In the 1980s the world of corporate finance prospered as entrepreneurs built conglomerates. In recent years conglomerates fell out of fashion and sector focus came into fashion, leading to spin-off of non-core businesses. But now, driven by the US motor giants, the automotive sector is metamorphosing to a new tune: modularity.
In many sectors, but particularly automotive, the concept of modularisation is gaining support. Modularisation refers to the process of supplying ready assembled sets of components straight to the assembly line. Its increased use is being driven by numerous factors but predominantly OEM (Original Equipment Manufacturer) desires to improve their balance sheet, increase outsourcing and implement true BTO (Build to Order) systems.
Merger and acquisition activity in the automotive sector over the last three years has been driven by the desire to win integrated systems and modular business. Schroder Salomon Smith Barney reports 125 acquisitions and 65 joint ventures and alliances in the last three years as suppliers reposition themselves.
So who benefits? OEMs reduce their cost base and increase flexibility, essential in today's market of many variants and sub-sectors. The number of niche vehicles is growing, and while the number of modules is actually shrinking, they are becoming more complex as the number of components increase. Benefits for the supplier include increased volumes, although suspicion continues that return on capital employed could be weakened by the extra capital committed to additional facilities.
Modularisation also offers opportunities for engineering firms to impress the City, divest non-core businesses, or both. By its nature modularisation requires a number of components to be integrated; owning many of the relevant components is often more efficient than relying on external suppliers.
Increased demand for modules, not individual components, does provide an avenue for players under pressure to sell to others in the sector who have complementary processes. For example: cockpit modules encompass four major technologies: electronics, dashboards, heating/air-conditioning and wiring. A fifth technology might be the rapidly growing navigation systems market. If a supplier has three of the processes, the missing fourth technology becomes an attractive purchase in the drive to provide modules.
Some areas, seating for example, are already consolidated, but opportunities still exist in other sectors especially cockpits, front-ends and corner modules. Systems such as doors are even less developed, and are likely to grow rapidly.
One group taking advantage of this rush to dispose of non-core businesses are MBO/MBI candidates eager to be in charge of their own destiny. MBO activity has increased dramatically over the last five years in 'old economy' sectors such as automotive as companies divest their non-core activities and strong business opportunities emerge from the chrysalis of larger companies. The same factors rolls down through Tier 0.5 to Tier 1, Tier 2, etc. The message is clear: gear up or get out. Re-grouping and re-focussing results.
For example, last year Hammond Suddards Edge advised an MBO team headed by former Jaguar director John Grant on its acquisition of four engineering businesses from specialty chemicals producer Ascot plc, in a deal worth £45.6 million. The businesses manufacture automotive manual transmissions and other parts, and their disposal enabled Ascot to focus on developing its chemical business - and the MBO team to focus on automotive markets. Everybody gained.
Last year the aggregate value of MBOs completed increased for the seventh year in a row to £23.4bn, up 38% over 1999. Although VCs have arguably already snapped up many automotive bargains and moved onto other sectors, plenty of deals remain as the drive for both narrow focus and modularisation intensifies. Able to bring a new commitment, energy and determination to succeed, management teams who have significant and personal stakes in the future of businesses often turn poorly performing businesses into a profitable ones.
So modularity, led by the giant OEM automotives at the head of the supply chain, drives both spin-offs and a form of conglomeration. Single component suppliers become module suppliers – effectively multi-component suppliers - and can enjoy larger revenues. The automotive supply chain shakes down pushing owners to invest further to sell.
But is this simply another boost for the corporate finance world, acting as the latest driver for transactions? Not for everybody, no matter how august your name. Professionals are part of the supply chain, feeding services to clients who are now better-informed, like their own customers. Those clients purchasing services are demanding sector-focussed investment in knowledge and added value from the professionals. The more enlightened corporate finance professionals invest in sector knowledge to gain competitive advantage – and discriminating companies on the road to modularity choose to take them on as their new partners. Like the OEMs, the clients on the road to success demand more from their service suppliers. Professionals who fail to invest and focus do so at their peril.
David Armitage is Head of the Engineering Group at Hammond Suddards Edge
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
