Andrew Wilson, Partner, M&A Transaction Services, Deloitte & Touche LLP, discusses M&A in today’s auto supplier industry.

So far in 2008, auto sales in North America are down and gas prices are up, credit markets are in turmoil, and uncertainty about the future of the Big Three abounds. Not surprisingly, the number and size of global mergers and acquisitions (M&A) in the industry has declined, with 257 deals announced by the end of this year’s second quarter compared to 280 announced in the same period of 2007. The spigot of easy credit, which fueled the M&A boom in 2006 and the first half of 2007, has been turned off. Add to these facts the broader economic issues affecting the industry, and it’s not surprising that the automotive deal market suffers from significant uncertainty about value and direction.
As the M&A market cools, auto bankruptcies are rising. Many auto companies are forced into or, in some cases, choose this “last chance” option to re-structure contracts and shed under-performing assets that weigh down the balance sheet and inhibit new investments. Businesses with products that are sensitive to commodity price pressures (such as plastic injection molded parts) or to over-capacity (such as stampings) continue to be vulnerable.

Given all these dark clouds, are there any opportunities in the M&A marketplace for North American auto suppliers? The answer is yes – a qualified yes, but yes nonetheless. For example, as suppliers try to balance product portfolios, they divest non-core businesses that others may find valuable.

To ensure maximum return on deal activity, an auto supplier in North America reassessing its M&A options for buying or selling should keep top-of-mind these several key concepts relevant to today’s auto M&A market.

Bigger is not necessarily better.

Perhaps a competitor’s business is up for sale. Is that an automatic target to consider for an acquisition? Not at all. Today, the smart money is not on growth (or size) for its own sake but, rather, on investments that increase one’s value to customers. Responding to opportunities in the M&A market is fine, but only if the deal truly fits a broader, long-term competitive business strategy.

In trying to grow through M&A, buyers need to be careful of not duplicating or increasing any existing overcapacity or customer concentration issues. The most promising deals are those that expand the supplier’s capabilities and, hence, its value to customers. Strategic buyers should ask themselves, “How will this deal make us more important to our OEM customers?”

For example, adding a complementary technology component to its product portfolio may increase a supplier’s revenue, while at the same time (and more critically), enabling the company to deliver a more complete solution to its customer, thereby positioning the supplier as more integral to the customer’s supply-chain. If a supplier of underbody components were to acquire a supplier of electronic sensors, it could offer customers a more complete assembly, which could in turn result in both better pricing and new business, as the supplier provides greater value with research and development and product design.

As a rule, in today’s market, deals that add products or technology to the supplier’s business portfolio are more likely to succeed in generating long term value through greater and, more importantly, more profitable revenue.

Auto making is a global business and so is auto deal-making.

The auto supply chain has been global for some time. Cross-border automotive M&A will increase as buyers and sellers look outside their geographic regions for deal opportunities.

A weak dollar may be the impetus for some foreign investors to look at North American suppliers that are up for sale. While the flood of money from China and India has not occurred yet, and may not for some time to come, the maturing in the auto sectors in these and other developing countries will eventually lead to their entry into the largest consumer auto market. Increasing transportation and logistics costs, coupled with the currency movements of the last year, make locating production facilities in the NAFTA region a more profitable proposition than before for those companies wanting to sell in North America.

In the past, foreign investors have often shied away from acquiring companies tied to the Big Three domestic OEMs. But now, with foreign OEMs building more and more assembly plants in North America and with the weakened dollar making U.S. assets relatively cheap, foreign suppliers may look at an acquisition, rather than building a new facility, as a way to expand into North America. Acquiring an existing auto supplier can give the buyer new products and technologies, an experienced workforce, and existing customer and supplier relationships – advantages not likely with a Greenfield investment. These benefits, coupled with the currency and logistics trends, should drive foreign suppliers to re-assess their strategy for the NAFTA market and open opportunities for divestitures by North American suppliers.

The opportunities for North American suppliers aren’t only in selling their businesses. While sales volumes in the U.S. will be lower in 2008 than in 2007, other geographic and market segments are growing. U.S. suppliers might find the right strategic opportunities for M&A in Europe or Asia, despite currency issues. The promises of focused out-bound M&A – new technologies or products, access to global new customers and markets or, in some cases, even expanded relationships with the European or Asian arms of the Big Three – can all result in profitable growth.

But casting the net for opportunities outside North American operations can be challenging. To put it bluntly, cross-border M&A can be tricky. Even if a buyer has been active in another country – say, China, India, or Russia – through sourcing parts or even joint ventures, executing an acquisition is much more complicated. Legal, tax, and legacy corporate structures can be difficult to navigate, transaction execution can be time-consuming, and complex cultural issues can raise unforeseen roadblocks. Executing globally on a well-thought out M&A strategy requires patience, local expertise in the foreign regions, and significant time spent planning for post-acquisition operations. The end-result, however, can be significant, profitable expansion of the supplier’s business.

Focus is fundamental.

An auto supplier considering any deal has to keep its own business strategy front of mind: How will the merger or acquisition contribute to the business’s long-term stability, security, and success? Three necessary, but sometimes difficult, steps – focusing on the right reasons for an acquisition or divestiture, sticking to the strategy as the deal unfolds, and being willing to walk away when the deal stops making sense – are key for success in auto mergers and acquisitions in today’s challenging environment.

North American suppliers are faced with a myriad of difficulties in their business everyday. Looking at M&A activity in a structured, strategic way is fundamental to achieving the “right” global footprint, customer base, and product portfolio.

Andrew Wilson can be reached at andwilson@deloitte.com.