Over the past several years, the auto ancillary industry has been in the thick of action on the M&A front. Indian players have been acquiring overseas assets to get access to technology and customers while global players, particularly Japanese and European companies, under mandate from their key original equipment manufacturers, have been investing in Indian component makers.
However, capital raising–whether through private equity or capital markets–has been tepid; the returns generated by investments made in the space before the financial crisis have been poor to modest with several private equity investments still awaiting an exit. In this context, we look at how the sector could pan out in 2016 from an M&A and capital-raising perspective.
Let’s look at capital raising first. When the Narendra Modi government came to power in May 2014, the public markets gave a thumbs up. With indices gaining more than 30 per cent, several auto ancillary companies were hoping for public markets to become the source of much-needed capital for expansion and technology upgradation, exit for private equity investors and in some cases, for promoters to repay bank loans and reduce financial distress.
While there have been a few IPOs since then, including the most recent one by Precision Crankshafts, which barely scraped through with 1.9 times subscription, the fact remains that public markets in India don’t like the auto ancillary story. This was reaffirmed by the TeamLease IPO, which was oversubscribed 66 times immediately after Precision Crankshafts.
With the markets having lost the “Modi premium” and now going through a bout of significant volatility, it is unlikely that anyone apart from a blue-chip company would venture into public markets anytime soon.
The private equity story is no different and with the relatively bad experience on pre-financial crisis investments, not many investors are queuing up. Fundamentally speaking, Indian companies in this space are mid-sized and family-run, innovation and focus on technology is quite poor, have limited pricing power versus OEMs and hence would always generate poor to modest returns in the long term.
There are serious gaps in corporate governance, disclosure standards and professional management, as has been seen recently, which doesn’t inspire confidence among investors. Globally, public markets and private equity investors invest heavily in auto ancillary assets. However, unless the fundamental issues are addressed in India, things are unlikely to change in 2016 and beyond.
The M&A space, on the other hand, is likely to continue witnessing action during 2016. The Japanese players will continue to play a major part in this space. Some of the likely trends are as follows:
1. Many Japanese investors are looking at restructuring existing joint ventures with Indian players with the clear objective of taking management and operational control. One of the key reasons for this is that the technology requirements of OEMs have become far more stringent and the global suppliers are being held accountable. We expect this trend to pick up during 2016 and also forecast some strain in the relationship between JV partners in such restructuring situations — in most JV agreements, there are no mechanisms for increase in shareholding by one of the partners and hence, there may be a willing Japanese buyer but an unwilling Indian seller.
2. With China slowing down, some European auto suppliers could reorient themselves towards India. However, with European OEMs still having low volumes in India, we expect this to be a trickle rather than a wave in 2016. Europeans have found more success in India on the commercial vehicles side and with volumes picking up through 2015 in the medium and heavy commercial space, one needs to see how the auto supplier community for commercial vehicles, which primarily remains Indian owned and controlled, responds to this from an M&A perspective. There could be interesting JV and acquisition situations on the commercials vehicle front in 2016.
3. Domestic consolidation was one of the M&A themes through 2014 and 2015 whereby local suppliers have exited in favour of domestic competitors. Such exits were triggered due to succession issues and weak balance sheets, etc. Given the stressed financial position of several auto suppliers, we expect this trend to be stronger in 2016. Another interesting consolidation story could play out if the speculated alliance between Toyota and Suzuki fructifies; this would trigger a never before wave of consolidation and restructuring among Japanese suppliers across the globes including India.
4. Overseas acquisitions by Indian companies are likely to be few. Only companies with relatively stronger balance sheets, access to financing and, above all, courage to invest in volatile global markets could carry through such transactions. Our view has always been that Indian companies should be extremely selective and careful in such adventures. On the other hand, 2016 is likely to witness a few exits from the earlier overseas acquisitions to support parent company balance sheets in India.
5. The automotive space itself is undergoing significant regulatory changes on the emission and safety norms front. Further, the vehicles themselves are becoming more electronic than mechanical. This would lead to formation of greenfield JVs with global players bringing technologies and Indian players contributing customer relationships and local execution capabilities. We expect this to be a major theme in 2016 and would bring the much-needed technology orientation among Indian auto suppliers.
6. Some private equity investors could exit in favour of global strategic investors as is being contemplated by KKR; Alliance Tyre being the investee company and subject matter of a potential exit. However, these situations are likely to be few and far between and possible only for blue-chip assets; generally speaking, private equity investors would struggle to find exits through 2016 except at significant losses.
With inputs from Somika Agarwal.
Ashish Gulati is partner, M&A, and Somika Agarwal is senior vice president, M&A, at BMR Advisors.