By on October 3, 2014

FEDERAL-MOGUL CORPORATION LOGO

ZF Friedrichshafen is buying TRW; JCI sold its automotive business to Gentex and Visteon. Are we in a new era of supplier M&A activity? The previous wave didn’t work out well – Dana, Tower, Dura, Lear and others ended up in Chapter 11.

So how about Federal-Mogul? They too went on an acquisition binge in the late 1990s, including the British firm T&N. In the process they took on debt, with a $2.75 billion package just for the T&N purchase. As with others, they bit off more than they could chew. Federal-Mogul’s downfall however wasn’t operational issues but one T&N factory that had used asbestos. The accompanying $1 billion-plus in costs tipped them into Chapter 11, and it took until 2007 – 6 years – for them to emerge. So where are they heading?

Now back in 1999 Carl Icahn, a corporate raider, started buying shares in Federal-Mogul. The value of his initial holdings vanished in Chapter 11, but he also bought Federal-Mogul debt, a lot of it, and in 2007 emerged as the dominant shareholder in the new firm. Icahn’s modus operandi had been to acquire a majority stake in a company – the list includes Viacom, Marvel Comics, Blockbuster and Time-Warner – and then replace management with his own associates. They then would dismember the company in search of cash, with Icahn unloading his holdings as soon as practical, to make way for the next target.

Obviously 2008 was not a good time to unload anything automotive, and overall profits have since been spotty. But by 2012 profits were looking up, and Icahn split the firm into two pieces, separating powertrains (a $4.2 billion business) from aftermarket ($3.1 billion). This made sense only as a prelude to Icahn’s selling one or both of pieces. Consistent with preparing for a sale, he appointed an associate, Daniel Ninivaggia, as co-CEO of the aftermarket portion. [See a Sept 3rd Automotive News story.]

In a visit to a Federal-Mogul R&D center in Plymouth, Michigan we [Dawejko and the rest of the class] saw how focused their people were on designing and manufacturing new products. Most of the class had never heard of the test equipment we saw. Unlike the tribology labs, some of the products under development were self-explanatory, such as the corona discharge spark plug about which TTAC reported in 2011. What became clear is that Federal-Mogul is in fact a high-tech operation that spends 5% of revenue on R&D. They have been a PACE supplier innovation finalist 32 times, and an award winner 11 times. In the context of the automotive product cycle, however, technology is not a route to quick profits.

Back to Icahn. The new co-CEO of the aftermarket half of Federal-Mogul may be an Icahn executive, but unlike the people Icahn installed on the board, Ninivaggia previously spent 6 years at Lear. He is an industry person, and not just an M&A specialist. In the same vein, Rajesh Shah, named CFO in 2013, has a long career working for auto suppliers, and came from another supplier rather than from Wall Street. Looking forward Ninivaggi noted, “There’s been a significant consolidation in the industry and as our customers have become very large companies, we need to do the same thing; we need to grow fast, improve our capabilities and expand our product lines”. It will take some years to show that the newly autonomous aftermarket operations are firmly profitable.

M&A may be a useful tool as major suppliers work to adjust their portfolio to match their global footprints, selling pieces that don’t fit to erstwhile rivals and buying similar operations from their competitors. Federal-Mogul is itself an assemblage of such pieces, cobbled together over the past 20 years. (An aside: one engineer the prof knows worked for five different firms, while never changing his desk at what is now a Federal-Mogul facility just outside Ann Arbor.) At the Plymouth tech center we were presented with their R&D roadmap, shared with their customers. They’re looking a decade down the road, 3 product cycles, for what future drivetrains will require. If they get that right, they will be one of 2-3 global players left in each of their product segments, with profits to match.

Pension fund managers operate on a 60 day cycle; the customers of hedge and restructuring funds take longer to get restive. Neither is compatible with the auto industry. History suggests that buying and selling automotive firms is not a quick route to riches for anyone but the lawyers and investment bankers who participate on a fee basis. Wittingly or not, Icahn is in this one for the long haul.

By Alexander Dawejko ’17 and Michael Smitka, Economics Department, Washington & Lee University

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8 Comments on “In for the long haul?...”


  • avatar
    28-Cars-Later

    Nice piece. Now analyze GM and show where it is headed.

  • avatar
    tresmonos

    I used to bang a daughter of a Federal Mogul plant manager in Naucalpan (Mexico City). They made small powertrain components, spark plugs etc. He was an interesting dude – he help shut down Federal Mogul’s plant in Detroit and relocate it’s operations to Alabama / Mexico.

  • avatar
    deanst

    Not sure how you reached your conclusions regarding investors in auto supply firms, but I can tell you my perspective. I am currently looking at lending to 4 firms in the industry. Many smart buyers moved in during the downturn and bought these firms on the cheap. They are now extracting most or all of their cash invested via debt issuance. Given the cyclical nature of the auto business, you can make a quick buck if you time it correctly.

    Also, Icahn usually does not take a majority stake – a 10% stake (or even less) is often enough to put pressure on a company to make some changes and then get out after the stock pops. (see family dollar)

    Lastly, I would suggest you differentiate between what the guys on the factory floor tell you and what Icahn plans to do. At his age, its just a game to him – and he’s eager to get a big win and move on to the next target to keep things entertaining. With Fed Mogul generating less than $200 million in cash in 2013 on revenues approaching $7 billion, I don’t see him having any reluctance to sell at the right price.

  • avatar
    Fred

    I’ve worked for some publically held industrial companies and they are always beating you down for price, not so much quality. When it comes time to sell out, they paint the buildings and plant a garden and layoff folks to get their costs down. New owners come in heavy with debt and lay off more folks. Then it starts all over again with the cost cutting. Some are worse than others, but in the end it’s all the same. Now working for a private firm and while costs are an issue, guality comes up more often and no more short term goals.

  • avatar
    Mike Smitka

    Icahn isn’t alone in holding onto things, Wilbur L Ross with Intl Automotive Components has been “in” for a long while as well. Is there not irony when corporate raiders turn into stable, major shareholders, so that these look more like privately held firms investing across the business cycle than ones whose strategy is driven by the stock price of the moment?

    Yes, Wall Street has its ups and downs and you can sometimes milk a cow dry while arranging to sell it to a dairy farm that’s caught short on its herd size. My sense is that automotive purchasers are now more sensitive to this and seek suppliers in it for the long haul. When the ownership games start impeding investment in Gen III products, then you as an assembler are heading for trouble. We’ll see assemblers that take their eye off the ball from time to time and end up unable to keep up with their rivals for a while due to such short-sightedness. The industry is anything if not heterogeneous. Anyway, I will try to develop a couple overlapping issues. This post was a first cut at taking apart a complex phenomenon.

  • avatar
    golden2husky

    Hopefully what they say is true that karma is a bitch. If so, Ichan should die a 5 year painful death. The tens of thousands of lives he’s ruined playing business chess for sport is a disgrace. And no amount of philanthropic giving (with all the tax advantages he gets from that) undoes the harm he has inflicted in his search for maximum dollars for his greedy self.

  • avatar
    05lgt

    Prof Smitka, thanks for the entertaining and essentially free education. I look forward to watching this shake out over the next several years. Thanks for making it interesting.

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