costs.
[The usual opposing argument is that such standardisation runs the risk of reducing the differentiation (ie relative performance capability) per variant and model type, especially for the high margin, lower volume spin-off variants].
[The usual opposing argument is that such standardisation runs the risk of reducing the differentiation (ie relative performance capability) per variant and model type, especially for the high margin, lower volume spin-off variants].
Slide seven highlights
that...”some OEMs are trying larger scale commonization across
diverse brands”. The corporate strategy examples of VW Group and
Toyota Group are illustrated with respectively the MQB and MC-M
architectures.
[Of course, as already seen, the reduction of core platforms and associated costs has been partially undermine by automakers expansion of vehicle types - apparently responding to apparent market-demand - so increased costs of providing more body-styles per model and all new model name-plates. So careful assessments regard the realistic contribution of new variants and models must be undertaken by the VM. And whilst comment regards "model/variant proliferation" undoubtedly has relevance, it must also be noted that the best producers will invariably be "cost-intelligent"].
[Of course, as already seen, the reduction of core platforms and associated costs has been partially undermine by automakers expansion of vehicle types - apparently responding to apparent market-demand - so increased costs of providing more body-styles per model and all new model name-plates. So careful assessments regard the realistic contribution of new variants and models must be undertaken by the VM. And whilst comment regards "model/variant proliferation" undoubtedly has relevance, it must also be noted that the best producers will invariably be "cost-intelligent"].
In slide eight we see
the alternative strategic ploy...”[while] others [gain] through
one-off co-operations, JVs and other equity tie-ups”. Here proper
distinction is made between these various methods with also that of
'full integration', each category populated with projects deems
successful or unsuccessful, depending upon “level of expected
impact” vs “level of integration”. The stated results indicate
that the category of “one-off industrial co-operations” provides
the greatest success rate (of 4 successful projects vs 2 failed).
[Without details of the studies examples, it seems likely to investment-auto-motives that the basis for success of the “one-off co-operation” category may well be upon the historical strategic deployment of both:
[Without details of the studies examples, it seems likely to investment-auto-motives that the basis for success of the “one-off co-operation” category may well be upon the historical strategic deployment of both:
a) “badge engineered”
vehicles, wherein one firm acts as contract supplier and another as
client seeking to supply a specific market segment or niche quickly
and cheaply (at the possible expense of devaluing own brand
reputation). (eg Dodge's use of FIAT vans).
b) a combined dual
vehicle development project, whereby both VM partners are either
fiscally induced to create a 'dual aspect' single vehicle package, or
believe they are so well mutually aligned to share the basic vehicle
package and majority of components. (eg Daimler's new Smart 'For4'
and Renault's new 'Twingo': both using unconventional rear-engine,
rear-wheel drive)].
Slide nine, however,
states that...”but all this has produced poor results so far, as
OEM returns and valuations are still depressed. Here the ROIC and
EV/EBITDA for mainstream auto-cos are depicted against the previously
listed industrial sectors. Whereas Mainstream Autos are shown as
providing a ROIC of 7.8% (against an averaged WACC of approx 9%), Oil
And Gas offered 10%, Telecoms 11%, Building Materials 12%, Chemicals
13%, Packaging Materials 14%, Aero and Defence 16%, Pharma 19%,
Consumer and Retail 22%. Likewise EV/EBITDA is shown as Mainstream
Autos: 4x, Oil and Gas: 6.2x, Telecoms: 6.8x, Aero and Defence: 9x,
Packaging Materials: 9.1x, Chemicals 10.7x, Building Materials: 11x,
Consumer Retail: 11.1%, Pharma: 13x.
[Whilst FCA's (or very possibly its corporate banker's) own calculations generate this conclusion, it should be recognised that given the present generally depressed global market demand conditions (aside from re-buoyed N.America and improving Europe), that Mainstream Autos today sits at a relatively low point of the global economic cycle - with demands of ongoing EM and partial AM CapEx cash-burn - so currently undermining their increasingly global foot-print business models].
Slide ten asks...”why
haven't these approaches provided a significant lift to
returns?”...and highlights 2 headwinds. Firstly, the 'large scale
organic reduction in platforms' the challenges are:
1. prolong the
life-cycle of older platforms given inherent cost savings gained [esp
new CapEx]
2. this option only
suited to those firms with existing scale, desire to grow body
variant numbers and have wide regional presence
3. temptation to
over-engineer (incurring additional cost) so as to 'package protect'
the platform.
4. attraction of low
risk, improved margin short term gains at expense of much improved
long term advantages.
Secondly, the topic of
'OEM co-operations', its prevalence typically non-core to operations:
a. most effective on
single ventures, but with limited scope
b. usually involve
non-core elements of portfolio
c. not a pervasive ,
substantive solution for any OEM
[Herein, Marchionne conveys the reasons why the aforementioned efforts of platform reduction, internal cross-brand common engineering and inter-company relationships have, in FCA's view, failed to raise the sector's (averaged) bottom-line. These are indeed salient points, but as critically as CEO's and CFO's and attuned investors well recognise, the near and mid-term advantages of a redeployed of a previous generation platform can be acutely compelling. Whether used as the ongoing underpinnings for 'new' model replacement, or as a reduced cost method for entering (or creating) a new segment with a new product line (as seen previously with original Ford Mustang, that template copied ever since including the mid 1990s radically styled FIAT Coupe, and very importantly by Renault to create the Dacia Logan and the early variants of its off-spring family). As per 'OEM co-operations and their typical 'non-core' use of shared development projects, unfortunately Marchionne may have overlooked the vitally important contribution of the previous project alliance for Ford and FIAT on their small car platform, for series 2 Ford Ka, and FIAT's series 2 and 3 Panda and retro 500. As such this all too close to home case study has proven that such efforts – when well executed – may indeed be substantive].
As for slide eleven,
the question...”why does industry consolidation matter”...the
conclusion is that 'the potential savings are too large to ignore'.
But also recognises that previous attempts have failed because of
various pertinent problems, including: cultural divide, inequality of
integrating parties, very different operating methods, lack of
sensitivity for brand differences, lack of mutual respect / trust.
Hence the barriers and complexity viewed as overtly problematic. But
'it enables': fast execution, enabling rapid scale gain, fosters
step-change to best practice development approach toward engineering
commonality and modularity.
[This then once again truism, seeking to convince that the problems potentially incurred are worth the outcome. However, objectively this can only be assessed on a case by case basis].
[This then once again truism, seeking to convince that the problems potentially incurred are worth the outcome. However, objectively this can only be assessed on a case by case basis].
Slide twelve
presents...“the facts; breaking down product development costs”,
illustrating the current proportionate costs of frame/body related
systems (excluding power-train) and the potential for common-parts
cost-savings whilst importantly maintaining differentiation. FCA
shows the following (Current Cost as % of overall vehicle / Potential
for Commonality):
Under-body (11% / 70%)
Upper-body exterior
(38% / 10% [minimal])
P-T installation
systems (7% / 75%)
Brakes (1% / 90%)
Suspension/Wheels (4% /
80%)
Steering (1% / 80%)
HVAC (2% / 80%)
Electrical (5% / 70%)
Interiors (17% / 30%)
Gen. Assembly / Paint
(14% / 100%)
FCA Group calculates
potential gains of “up to €2bn on vehicle investments”.
[These respective percentages for these important calculations appear generally convincing to investment-auto-motives. However, it should be recognised that there is probable potential for slightly greater Upper-Body Commonality amongst participating firms, whilst given the desire for model specific wheel-sets, slightly less potential for commonality within the wheels portion of Suspension/Wheels (although there may be scope for low cost adaptation of core wheel designs, so re-raising the commonality quotient). This need to find low-cost adaptation solutions to core designs would also applies to HVAC systems, Electrical systems and possibly Interior items (from trim panels to carpet-sets to seats)].
Slides thirteen and
fourteen highlight that...”Powertrain portfolios show even higher
dupications across OEMs, both for engines...and for power-trains”.
These two successive diagrams demonstrate to what degree the current
engine and transmission portfolios of 8 other OEMs match/overlap that
of FCA Group.
[Though without the names of its competitors identified, it is apparent that those companies with a full ladder of brand and product types will invariably have a broad span of small to large capacity engines/transmissions, with increasing hybridisation capability. Likewise, for those corporations created from mergers with the rational of spanning smaller and larger engine regions and product types (as was the case for indeed FCA Group). And distinction of those firms with historical roots in small capacity regions and so 'small engine' regimes. Also interesting is the manner in which diesel and petrol/gas descriptions have been differently assigned, the former reflected by capacity of engine, the latter by engine configuration. This may be to extenuate the central point of overlap, or to simply aid clarification. Marchionne's point is indeed valid, but already well understood. However, the fact remains that most VMs tend to maintain power-train capabilities and manufacturing as a core competence. in order to allow the VM to massage performance levels for not only a seemingly 'all new' vehicle, but critically for mid life-cycle 'face-lift'. And today and well into the future.major focused upon the issue of 'eco' power-train performance (initially as 'down-sized' and also allied with full hybrid systems), (FCA's own two-cylinder 'twin-air' and BMW's twin-turbo three cylinder engines high profile). Ultimately it is suspected that Marchionne has publicised this chart in order to attract OEM attention towards FCA's own proven 'Multi-Air' system for either contract production or licence-out].
[Though without the names of its competitors identified, it is apparent that those companies with a full ladder of brand and product types will invariably have a broad span of small to large capacity engines/transmissions, with increasing hybridisation capability. Likewise, for those corporations created from mergers with the rational of spanning smaller and larger engine regions and product types (as was the case for indeed FCA Group). And distinction of those firms with historical roots in small capacity regions and so 'small engine' regimes. Also interesting is the manner in which diesel and petrol/gas descriptions have been differently assigned, the former reflected by capacity of engine, the latter by engine configuration. This may be to extenuate the central point of overlap, or to simply aid clarification. Marchionne's point is indeed valid, but already well understood. However, the fact remains that most VMs tend to maintain power-train capabilities and manufacturing as a core competence. in order to allow the VM to massage performance levels for not only a seemingly 'all new' vehicle, but critically for mid life-cycle 'face-lift'. And today and well into the future.major focused upon the issue of 'eco' power-train performance (initially as 'down-sized' and also allied with full hybrid systems), (FCA's own two-cylinder 'twin-air' and BMW's twin-turbo three cylinder engines high profile). Ultimately it is suspected that Marchionne has publicised this chart in order to attract OEM attention towards FCA's own proven 'Multi-Air' system for either contract production or licence-out].
Slide fifteen
highlights...“the facts: sharing platform, vehicle and powertrain
development can yield significant savings”. Herein, nominal
indications are given as to what level of savings 'consolidated
investment' may bring to what would have been separate 'stand-alone'
projects. The first example for a (whole vehicle project) A/B class
car is viewed as saving 20-40% overall. Whilst the second example is
for a notional 4-pot engine with similar comparison, the amalgamated
effort saving approximately 25-30%.
[The notations regards the calculation provides interesting food for thought, since the former car example is shown as essentially a 'spin-off' product (a la Ford Mustang from Falcon), and the latter engine example states that this is without “tooling synergies”, which typically comprise a substantial portion of a power-train development project. More detail was necessary to be convincing, and even if provided, would simply be a notional exercise given that through the time of a JV development project, all too typically, one party usually seeks to alter the original specification parameters to the frustration and chagrin of the other party].
[The notations regards the calculation provides interesting food for thought, since the former car example is shown as essentially a 'spin-off' product (a la Ford Mustang from Falcon), and the latter engine example states that this is without “tooling synergies”, which typically comprise a substantial portion of a power-train development project. More detail was necessary to be convincing, and even if provided, would simply be a notional exercise given that through the time of a JV development project, all too typically, one party usually seeks to alter the original specification parameters to the frustration and chagrin of the other party].
Slide sixteen
states...”we believe large scale integrations are required to
unleash full potential”. Herein, a broad-based theoretical two axis
graphic is provided to demonstrate the levels of “potential capital
rationalisation' available for different types (ie depths) of
co-operation across various facets of VM operations. Hence
co-operation is split into: a) one-off technical co-op, b) JV, c)
cross share-holding enabled co-op, d) full integration, whilst the
operational facets are: 1) shared R-D costs and tech development,
2) optimised tooling investment, 3) maximise plant utilisation, 4)
capture cross-selling opportunities, 5) capture other op-ex
opportunities and 6) (total) potential for capital rationalisation.
[Obviously and unsurprisingly, as shown, “full integration” provides the highest levels of per activity efficiency and overall combined activities capital rationalisation. Of specific note are the remarks made about “key enablers” relating to tooling investments and plant utilisation regards “integrated industrial footprint strategy”, and the ideal of R-D efforts and cross-selling opportunities providing for “integrated product strategy”].
[Obviously and unsurprisingly, as shown, “full integration” provides the highest levels of per activity efficiency and overall combined activities capital rationalisation. Of specific note are the remarks made about “key enablers” relating to tooling investments and plant utilisation regards “integrated industrial footprint strategy”, and the ideal of R-D efforts and cross-selling opportunities providing for “integrated product strategy”].
Thereafter is slide
seventeen, with...”potential synergies from consolidation of auto
OEMs would be approximately 70% driven by industrial rationale”.
The four major obvious gains identified are: 1. shared platform
development expense, 2. top-hat development costs, 3) avoiding budget
duplication for power-trains, 4) optimisation of manufacturing
investments and production allocation. The gains to be had are seen
as: approx. 70% in technology and products, approx. 15% in op-ex
opportunities (ie procurement, SG-A etc) and likewise approx 15% in
cross-selling opportunities. It is propagated by FCA that
combinations with another large OEM could provide advantage to the
tune of between €2.5bn - €4.5bn annually.
[Once again the ideology of 'two acting as one' is hard to refute in principle. Yet such gains have always been known by industry executives and analysts, this type of common leverage the very cornerstone of the industry, applied since the 1920s onward. What is of primary importance to industry leaders and the large shareholder families and institutions, is real-world vs theoretical potential. Because of the many issues and vagaries (inc. core competencies, advanced IPR, secret commercial ambitions and direction), the question of ultimate leadership, of outcome voting rights and influence and overall control matters relating to such a monumental venture, as well as critically, the ability to ride regional and global economic timing. Reality then, is far more complex than idealism].
[Once again the ideology of 'two acting as one' is hard to refute in principle. Yet such gains have always been known by industry executives and analysts, this type of common leverage the very cornerstone of the industry, applied since the 1920s onward. What is of primary importance to industry leaders and the large shareholder families and institutions, is real-world vs theoretical potential. Because of the many issues and vagaries (inc. core competencies, advanced IPR, secret commercial ambitions and direction), the question of ultimate leadership, of outcome voting rights and influence and overall control matters relating to such a monumental venture, as well as critically, the ability to ride regional and global economic timing. Reality then, is far more complex than idealism].
Slide eighteen
highlights how... “consolidation can support significant ROIC and
valuation improvement”. This interesting 'X and Y axis' graphic
plots the relative (2014) ROIC vs (2014) EV/EBITDA for FCA Group
amongst its previously mentioned competitor VMs and the calculated
average values for the set of various comparative industrial sectors.
By its own admission it demonstrates how FCA is presently positioned
as the second weakest VM and similarly a lowly player amongst the
other sectors' firms with an ROIC of approximately 5% and 3x
EV/EBITDA. In contrast the average for the auto sector is about 8%
and 4x. As seen FCA and its auto peers are seen to critically sit
under the 9% WACC level, whilst all other sectors sit above. By 2018
the stated consensus is that FCA will be at 9% vs 5.5x. (The average
for the sector is unstated). Crucially, Marchionne believes that if
consolidated with another, FCA would reach 13% and 7.5x. Such a move
would propel the group into the bottom third of the better performing
comparator sectors.
[Whilst valid to assume improved corporate performance, the outcome as presented is highly speculative, much depending upon the true costs and efficiency advantages of any one agreed consolidation].
Slide nineteen
provides...”some conclusions” and provides the sign-off statement.
These are:
1. Top OEMs spent over
€100bn for product development in 2014 alone, about €2bn per week
and likely to continue
2. Historical volumes
have been broadly below the cost of capital, even after the
restructuring of the US auto industry and NAFTA volumes at peak.
3. Single purpose
projects, JV (et al) will assist, but not enough
4. Capital consumption
rate by OEMs is unnacceptable – it is duplicative, does not deliver
real value to customers and is a pure economic waste.
5. Consolidation
carries executional risks, but gains too large to ignore
6. It is ultimately a
matter of leadership style and capability.
The Take-Away -
Industry professionals
and auto-sector analysts will undoubtedly agree with everything said,
wholly valid in theory. As long as the conjoined assets and
capabilities of any merger ensured, through a myriad of distinct
function by function efforts, that the essential positive attributes
of both companies previously enjoyed are retained, with critically
the individual brands within a broad new stable remaining (for all
intense purposes) undiluted.
This is far easier said
than don, especially when the temptation is to recycle the centrally
planned synergistic savings (from purchasing, development, production
and retail) months or years later to once again grow brand and
product differentiation in the bid to remain market competitive.
Of course when there is
a very strong region, product and brand rationale to do so, the
result can be truly transformative for both parties, securing a long
term stability and prosperity (ie Renault-Nissan). But when whet even
appears a good fit is undermined by a culture of post-merger internal
politics, a 'not invented here' silo mentality (bad enough across
parallel functions, let alone 'diaganal ones), and so initial target
cost savings targets and project budgets become fatuous, then severe
value destruction inevitably follows to the detriment of not only
immediate share-holders but to the industry in general (ie
Daimler-Chrysler).
History of merger and
acquisition consolidation appears to demonstrate that much depends
upon the exact fit and timing relative to broad regional economics.
The history of the auto-sector is littered with such examples,
especially in the early, mid and late periods of the 20th
century. Here are just a few:
Conglomeration in
period of market expansion:
1909 General Motors –
healthy firms entwined in strong (national/global)market: success
1925/8 Chrysler Motors
– healthy firms amalgamated in good (national) market: success
1922 Ford-Lincoln –
poor management of luxury firm allows for takeover: success
Conglomeration in
period market of market contraction:
1929 Rolls-Royce-
Bentley – high debt exacerbated by 'crash' and RR buys to
rationalise: success
1954/70 American Motors
- weaker companies merged in successive (national) downturns :
failure
1968 Citroën-Maserati
– original business ideals undermined by oil crisis and inflation:
failure
History then has its
uses, the indepth analysis of case studies can indeed assist, but
what of Sergio Marchionne's present-day ideals? Here,
investement-auto-motives very simplistically outlines the
probable
intentions behind his presentation
1. To convince
investors of the innate pro-investor mentality of FCA Group.
2. To subtly highlight
FCA's willingness to conjoin with another VM (in one form or another)
a. Any attracted VM
unlikely to be American or European, most likely Japanese or Chinese
b. This would give FCA
a true 'three continents' global footprint.
3. To actually generate
yet more project and platform based JV exercises
a. Prompting others to
this as a “lesser evil” versus full consolidation.
b. This a ploy to
expand FCA's own global presence,
c. Using already
'localised' JV partners as essentially contract manufacturers
d. So reducing the
heavy CapEx demands of foreign production plants.
4. To help generate
better secure JV contracts for FPT (FIAT Power Train), Teksid,
Magneti Marelli and Comau, the legacy divisions of FIAT now viewed as
“global enablers” given their contribution within the vertical
integration model (metal castings, components and production
processes).
a. The prospecting
position by FPT to help others 'plug the gap' of their own product
down-sizing and up-sizing expansion strategies.
b. An expanded order
book for FPT power-train systems no doubt a prime ambition for FCA.
Lastly, it might be
worth considering that Marchionne may have subtly timed the
presentation for two tactical and strategic outcomes.
A. To instigate a
possibly welcome reprieve to the potential stock price overheat of
FCAU.
B. To spark actual eventual consolidation interest amongst either one of China's (SOE) or India's larger auto-makers (to create a "globally embedded" 3-continents auto-maker). So providing FCA's improved entry into
China, India and as consequentially SE Asia. The obvious reciprocity being China's or India's ultimate entry into NAFTA and Europe).
