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Meeting market disruption head on

Strategic M&A in the automotive industry

In recent years, the more proactive automotive OEMs, parts suppliers, dealerships and wider service providers have increasingly turned to M&A as a strategic tool to prepare their businesses for a dramatically different future. For example, in the last three years there were 1,500 M&A deals in the global automotive industry totalling £250 billion.1

As these companies develop long-term corporate strategies to define their place in the future automotive industry, honest and open assessment of existing capabilities and resources is essential, not least to identify gaps that could hinder strategy execution. The key questions here are how these gaps will be filled and how will this be funded?

The most successful companies will take bold and urgent action to realign their portfolio of capabilities, enabling them to implement their strategies. Companies that transform their business models through a balance of build, buy and partner approaches, will be best placed to respond to the unprecedented level of market disruption. An equally bold decision is to exit from markets where management teams cannot see a prosperous future. What is clear is that inaction is not an option.

The COVID-19 pandemic has added additional challenges to those operating in the automotive industry, impacting manufacturing, supply chains and an already shrinking global demand for new vehicles. Post COVID-19, we may expect increased M&A and disposal activity due to necessary sector consolidation and companies focusing on rapid strategy execution, using M&A to accelerate new capability capture and maintain or even improve their position in the market.

Disruption in the automotive industry

The automotive industry is under constant pressure: from customers demanding new and costly features – often without being willing to pay for them – to regulators rightfully demanding the strictest adherence to environmental and safety standards. At the same time major tech players with deep pockets are increasingly investing in mobility business models and threatening traditional OEM dominance. There are also major political, social and macroeconomic factors such as the ongoing uncertainty around Brexit, ongoing trade disputes between the US and China and, of course, the immediate impact of COVID-19 on global supply and demand.

These pressures are being more keenly felt due to the impact of the CASE (Connected, Autonomous, Shared and Electric) megatrends on the industry. The CASE trends are disrupting traditional business models across the automotive industry, impacting revenues, profits and investments, and ultimately the strategic direction of businesses.

The disruption caused by these trends is restructuring the market with the future automotive industry likely to look substantially different to that of today. Although disruption is often seen as a risk, it also present opportunities. Existing players are already refreshing their corporate strategies and making decisions about where to focus and how to succeed in the future market.

When considering their future role in the industry, incumbent players need to consider what their vision of the future will look like. Scenario planning conducted by Deloitte has identified the likely changing areas of profitability over the next 15 years. The results are a stark warning to OEMs and their partners that standing still is not an option. The biggest areas of disruption for mature markets include the predictions that vehicle sales and aftersales turnover could drop by around -16 per cent -55 per cent respectively. In contrast, financial services, mobility as a service and the car as a platform are identified as growth areas, but these all start from a relatively low base and their growth will not mitigate the losses. Responding to these challenges requires OEMs and their partners to change fundamentally their business models.

Build, Buy, Partner?

To respond to the disruption occurring in their industry, OEMs and their partners have three options: build, buy, or partner. These options all require careful planning and execution as well as substantial amounts of capital investment.

Build
For automotive companies that decide to build their own products, capabilities or technologies, the costs can be huge. Although the future of the automotive industry might be based around a shift to electric powertrains and autonomous vehicles that offer shared ownership opportunities, the present industry is still dominated by consumer demand for ICE (internal combustion engine) vehicles. As a result, some OEMs have effectively seen their R&D bills more than double over the last few years. Not only are they having to maintain existing products and launch new generations of petrol and diesel cars, they are also having to ramp up the manufacturing and production of hybrid and electric cars, and develop fundamentally new products which require factories to be retooled, workforces to be retrained and supply chains to be reorganised. The capital investment required to manage two parallel manufacturing strategies can be immense.

The main advantage to adopting a ‘build’ strategy is that the company in question owns the intellectual property associated with the capability or technology they have built. This means that they can benefit exclusively from the competitive advantage it gives. However, time and access to the right talent are major issues when building in-house capability. The risk of missing the opportunity increases if you cannot deploy ready-made capabilities into the market at speed, and accessing the required technology skills is increasingly competitive.

Buy
To supplement in-house development, companies are also increasingly turning to M&A to help fill the gaps and get instant access to the technology they require. However, this presents its own unique challenges. More than ever, these assets are becoming very expensive to buy for a number of reasons.

The assets that incumbent automotive industry players are looking to acquire are both highly desirable and relatively rare. For example, due to the direction the industry is going, electric powertrain or connected car assets are highly sought after. Meanwhile, there is a scarcity of assets associated with future technologies that have appropriate scale. While there is an abundance of start-ups developing CASE capabilities, not many have developed to the stage where they could be bought and utilised by a more established player.

In addition, the drivers and determinants of corporate value are constantly evolving. Newer business models that use enabling technologies are more important than ever. Industry convergence and technology enablement have led investors to allocate their capital more towards companies that use intangible assets to serve customers. As a result there has been an influx of capital towards companies that are yet to generate any revenue, accelerating the growth in value of tech-enabled companies that could provide important CASE capabilities to incumbent players.

Partner
Our analysis of the market has shown, and will likely continue to show an increased focus on partnering between automotive businesses that are looking to share the burden of product and capability development. These deals commonly take the form of joint ventures and strategic partnerships.

Traditionally, we have often seen automotive partnerships formed over technology or capabilities that are highly commoditised and where it makes little sense to adopt an expensive build or buy strategy. However, we are now observing increased partnering related to next generation technologies.

We expect full mergers (the ultimate level of partnership) to continue to be used to create larger companies with larger balance sheets that can better deal with capital spending requirements.

While partnering with third parties and competitors is a way of reducing the capital burden in the short term, it should not be solely relied on: this is because a company that follows this path will end up with no IP-base of its own. Meanwhile, companies that own innovative technology or capabilities, and are approached about partnership opportunities by incumbent players, should consider the extent to which the IP in question forms a part of their core competitive advantage and whether they want to retain exclusive access, against the benefits a partnership might offer.
 

Buy/Build/Partner – balancing the three options is key

The most successful strategies will consider the benefits of all three options. Businesses need to balance buying, building and partnering to retain competitive advantage.

There are advantages and disadvantages to each option:

  • If a company builds everything from scratch it will retain all the IP. However, it is a long process and a single company could not afford to build all the necessary CASE technologies and capabilities on their own as the costs would spiral into tens of billions of pounds.
  • Partnering is faster and cheaper than building as the companies share the R&D burden. But if companies partnered on everything, they would end up with none of their own IP and would reduce their competitive advantage.
  • Buying is also a faster option than building, but it is also very expensive. In addition to this, if a company buys everything, it risks ending up with a disparate set of businesses without a true corporate ‘soul’ and without anything the business is ‘famous for’ that it has built itself.

These dynamics come to the fore if these options are adopted in isolation. However, through careful planning, a company can reduce the risks associated with any one individual strategy and maximise the opportunities available to it by using a combination of buy, build and partner. Once companies have set their future corporate strategy and identified capability gaps, they need to think about how they will fill those gaps; deliberate choices are needed about which capabilities will be built in-house, which will be bought in and which will require partnership to obtain. It is important to recognise that in this instance, the ‘how’ is as important as the ‘what’ when determining strategy.
 

Non-core carve-outs and disposals: de-risk and release capital

Bold decisions need to be made around where a company will focus (and how it will succeed) in the future automotive market, but equally bold decisions need to be taken around where a company will no longer operate.

To raise capital for investment in buying, building or partnering around technology, incumbent players are increasingly making decisions about carve outs and disposals. Automotive companies that cannot manage the capital demands of multiple existing operations as well as investment in innovation are likely to retrench and sell off existing assets in an effort to consolidate their business, focus on fewer areas and generate revenue that can be reinvested.

M&A activity is not just a solution for long-term planning about the future of the automotive industry. For many incumbent players, the pressures of a changing industry combined with rising costs, falling demand in the short term, political uncertainty and challenging social and macroeconomic factors are already threatening their ability to run a profitable business. Those companies that do not adapt quickly face a number of challenges. For example, some businesses will need to consider closing or selling off non-core parts of their business, potentially with a ‘dowry’ to limit the drain on the business. These companies need to take early and decisive action, as without it they risk being viewed by the market as a distressed seller which will harm the value of their assets. Meanwhile for other companies, balance sheet and cash restraints will limit their ability to make investment decisions, meaning they are unable to position themselves for success in an industry in flux.
 

Maximising the M&A opportunity

As the automotive industry evolves, all companies need to create a clearly defined strategy for the role they want to play in the automotive market of the future, and how they plan to succeed in that role. The disruption caused by CASE and the potential risks and rewards associated with the changing focus of the industry mean that maintaining the status quo is not an option. The industry is changing fundamentally and every company in the market will have to adapt – some more than others.

To maximise their chances of success, businesses must be open and honest about what new capabilities they need to bring in to their organisation. Once a business has identified what the gaps are, an assessment of buy/build/partner is key in terms of how to fill those gaps with new capabilities. To determine the most appropriate strategy, and to execute it successfully, there are some key questions business leaders need to ask:

  1. What role will my company play in the future automotive market? 
    • Which niche(s) will it profit from?
    • Which of the future profit pools will we focus on – will they be the same or different?
  2. Have we undertaken an open and honest assessment of our company’s existing capabilities, identifying any gaps that need filling in order to execute our corporate strategy?
  3. Have we gone a step further and decided how those capabilities will be acquired – taking into account the build, buy, partner framework?
  4. How will my company fund the capital needed to transform our business?
  5. What sources of capital are available: cash flow from existing operations, existing shareholders, debt, third party capital?
  6. What parts of our business no longer form part of our strategic vision? 
    • Can these be sold to raise capital, or closed in an orderly fashion to limit losses?
  7. If we decide to sell parts of our business, how do we best present our assets to maximise value?

The automotive industry is evolving and further disruption is coming. It is not a question of whether change will happen, but rather when and how it will happen, which companies will succeed, and how quickly incumbent players will adopt new models. Some current players will not exist in 20 years’ time, while others will be thriving. Companies face difficult decisions about the technologies and capabilities they will need to succeed, and those they no longer need. A clearly-defined M&A strategy will play a key role in achieving that success.

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1 MergerMarket

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