TRW Inc. is taking the automotive industry maxim 'Get bigger or get out' to the next level.
By agreeing to buy LucasVarity PLC for $7 billion in cash, TRW Chairman Joseph Gorman, 61, would create North America's largest independent automotive parts supplier, with pro forma automotive sales of $12.8 billion.
On the global stage, only the captive supplier divisions of General Motors and Ford Motor Co. and Germany's Robert Bosch GmbH and Japan's Denso Corp. are larger.
The combination is a 'true global growth engine,' Gorman told analysts and reporters in a meeting in New York last Thursday, Jan 28. 'We have tremendous strategic advantage looking forward.'
The price tag for Gorman's vision is steep, the biggest ever for an automotive parts company. It even exceeded the $6.45 billion Ford offered last week for the car operations of AB Volvo - and it could go higher.
Federal-Mogul Corp. made an unsuccessful $6.4 billion bid for LucasVarity earlier in the week. Later, Federal-Mogul, itself on an acquisition binge, publicly urged LucasVarity shareholders 'to take no action on TRW's offer.'
A revised bid for the London-based parts maker may be in the offing, the statement suggested. TRW's bid was not only higher, but it was all cash; Federal-Mogul offered half cash, half stock.
A combined TRW-LucasVarity will raise the bar on size for Tier 1 suppliers, said auto analyst David Strickler of Bowles Hollowell Conner & Co. in Charlotte, N.C. 'The new level is pushing the $10 billion to $15 billion (annual revenue) range,' he said. 'Supplying entire modules instead of parts for a global industry is requiring added capabilities and resources.'
TRW's bid also signals another conglomerate in flux. TRW - which also has aerospace and information systems holdings - said last year that it might spin off some of its automotive operations. That is still possible, analysts say. But with LucasVarity, TRW would be more heavily dependent on the automotive business. About 70 percent of combined TRW-LucasVarity sales of $19 billion would be automotive.
Another conglomerate, Tenneco Inc. agreed last week to sell its containerboard business as the first step in the restructuring and repositioning of its automotive business. And last month, United Technologies Corp. began accepting the first round of bidding on its UT Automotive unit.
The race by TRW and Federal-Mogul to acquire LucasVarity underscores the consolidation of the world's automotive industry. The move has accelerated during the past three years. Mergers between like companies have become the market's way of reducing excess automotive industry capacity, aggravated last year by declining Asian economies.
Billion-dollar deals are no longer rare. Just three years ago, LucasVarity itself was formed by the $2 billion merger between Lucas Industries PLC and Varity Corp. of Buffalo, N.Y.
LUCAS/TRW: GOOD FIT
The latest LucasVarity deal makes sense strategically, said analyst Eli Lustgarten of Schroder & Co. in New York. The price is prudent, and the fit is right for TRW. It enables the integration of TRW's steering and suspension business with LucasVarity's braking business for the 'four corners' with the next generation of vehicle control systems, Lustgarten said.
LucasVarity brings the antilock braking technology, and TRW offers a leading position in occupant-restraint systems.
LucasVarity also supplies 30 percent of the European diesel automotive market with fuel-injection systems. That would complement TRW valve-train systems, said analyst Gregory Kagay of McDonald Investments Inc. in Birmingham, Mich.
TRW, in turn, could help LucasVarity's switches and controls business, Gorman said. He also said he likes LucasVarity's strong European aftermarket business.
LucasVarity CEO Victor Rice said during last week's conference that the two companies are 'a wonderful fit in terms of what you can offer the customer.'
Rice, 57, stands to be named vice chairman of TRW and head of the combined automotive operations, reporting to Gorman. He also is expected to be elected to the board. The companies hope the deal will be approved this spring.
Cost savings from the deal are expected to exceed $200 million annually by the end of 2001. Gorman said the savings would come from combining purchasing power, cutting overhead and plant closings.
Before last week's deal was announced, LucasVarity told employees that it would close a brake parts plant in Cincinnati this year.
Some analysts expect the deal to unsettle other large Tier 1 suppliers. 'Lear Corp. bought Automotive Industries and Masland Corp., and that spurred Johnson Controls Inc. to buy Prince Corp. and the Becker Group Inc.,' said analyst Eric Goldstein of Bear Stearns in New York.
'Everybody now has to take a look in the mirror and say the world has changed,' said Goldstein. 'They have to ask, 'Am I competitive?' '
Robert Oswald, chairman of Robert Bosch, asked rhetorically, 'Will I be forced to do something different? No, but we're always looking.'
A QUESTION OF DEBT
Merger mania has added significant debt to an industry once wary of leverage because of cyclical downturns.
TRW's Gorman told analysts that company debt will remain solidly investment grade. The purchase is expected to push TRW's debt to about 73 percent of total capital from 54.2 percent. Moody's Investors Service said it may lower TRW's rating.
Kenneth Blaschke, an analyst with BT Alex. Brown Inc., said TRW may offset some of that debt by selling noncore assets or with a small equity offering.
Even without LucasVarity, Federal-Mogul's debt rating was a much lower 'investment grade' or 'junk,' as it is known. Had it won LucasVarity, Federal-Mogul's rating would have been re-evaluated again, said Christina Padgett, a vice president and senior analyst with the New York rating service.
Federal-Mogul's estimated 1998 revenue was about $7 billion. Its debt has ballooned to $3.8 billion following the purchase of T&N PLC, Cooper Automotive and others during the past year, she said.
TRW hopes for a better year with LucasVarity in its stable. Its automotive business suffered in 1998 even though its products enjoyed higher volume. Twin strikes at General Motors cut three cents per share from consolidated results; severance costs reduced earnings another seven cents, according to Value Line Publishing Inc.
TRW also faced weaker markets in Asia and Brazil, and price competition remained intense across all product lines, especially occupant-restraint systems.
Gorman said the erosion of profit margins has stopped. 'We have stabilized the margins, and we are well on the way to getting back.'