The global credit crunch is dramatically changing the nature of mergers, acquisitions and spinoffs in the auto industry. To understand its impact, we'll navigate through the general headwinds of the financial community, track the rise of private wealth and the decline of IPOs, and suggest what may lie ahead.
Slower growth rates, rising inflationary pressures, high fuel prices and falling property values in the United Kingdom and the United States continue to rock consumer confidence and challenge economies and companies worldwide. We have witnessed massive write-downs from the financial community, in which we saw the fall of Bear Stearns, the bailout of Northern Rock by the U.K. government, the proposed purchase of Merrill Lynch by Bank of America, the filing of bankruptcy by Lehman Brothers, the collapse and sale of Washington Mutual and reports of losses from publicly traded companies due to a combination of high raw material costs and decreased sales.
These factors have resulted in a slowdown of deal activity in Europe and indeed, in the broader global market. The private equity boom in this region has abated significantly, with reports of a 50 to 75 percent decline in deal activity. The main reason can be attributed to a smaller pool of available funds for debt-financed buyout deals, in addition to a general uncertainty facing the global markets. This is especially true in the mid-market, where most automotive deals usually take place.
Companies backed by established, wealthy families seem to be riding the credit crunch well. In Germany particularly, as seen in Figure 1, family-owned companies contributed 41.5 percent of total 2005 turnover in Germany and are better able to weather tough economic times than the DAX-traded firms. Examples of privately-owned automotive firms include Robert Bosch Group, Schaeffler Group, Freudenberg Group and Hella Group.
During crunch times, the strength of
these private companies must not be underestimated - the benefits of
being family-owned can give them a mighty edge over their public
competitors. They can be cash-rich, they often have a longer-term
approach in their planning and strategy and they do not have to answer to
public stockholders through quarterly reporting - beneficial
traits during economic downturns.
The current credit crunch may be perfect timing for cash-rich private firms to hunt down their very public competitors because the pace of deal activity has eased. Hence, it is unlikely that they will be involved in bidding wars that are so common during the frenzied boom times where the end result may be overpaying for a target company. They also will have more time to conduct their due diligence process to justify their takeover plans.
For example, in July 2008, family-owned Schaeffler launched a hostile bid for publicly-traded Continental AG. Schaeffler announced it had acquired a 36 percent stake in Continental and launched a bid for the rest of Continental's shares.
The move caught Continental off guard, as Schaeffler built up its stake in the company with swap transactions through a group of banks working on Schaeffler's behalf, bypassing disclosure thresholds and avoiding a hefty premium over market price. On August 20, Schaefflerstruck a deal with Continental. It agreed to limit its stake in Continental to 49.99 percent until 2012, and guaranteed to compensate the company for possible tax and credit costs of up to €522 million. Schaeffler also agreed to refrain from breaking up the company, keep it listed and support management's strategy.
This bid was well-timed. The auto industry is currently out of favor with the public markets, private equity is laying low and Continental is struggling somewhat with high levels of debt following its acquisition of Siemens VDO at the peak of the economic cycle last year. It also provides an opportunity for Schaeffler to buy a well-known brand, gain a more global automotive presence (especially in Asia) and increase its product portfolio instantly at what may seem like a bargain price.
This is not the first time
Schaeffler has made a hostile bid during a market slowdown. Its
Continental strategy replicates its hostile bid for a rival listed
bearings group, FAG Kugelfischer, back in 2001. That bid also took
advantage of a weak economic environment and weak stock markets.
However, not all bids are hostile. Another privately owned European company that has been busy buying up competitors is Robert Bosch, a German industrial group and major player in the automotive industry. In the last four months, it has struck a variety of deals around the world to strengthen its position in its various portfolios, including its €1 billion purchase of Ersol Solar Energy AG to gain a foothold in the renewable energy market and its majority stake in Chinese pneumatics company Easun to strengthen its Asian market presence.
From the looks of the German automotive industry, the current global economic turmoil has put listed companies under intense pressure compared to their privately held competitors. They are experiencing stress on their financial reserves from the volatile market environment and are challenged with maintaining financial performance (and share price) in an ever-compressed financial reporting cycle. These factors have made it difficult for listed companies to obtain debt financing and in some cases have made it undesirable to float additional common stock shares in the public markets. As a result, they are vulnerable to hostile bids. The depressed markets also make it very difficult for a public company to defend itself against a bid during a credit crunch, as we have seen with Continental AG.
As for the impact of the crunch on initial public offerings (IPOs), Figure 2 shows the relationship between the economic sentiment index and the number of IPOs completed in Europe.
The correlation of the highs and lows between the two sets of statistics is evident. When the ESI began to fall between 2002 and 2003, the number of IPOs also fell. When the ESI took an upturn in 2006, we also saw a surge of European IPOs. Drawing from this pattern, it is not unreasonable to expect that the number of IPOs will continue to fall as the ESI falls during the current economic downturn. In reference to IPOs in the automotive industry, the number of IPOs announced since 2001 steadily increased to 12 in 2007. But so far in 2008, there have been no automotive IPO announcements in Europe.
The trend of family-led companies acquiring stakes in their listed competitors has made significant headlines in Germany. While this may be partly a function of German takeover regulations, the fact remains that those companies with deep pockets and the ability to operate "under the radar" of public markets have a compelling edge over their not-so-fortunate listed competitors. Meanwhile, European IPO activity is likely to continue to be depressed until broader economic sentiment improves and investor demand returns.
Dr. Penelope Quah may be reached via email at penelopequah@csmauto.com and Mike Wall may be reached via email at mikewall@csmauto.com.
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