A Merger for Sequel?

Automotive Industries,  Sept, 2001  by Lindsay Brooke

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ArvinMeritor has proven that supplier mergers can work. It could serve as a model for future M&As, when the right business conditions return.

For five straight years beginning in 1996, supplier merger and acquisition (M&A) news dominated the business media headlines. Driven by the industry's ongoing need to consolidate, the so-called "merger mania" rose to fever pitch between 1998-2000, with 30 major deals worth $58.4 billion -- $30.2 billion alone in 1999, the pinnacle of the trend. All but one of them were acquisitions.

But the M&A blitz sputtered to a stop in 2000. The frenzy has yet to pick up and the supply-chain's ability to muster M&A resources remains weak, even as competitive pressures to consolidate further remain high. Analysts note that many of the big players that grew through acquisition in the 1990s are still unable to swap the debt they accrued for the equity needed to buy what's currently available (see chart). The recent Heartland Industrial Partners-Textron Automotive deal has been a rarity in this environment.

Auto-supplier stock prices will certainly rebound. But business experts believe M&A activity will remain quiet for the foreseeable future.

"There must be a continued stabilization in public market equity valuations and light vehicle sales, as well as recovery in the high-yield markets, in order for M&A activity to come back in earnest," notes Darren Kimball, who follows the supplier sector for Lehman Brothers in New York.

A recent survey of 200 senior auto industry executives, both OEM and supplier, by The Economist Intelligence Unit (EIU) supports this observation. Only 23.6 percent of survey respondents anticipate more supplier M&As in the coming years -- a lower share than in previous EIU industry surveys. But nearly 54 percent believe that alliances, partnerships and joint ventures are the quickest, most cost-efficient route to global growth.

Taking the Road Less Traveled

"It's very important that everybody understands the goals of our company," asserts the man on stage. It's an April morning, just after starting time at ArvinMeritor's Troy, Mich., headquarters, and CEO Larry Yost is front and center among his troops. In shirtsleeves, Yost addresses not only the Troy-based employees but the entire company, more than 36,000 people at 150 facilities worldwide, via a taped broadcast.

The occasion is the company's quarterly business update, an event that's somewhat of a personal crusade for Yost. He's been hosting it since his former company, Meritor Automotive, joined with Arvin Industries in a stock-for-stock merger in July 2000. When it was announced as a "merger of equals," skeptics howled -- Daimler-Benz had applied the same term to its heavy-handed takeover of Chrysler Corp.

But the resulting ArvinMeritor -- Mentor owns 65.8 percent -- has proven to be an amicable marriage. It is now the industry's 12th largest supplier, with $7 billion in annual revenue from light vehicle and heavy truck systems and modules, and the aftermarkt (www.arvinmeritor.com; ARM/NYSE). Securities analysts and even former critics describe it today as a genuine merger, the only one to come out of the 1990s mania. Its relatively healthy balance sheet is the result of $50 million in cost-saving synergies this year and a projected $100 million by 2003. It has some alliances, with partners ranging from Volvo and ZF, to SommerAllibert and Kayaba.

Its operational success is due primarily to both companies carefully planning the integration process and establishing a rigorous follow-through, explains Juan de la Riva, the VP of corporate development and strategy who directed the integration.

As a company born from a daringly different spin, ArvinMeritor is worth watching closely as a potential model for future supplier mergers.

To those listening to his quarterly report (over 6,500 of ARM employees own company stock), Yost comes across as both a captain and a colleague. He leads them through a detailed road map of the young company's strategic goals, explaining the financials in clear, simple terms that would impress any investor-relations manager. And he stops often along the way to tell the troops exactly where they can directly impact the overall bottom line -- from speeding accounts payable, to increasing inventory turns, to curtailing capital spending and driving waste out of every department.

ArvinMeritor's financial goals are aggressive, say securities analysts. Maintain a strong investment grade. Grow "organic" sales by 10 percent and earnings per share by 15 to 18 percent, both compounded annually. And generate cash. Lots of it. The company is working to reduce working capital as a percent of sales from the current 6.8 percent, to four percent. That is projected to save $10 million annually by 2003 and free up roughly $120 million in cash. Increasing inventory turns from 11 per year today to 25 per year in 2003 will save $30 million and free up a whopping $335 million. There is also a major drive to reduce warranty costs by boosting quality -- potentially a $40 million annual savings that liberates $30 million in cash.