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 Date:6/5/2009

 

Dollars & Sense
Auto Suppliers? Do you dare to buy a business?


In today’s automotive industry, there are plenty of undervalued assets that could be acquired by an opportunistic buyer with cash and perhaps an appetite for risk. Most automotive suppliers appear to be standing by, waiting for someone else to act, waiting for the lending environment to improve, or waiting for consumer demand to begin to climb.

As the industry continues to consolidate, the suppliers left standing could be much better positioned for future profitability than they are today. If your company has a vision of where it wants be and the stomach to invest in the current environment, this could be a great time for a bold move. But before entering into a transaction, you should be disciplined in due diligence. And given these extraordinary times, a “garden variety” due diligence process probably won’t be enough.

If you are considering buying an automotive supplier during this transformational era in the industry, there are many non-traditional transaction and due diligence considerations:

Apply new rules for valuing a business.
In a normal situation, due diligence begins with a look at the target company’s value as generally indicated by a multiple of EBITDA (earnings before interest, taxes, depreciation and amortization) and free cash flow performance incorporating working capital cash impacts. But in today’s economy, a lot of suppliers aren’t generating any positive cash flow, so traditional measures of value may not be appropriate. Putting a valuation on a business with distressed assets requires some special considerations. So, how can you know what a target company is really worth? The answer may be driven by the strategic fit of the target: “How might the acquisition position your company for the economic upturn?” For example, a differentiating technology or access to a new market channel might suggest a valuation not supportable by traditional methods or trailing cash flows.

Figure out how long the target company may survive.
Is the supplier burning cash? What is the monthly cash depletion rate? How much cash does the company have on its balance sheet or available in credit facilities? Is it in danger of tripping loan covenants? These are only a few challenges that many suppliers currently face and reflect an important focus necessary for any buyer to incorporate into due diligence analyses.

Assess how customer and supply chain events could affect the value of the deal.
Does the target company have exposure to OEM bankruptcy filings? What will be the impact of OEM customer temporary plant shutdowns? What about vulnerability from a critical dependency on other suppliers? If a few major Tier One suppliers fall, will others follow? Purchasers need to assess how buying a company can position itself for success…while not becoming vulnerable to a domino effect from distress among customers, suppliers and competitors. If the company ends up in a bankruptcy proceeding, other companies might also want to buy its assets, and competition could mean a higher price. On the other hand, bankruptcy protection can allow the target company to shed burdensome contracts and outstanding debts that you’d rather not absorb. One strategy is for OEMs or suppliers to seek partnerships or other forms of agreement to absorb a failing competitor or supplier and effectively take over their book of business, collect their tools, and finance a transition to return the assets to profitable operations. Due diligence in this environment requires a thorough understanding of supplier health and interdependency as well as cost structure changes resulting from bankruptcy or other negotiations and concessions. Timing is everything, and everything is negotiable these days.

Assess the changing cost landscape.
The auto worker unions are making significant concessions as part of the urgent transformation of the industry. For example, auto companies are negotiating Voluntary Employee Beneficiary Association (VEBA) trusts to off-load the balance sheet burden of financing of retiree healthcare. With a VEBA, the company agrees to fund a portion of a trust that is set up to pay future benefits, which gets a big liability off of their balance sheet. VEBA trusts, revised labor contracts, renegotiated supplier terms all mean that when assessing a potential acquisition, you need to model the business case based on a future, not historical, cost structure and actuarial and other benefits specialists should be incorporated into the due diligence teams in an even greater capacity. The impacts of foreign benefit plans should be taken into account as well, as funding requirements in the event of a change in control can be very different overseas.

Consider the possible impact of government intervention.
Will government relief to troubled suppliers improve the target company’s sustainability as a going concern? Not entirely. Vehicle SAAR (Seasonally Adjusted Annual Rate of Sales) declines have been devastating for not only OEM’s but for all tiers of the supply chain as well. Even a government guarantee of supplier receivables only provides relief to a supplier if its customer is still ordering parts. However, the “bailout” of the OEMs not only helps them, but in turn allows them to aid suppliers that they are dependent on for their own survival. Consequently, A potential buyer needs to assess not only the interdependencies in the target’s specific supply chain but also the degree to which its suppliers have signed up through the OEM’s for the government backed support to factor the receivables.

The automotive industry is going through an unprecedented (and painful) transformation. Some companies will thrive as their leaders make bold plays that pay off. Other leaders will end up seeing their companies and assets liquidated. It’s important to be proactive in positioning your company to be among the survivors, and it is more important than ever to have your due diligence processes in high gear.

Jack Koenigsknecht is Accounting Partner, M&A Transaction Services, Deloitte & Touche, LLP.
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