By Ajay Shah
The speed at which the auto industry is heading underscores their attempt to escape their traditional model and consolidate with Silicon Valley. But, and here is the big question: who will reap the profits of autonomous driving, electrification, and ride-sharing?
Brave New World
The scandal from Volkswagen AG for deliberately misleading regulators about their carbon emissions illustrates the political emphasis the world places on green-technology. And if the Nissan Leaf was any indication of electric vehicles, the future looked dim. On the other hand, Tesla's stylish Model S, is a vehicle that both car enthusiasts and average consumers can now appreciate. Elon Musk has said the company does not know how to make slow cars -- the Model S P100D can do 0 to 60 in 2.5, we're talking McLaren P1 and Bugatti Veyron time. The Model S, which also includes advanced autonomous driving capability, has recently surpassed the Mercedes S-Class in US sales. By 2020, with completion of its Gigafactory, Tesla is looking to penetrate the mass-consumer automobile market with its Model 3 Sedan. With a car that is high-tech, stylish, quick, and eco-friendly, they have given consumers a real reason to purchase their cars over traditional automakers.
Meanwhile, Uber and Lyft in the US, Didi in China, and more ride-sharing companies have radically altered the way consumers think about getting from point A to point B. Bill Gurley, a VC heavily invested in Uber, suggested two years ago that its quicker pick-up times and higher coverage density, trust and civility between driver and user, and ease of payment through its mobile application, would force consumers to ditch their second cars and get on-board with the company. This is an attractive option to consumers too: AAA estimates that it cost an average of $8,558 per year to own a car in the US, but each vehicle is used just 4% of the time.
The dot-com boom of the late 1990s did not have the same ramifications as it did for automakers, it was neither here nor there -- it just was. However, more recently, innovation has charged forward in the auto-industry: if both driver-less tech and consumer / commercial ride-sharing applications can drive-down regulatory hurdles, the world will begin to get close to period where the same Model S may be used 20-24 hours per day, six-to-seven days a week. As a result, global automakers remain in a frenzy as technology has found a way to penetrate and disrupt the automobile industry.
Auto M&A
When WSJ Correspondent Mark Baker asked how Ford was preparing for both electrification and autonomous driving, CEO Mark Fields responded, “We’re going to disrupt ourselves ... We want to lead in specific areas around autonomous vehicles, around the connected car as it becomes part of the Internet of things, around mobility, ride sharing, car sharing, around data and analytics and how we can anticipate customers’ needs.” Investors can see how Ford's recent investments in laser-sensor maker Velodyne Inc. ($75m), cloud-computing company, Pivot Software Inc ($182.2m), and Civil Maps ($6.6m), a 3-D mapping startup, represent a significant shift in the company’s vision.
Other counter-parties are following suit. GM took a $500m stake in ride-hailing startup Lyft, and acquired Cruz Automation for a hefty sum. BMW recently announced that it was joining forces with Intel, one of the world’s largest chipmakers, and Mobile-Eye, who develops software and algorithms to process visual information for their driver assistance systems market. OEMs, Tier 1 and even 2 & 3 suppliers have also been forced to rethink how they can position themselves as big players look to them as cheap sources of inorganic growth. According to one of William & Blair's investment bankers, Todd Cassidy writes that when Visteon sold its interior business to Reydel Automotive Holdings, "For Visteon it was an optimization of its automotive portfolio, preferring to devote resources to its higher growth and profitable cockpit electronics products such as instrumentation clusters and infotainment displays. It will not be unexpected to see this wave of corporate portfolio rationalizations and divestitures continuing as diversified suppliers concentrate their energy on their highest-margin businesses." According to data compiled by Bloomberg, "the total value of automotive-supplier deals in 2015 and 2016 was $74.4 billion ... with each of those years far exceeding the $17.7 billion annual average in the previous 10 years. The number of transactions valued at $500 million or more also skyrocketed to 18 last year, triple the level of the previous decade. As important it is to recognize the global spike in M&A between these two industries, there is a few issue that investors in automakers need to examine before buying into this gleeful narrative.
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| Source: Bloomberg |
On The Contrary: Hard Times For Automakers
When Google successfully organized and made the world's information accessible and useful, many news-media companies were brimming with optimism. For instance, New York Times
reporter Peter H. Lewis wrote twenty years ago, "With its entry on the Web ... The Times is hoping to become a primary information provider in the computer age and to cut costs for newsprint, delivery and labor.” However, since then, news-corporations have faced near-extinction and bankruptcy. It finds itself trying to balance an unforgiving catch-22: they can either drive their advertising revenue by flamboyant articles or they can drive their digital subscription by solid journalism. However, either strategy does not look promising in revenue-growth. As digital advertising becomes more ubiquitous and saturated from Facebook and other social media companies, the value of ads continues to plunge. Executives also remain puzzled on how they can increase subscription in a world where consumers have always been reluctant to pay for anything on the internet, especially when there is a plethora of alternative news outlets that circulate the same information. The point here is that even the right move or step does not guarantee success or survival; there are revolutionary factors that can fundamentally break a business in half.
Fields closed his interview with this, "we need to make sure we have one foot in the present managing our current business and one foot in the future..." That sense of optimism is beginning to parallel the naivety the Times entered in with. At first glance, it seems like large automakers have properly hedged their bet on the future of transportation. But these bets in Uber and other ride-sharing companies, who have been attached market valuations of a few billion dollars, are simply cautious forays with long term pay-offs. And who knows how long it'll take for Uber to reach profitability and establish a cohesive business model? Furthermore, the investments in the smaller less-known tech companies remain uncertain as well.
Nevertheless, Ford's willingness to embrace technology is noble idea, but their biggest problem is the trade-off between sustaining their already battered business and reinvesting in the risky future of the automotive industry. Unfortunately, investors in automakers must be more cautious of the former, as more focus will have to be placed on their current auto-manufacturing business. This is because:
1. High Reinvestment
According to Sergio Marchioness, CEO of Fiat Chrysler, the “time to re-invest enterprise value in product development” is 36 years for retailers. By comparison, for automakers the time is estimated to be around 4 to 5 years. And between the vehicle's frame, power-train, brakes, suspension/wheels, steering, interior, exterior, and now greater emphasis on connectivity and electronics, it is a cost-structure that leaves operating margins slim. The small-chip bets on these tech-firms and in-house R&D has pushed their already high re-investment even higher. Furthermore, to make matter worse, competition between auto-makers is stifling which ultimately shortens product-life cycle time.
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| Source: Aswath Damodaran |
2. Low Growth
Unless you are Ferrari, the auto-business is a highly cyclical one. And with US auto-sales near an all time -historical high and a needed boost in sales from emerging market economies in Asia and Latin America, the compounded annual growth rate in aggregate revenues at auto companies between 2005 and 2014 was still only a abysmal 5.63%.
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| Source: Deal Engine, Todd Cassidy |
One writer for the Economist ponders, "Within the industry, the big question is not whether this future will arrive, but whether tech firms or car-makers will grab the spoils. Will the sign on the dashboard say Ford (powered by Google) or Google (powered by Ford)?" Financially burdened with higher- reinvestment and lower sales moving forward, how will they be able to compete with the Valley? Thus, until global automakers can can figure out a way to cut conventional automotive cost and decrease their reinvestment, tech companies with deep pockets and more focus and expertise on software development, such as Google, and disrupters who continue to patent their technology, garner funding, and alter the way consumers think about using automobiles, such as Uber and Tesla, are better positioned to reap the spoils of the new world.
Sources:
aswathdamodaran.blogspot.com
https://www.fcagroup.com/en-US/investor.../SM_Fire_investor_presentation.pdf
