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Competitive Challenges: Private Equity’s Evolving Automotive Role

You essentially have a choice. You can compete in the highly demanding market by collaborating, or you can quite probably get ready to do something else for a living.

One year ago, who among us would have thought we would be writing an article about a major domestic OEM having been bought by a private equity firm and taken private?

One year ago, who among us would have thought we would be writing an article about a major domestic OEM having been bought by a private equity firm and taken private? Yet we have witnessed the drastic changes Cerberus has made in its first three months of Chrysler ownership as they reevaluate every aspect of the business, bring in real change agents, and move at lightning speed to make it competitive in the global marketplace. However, Chrysler-Cerberus isn’t the only major private equity deal the industry has experienced over the past several years.

Historically, private equity has entered and exited the automotive industry throughout its cycles, but the industry’s recent structural shifts have increased interest substantially (see chart). With domestic OEMs focused on reducing the supply base through component commonization, more suppliers will become distressed and overcapacity will increase. Thus, the market will be prime for consolidation, and private equity’s push will continue.

Many industry observers and executive management teams are watching carefully, and are skeptical of private equity firms because their focus and, quite honestly, culture is the polar opposite of the American automotive industry’s. By tradition, automakers make decisions, and sit for long periods of time evaluating them before execution. Only when a significant amount of time has passed will they decide to modify a wrong choice. This behavior is unconscionable for private equity whose focus is to target underperforming companies with under-valued assets, take over controlling interest, restructure the business, and quickly sell the operations for significant multiples. Private equity is interested in the automotive industry because it is growing globally, a good sign for the industry.

Unfortunately, these cultures are like two trains headed toward each other on the same track, and is the biggest hurdle private equity firms face as they acquire traditional domestic automotive companies. However, culture change may be what the U.S. automakers desperately need to become global, world-class companies, and Chrysler-Cerberus is a benchmark for how the future will evolve. Organizational restructuring and getting the right people onboard to make swift decisions and achieve the speed-to-execution is critical in today’s market.

What are the pros and cons of private equity in the automotive space? First, private equity firms bring a fresh perspective on doing business by focusing on being a change agent, and bringing new ideas and methods to run the company more effectively. Second, it brings best-of-breed professional management, and has been very successful at pulling these people from the best companies and placing them in auto. Third, it is very focused on the vision, accepts nothing less than solid performance, and is very experienced at buying and turning companies around at a profit through capacity rationalization and other major moves. Fourth, and most importantly, it brings rational thinking to the process. Private equity won’t take on projects at a loss just to cover overheads at the expense of everyone’s returns, a traditional behavior of the auto industry that will be abolished.

Conversely, it also brings with it a very short-term perspective. Most of the major changes and decisions will take place in the first three or four years, which makes management and employees very nervous because of uncertainty about what the future holds. Additionally, private equity firms have a significant reliance on leverage—sometimes too much—which puts companies in very interesting positions. The perception of management, employees, suppliers, consumers, and—most significantly—Wall Street is a critical factor against which private equity firms often struggle to project a positive view of their motives and expectations. Nevertheless, there is a lot of money available today for investment opportunities, and with the right leadership and vision, private equity can play a key role in the turnaround of the domestic automotive industry. 

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