Auto suppliers divide to conquer

Detroit — Auto component suppliers around the world are tearing themselves apart.

On purpose.

They are convinced that by no longer being conglomerates, they will gain favor from investors and industry customers. And so, like amoebas under a microscope, parts makers are splitting in two, separating self-driving operations from drivetrain business units, old technologies from new, or selling off divisions deemed inessential for growth in the new era of electrified, connected and autonomous vehicles.

In the past 24 months, the industry has witnessed such "de-mergers" at Delphi, Johnson Controls Inc., Autoliv and Faurecia SA. Honeywell International Inc. has put its turbocharger division on the block. GKN plc tried to stave off a hostile takeover by splitting its automotive and aerospace divisions, and that scenario is still unfolding. Even the German technology giant Continental AG is considering a structural overhaul. There are several reasons for the global trend, executives and analysts say. For one, Wall Street and the rest of the world's investment sector believe there is greater earnings potential in the high-tech trends that are roiling the auto industry — autonomous drive, electrification and connectivity — than in nuts-and-bolts auto parts, however profitable they may be now.

Suppliers themselves say that by separating out a tightly focused and independent business, it won't have to fight for resources within a diverse conglomerate. And smaller, single-purpose companies also can be quicker to adapt to a fast-changing landscape, whether it's new tech or old tech.

Supplier R&D is running hotter than ever, with technology the focus of SAE World Congress in Detroit this week.

Automakers are leaning heavily on their parts companies to come up with the necessary innovations to make vehicles drive themselves, deliver better fuel economy and talk to each other in traffic.

Not every supplier is following the same script on how to obtain the needed cash and profit margins to deliver whatever it is the auto companies will need over the next decade. But they agree that they need keen focus on their core competencies in an increasingly complex business, analysts said.

"The supplier that was everything to everybody — that's becoming a much more difficult business model," said Michael Robinet, a managing director at IHS Markit Automotive. "Even the larger suppliers are looking inward and saying, 'Where can we see the added value? Where can we see the margins and return on investment that we targeted?'?"

Perhaps the most high-profile move came in December when Delphi Automotive, No. 12 last year on the Automotive News list of Top 100 global suppliers, formally split itself into two independent companies. Delphi Technologies will focus on powertrains and aftermarket, while Aptiv plc focuses on active safety, connectivity and autonomous vehicle technology.

The split was equally good for both sides, according to Liam Butterworth, CEO of Delphi Technologies.

"We're in a very good position as a stand-alone company and very much operating according to plan," Butterworth said in an interview this month.

Despite the perception that his half of the split has products that are "legacy technology," Butterworth argues that the spinoff has given Delphi Technologies the freedom to adapt to shifts in the drivetrain market. He pointed out that its portfolio includes products for not just gasoline and diesel engines, but also for electrification and software.

"We're 100 percent focused on propulsion — all of our investment strategy is around propulsion systems, and we are much more agile and focused in that space," he added.

The spinoff could not have come at a better time, he said.

"If we were still part of [the former] Delphi, in 12 to 18 months' time I think there would have been increasing capital allocation decisions that would have not been favorable for the powertrain part of the company," Butterworth said.

Like Delphi, Swedish supplier Autoliv is banking on future technologies as its growth engine. In September the company announced that it will become two separate companies, one making the passive-safety systems it is best known for, such as airbags and seat belts, and a separate enterprise that will focus on vision systems, radar products and advanced driver-assistance software.

Autoliv CEO Jan Carlson will move over to head the new company, called Veoneer.

Carlson will have some work to do: The order intake for electronics at Autoliv last year was about $900 million, compared with $2.5 billion for the company's passive safety products. And operating margin for Veoneer is initially expected to be "low- to mid-single-digit negative," Autoliv said in February. Its electronics profits are expected to lag until new products are rolled out in 2019.

Nonetheless, the split has won the blessing of financial markets.

Activist investor Cevian Capital disclosed in March that it had taken a 7 percent stake in Autoliv, worth about $850 million, and Cevian co-founder Christer Gardell endorsed the split.

"We are convinced that both Autoliv and Veoneer have strong potential for further value creation," he said in a statement.

To be sure, large global companies buy and sell businesses in the normal scheme of things. But the widespread strategy of splitting in two to reposition for a changing industry reality is new. Indeed, for much of the past three decades, suppliers have doggedly pursued expansion by acquisition to make themselves large and diverse enough to cater to any need a customer had.

That philosophy is evolving.

Battery colossus Johnson Controls spent decades building up its automotive seating business into the industry leader through acquisitions and investment. But in 2016 Johnson separated its seating division into a new company called Adient plc, saying the low-margin seating business required more capital than the company was willing to commit.

The clean-sheet start has energized it.

"Wrapping up our first year, it's been very good for us, on a few different fronts," said Byron Foster, Adient's executive vice president in charge of seating for the Americas, Europe and Asia Pacific regions. "We've committed to investing in the business again. The last three to five years under Johnson Controls we were seen more as a cash cow."

Adient has won $3 billion worth of new business, Foster said, and it will remain focused on seating. "Our clear strategy is to win at what we think we're world class at, and that's automotive seating," he said.

The stock market has agreed: Adient's stock price has risen by about 50 percent since debuting in October 2016, and at one point was nearly double the opening price.

Navigant Research analyst Sam Abuelsamid says the split gives Adient a better chance to survive, even as parts such as seats increasingly become commodity products, and the entire vehicle market levels off in the coming decades as car-sharing increases.

"One of the things that Adient has done over the past year is develop variations of their product lines that are better adapted to the future of shared, autonomous vehicles," Abuelsamid said. "They're going from just building conventional seats to asking, 'How do we re-architect the vehicle interior to better support autonomous vehicles, provide modularity and support different types of user experiences in the vehicle?'"

French supplier Faurecia sold its exteriors division to a onetime competitor, Plastic Omnium SA, for $753 million in 2016. The sale let Faurecia, in which PSA Group holds a controlling stake, retire outstanding debt, but it also gave Faurecia a war chest to acquire companies that are better aligned with its areas of strategic future competence: seating, interiors and clean mobility.

The exteriors division, which includes big plastic fascias, was not sufficiently international and was relatively low-tech, a Faurecia spokesman said.

"The money offered the group new investment capabilities that allow us to complete our technology road map," he said, citing its investments last year in Parrot Automotive and Jiangxi Coagent Electronics for connectivity and infotainment systems, and Hug Engineering, which develops exhaust gas purification components.

The move is paying off for Plastic Omnium as well, said Jean-Michel Szczerba, the company's co-CEO. Plastic Omnium wanted to win bumper contracts in the lucrative German market, and that is now happening.

"We wanted to create a relationship for bumpers with Daimler, with Audi and with Ford," he said. Last year, Plastic Omnium agreed to provide bumpers for the Mercedes S class.

Plastic Omnium is now seeking to sell its environmental division, which makes waste bins and playground equipment, and was one of the group's original businesses. Instead, the supplier hopes to devote its resources to research into composites and hydrogen fuel cell storage.

Some suppliers are still following the conglomerate model. Robert Bosch, No. 1 on the Automotive News list of the top 100 global suppliers with worldwide automotive sales of $46.5 billion in 2016, also sells home appliances, security systems, business logistics software and even garden tools. The largest Japanese suppliers, including Denso Corp., at No. 4 on the list, and Aisin Seiki Co., at No. 6, have not announced plans to spin off or sell major divisions.

But the biggest breakup could be coming this year. Continental, with a market cap of $43 billion, said it was in talks about a possible restructuring to reach its growth targets. Potential changes reportedly include a spinoff of its tire division.

"The suppliers who choose to consolidate and scale up will be the only player standing in some segments. That's a viable strategy," said Neal Ganguli, a managing director at Deloitte Consulting. "Then we've seen suppliers who say, 'We're going to shut these businesses and focus on becoming more of a profit seeker.'?"

Not every bid to divest or spin off divisions succeeds. The British supplier GKN, facing a hostile takeover by the London investment group Melrose Industries, had been working on divesting its automotive division to focus on aerospace and defense. GKN cited the "strategic optionality" in having "separate companies with distinct investment profiles and capital allocation policies." It was nearing a deal to sell its automotive operations to Dana, but shareholders late in March voted for Melrose — which had the opposite views on the split.

In wooing GKN shareholders, Melrose said that "any actions to immediately separate the businesses in preparation for a sale of one or the other would be value-destructive."

Ganguli said the current wave of mergers, acquisitions and divestitures is driven by foundational shifts in the auto industry rather than normal business cycles. "The forces that are driving the transformation are different," he said. People are thinking about mobility in a fundamentally different way, he said, and the value of a vehicle will increasingly be in its software and coding rather than in hard parts.

"This is going to have a profound impact on the Tier 1 suppliers," he said. "Going forward, they will have to look at what strategies to deploy to be a player and how to win in this new environment."

Economic cycles may also be playing a role in the flurry of divestments. Parts makers have been along for the ride as the global auto industry surged since the Great Recession, with worldwide light-vehicle production rising to more than 90 million in 2017 from about 60 million in 2009.

"We grew at such a fast pace that most suppliers were just holding on," IHS Markit's Robinet said. "It was not the time to go out and drive a revolution. It was a time to make money."

Now, with sales increases forecasted to slow, suppliers can pause and consider how they will approach the next phase of the automotive market.

Said Robinet: "It's a good time to stand back and ask, 'What do I want to be as I continue to grow? How do I best add value to the industry?'?"

Douglas A. Bolduc contributed to this report.