Is Private Equity the Answer for Auto Suppliers?

I just attended an excellent workshop sponsored by the Center for Automotive Studies (CAR), where I serve on the board, entitled "Supplier Challenges, Investor Opportunities". For an agenda of this seminar see: http://www.cargroup.org/investorsupplier/index.html There were many "takeaways" from the talks and discussion. For example: The core problem of the Big 3 is the inbred culture of those organizations and the environment in which they operate. The situation for the Big 3 (and their suppliers) will get worse before it gets better. By the end of this decade, the Big 3 will collectively have less than 50% market share in the United States. That will probably also be true shortly thereafter with respect to production share. The 2007 negotiations with the UAW will be fraught with danger, but might result in meaningful changes which will facilitate necessary changes in the industry. The North American automotive industry (the Big 3 plus its supply base) needs a major recapitalization with all that implies. Outside "Private Equity" investors can play a vital role in this recapitalization. The role of private equity as a necessary and beneficial actor to our industry's mutation is a debatable one (see, for example, the article which follows). My personal view is that the "right" kind of private equity recapitalization can play a useful role. What do I mean by "right"? I am not quite sure but here are a few minimum requirements: Long-term investment horizon. Quick buck artists stay away. Partners include at least some who are expert in the automotive industry. Exit strategies contemplate and facilitate the ongoing health of the resulting firm. What do you think about private equity in the automotive industry? October 26, 2006

DOW JONES REPRINTS This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, use the Order Reprints tool at the bottom of any article or visit: www.djreprints.com. • See a sample reprint in PDF format. • Order a reprint of this article now. For Car Industry, Sum of the Parts May Be Lifeline Hedge Funds, Buyout Companies Line Up to Pour Billions of Dollars Into Slimmed-Down Suppliers By JEFFREY MCCRACKEN in Detroit and IANTHE JEANNE DUGANHENNY SENDER in New York and October 26, 2006; Page C1 With Detroit's auto industry struggling through its darkest days in decades, some big investors are betting billions of dollars that the auto-parts sector is poised for a comeback. A handful of hedge funds and private-equity firms that specialize in struggling or undervalued companies have concluded that they can create big returns as auto-parts makers close plants, shift operations to lower-cost countries and cut retiree benefits. For years, investors have tried to remake the business without success, so the risks are high. But this time the calculus is that the companies, unions and other participants are so desperate, they are willing to make sacrifices they would have scoffed at in the past. According to some estimates, at least $50 billion in auto-parts businesses in North America are currently for sale. Two moves are expected within the next week -- a play for control of Delphi Corp., the former General Motors Corp. parts unit, and a separate deal for Lear Corp.'s North American auto-interiors business. The big New York buyout fund Ripplewood Holdings LLC likely will make a formal offer to buy some or all of the assets of Delphi, which collapsed into Chapter 11 bankruptcy last year, burdened by costly labor agreements and unprofitable contracts. Delphi is North America's largest auto supplier, and the biggest supplier to GM. Delphi has also attracted attention from Appaloosa Management, a hedge fund that already owns more than 9% of Delphi stock. It has proposed pumping in several billion dollars in a deal that would give that firm more than a third of Delphi's stock after the auto-parts maker emerges from bankruptcy-court protection. Hedge funds are private investment funds catering to wealthy investors and institutions. Also jockeying for a significant stake is Cerberus Capital Management LP, a large private-equity firm. Cerberus put in an official proposal for a stake in the company in the past few days, people familiar with the process say. Private-equity funds often invest in struggling companies and attempt to turn them around in hopes of selling later for a profit. Right now, each fund is "vying to run the show alone," says a person familiar with the Delphi bidding. This bidding process gives the United Auto Workers a key role as the funds try to persuade union officials of the worthiness of their rival plans. Delphi, in court filings, has said it wants to close 21 of its 29 plants. The UAW is pressing for more plants to stay open and could be swayed to support one fund's bid over another based on the issue, said two union officials familiar with the talks. At Lear, billionaire investor Wilbur Ross says his deal to acquire its $3.5 billion North American interiors business "should be resolved in the next few days, no later than next week." Mr. Ross says he has signed confidentiality agreements with eight other suppliers. "It seems like the whole components business is for sale," he said. Mr. Ross, who played a central role in the restructuring of the U.S. steel industry, has stepped up his interest in Lear at the same time as financier Carl Icahn has negotiated a deal to become the largest shareholder of the $18-billion-a-year maker of seats, instrument panels and other parts. For $200 million, Mr. Icahn's stake in Lear would grow from 5% to 16% and he would get a seat on the board. Another hedge fund, Pardus Capital Management LP, has spent $109 million this year to acquire 14% of Visteon Corp.'s stock, making it that supplier's second-largest shareholder. Pardus has also requested a seat on the board of Visteon, which is the former parts operation for Ford Motor Co. The renewed interest from private-equity firms in auto suppliers could have a big impact on the overall restructuring of the traditional auto industry, which financial experts say is going through an upheaval akin to textiles in the 1980s, steel in the 1990s and airlines earlier this decade. The real change could be that these funds alter the longstanding, usually one-sided relationship between suppliers and auto makers -- where auto makers traditionally call the shots. That kind of change could have enormous ramifications: Detroit's auto makers have been able to avoid bankruptcy in part by wringing concessions out of their now-beleaguered suppliers. Hedge funds now control about $1.1 trillion in assets -- more than double what they had five years ago, according to Chicago-based Hedge Fund Research. An estimated $1 trillion more is committed to private-equity funds and venture-capital firms. It adds up to more than enough money to acquire huge chunks of the distressed North American auto-supply industry at current values. This isn't the first time Wall Street money thought there was gold in the Rust Belt. In the late 1990s, investors like former Reagan budget director David Stockman spent billions of dollars rolling up smaller companies to create megasuppliers. > "This is much different, because the funds getting in now are consolidating around the world, not just in North America," said Tom Stallkamp, an industrial partner at Ripplewood and a former vice chairman at DaimlerChrysler AG, in an interview yesterday. "Plus, this money is more diligent, more disciplined, more focused on profits and not just growing the business or adding sales at any cost." Speaking yesterday at an investors' conference in Dearborn, Mich., Mr. Stallkamp added that funds like his prefer to buy "just before [the companies] go into bankruptcy, when you don't have this thing play out in public," as they do once a company is in bankruptcy proceedings. Write to Jeffrey McCracken at jeff.mccracken@wsj.com1, Ianthe Jeanne Dugan at ianthe.dugan@wsj.com2 and Henny Sender at henny.sender@wsj.com3