NEW YORK/DETROIT (Reuters) - With the U.S. car industry in a slow, fragile recovery from a punishing downturn, auto parts makers are reluctant to pull the trigger on deals, delaying a long-predicted wave of consolidation in the sector.
When Detroit's near collapse in 2009 prompted a flurry of failures across the supply chain, analysts and executives have forecast some of the sector's strongest players such as Johnson Controls (JCI.N) and Magna (MG.TO) could lead consolidation in the highly fragmented and commoditized industry.
That expected wave of deals has so far failed to materialize. And bankers say any return of dealmaking could be slow as the outlook for auto production remains uncertain and automakers, worried about potential distress at the supply chain, are asking suppliers to use growing cash for paying down debt.
Deal volumes involving U.S. parts suppliers have plunged to $3.4 billion so far this year, from $58 billion worth of deals during the same period last year when a wave of bankruptcies spurred changes of ownership, according to Thomson Reuters data as of October 27. Deals totaled $31 billion in 2006, the year when the industry's deep four-year downturn began.
Bruised by years of shoring up ailing suppliers to keep their own factories running, automakers are asking suppliers not to lever up beyond two times their earnings before interest, tax, depreciation and amortization (EBITDA), several people with knowledge of the discussions said.
That's also delaying the return of large leveraged buyouts by private equity firms, which used to strike deals at four to five times debt-to-EBITDA levels before the crisis.
"Financial strength in the supply chain -- there's a big emphasis on that from automaker customers," one source said. "If suppliers are distressed, guess who will have to step in?"
General Motors GM.UL took more than $11 billion in charges for the restructuring of Delphi, a parts maker it spun off in 1999.
Ford (F.N), in order to prevent costly plant shutdowns, stepped in to provide bankruptcy financing for Visteon when the former parts affiliate filed for Chapter 11 in May 2009.
Deal valuations in the auto supply sector currently range from five to six times EBITDA, bankers said. But a wide gap exists between what buyers are willing to pay and what potential sellers think they might be worth, they noted.
U.S. auto sales, which plunged to 10.4 million units in 2009, are expected to recover to 11.5 million this year and eventually rise back to the pre-recession level of more than 15 million in the next few years. As recently as 2007, more than 16 million vehicles were sold in the United States.
"Everybody is looking at higher auto production levels in the next three to five years, so nobody wants to sell at 2010 EBITDA numbers," an investment banker said.
Johnson Controls Chief Executive Steve Roell told Reuters this month that the company had made it "to the altar" with potential deals several times but walked away over valuations. The company could spend as much as $3 billion on a deal but sees few opportunities right now, executives said.
"People are still expecting pretty rich numbers," Chief Financial Officer Bruce McDonald said.
The catalyst for dealmaking next year may come from suppliers who emerged from bankruptcy in the hands of creditors led by hedge funds, who are not known for their patience.
Delphi, Visteon VSTO.OB, Tower International (TOWR.N), Lear (LEA.N), and Cooper-Standard COPST.UL all used Chapter 11 to slash obligations and debt, and the desire of impatient owners to monetize those assets could trigger some M&A activity, analysts and bankers said.
"As we go into 2011, we're going to see some assets turning over in the supply chain, because their shareholder bases are dominated by fast money," another banker said.
Meanwhile, while multibillion-dollar leveraged buyouts may be the thing of the past, private equity firms are returning for deals in the $500 million to $1 billion range to play the improving industry cycle, bankers said.
"I don't think you're going to see mega-mergers," said George Magliano, an analyst at IHS Global Insight. "You've got to cover too many bases to get profitable."
Buyers with the most firepower like Johnson Controls, Magna and BorgWarner (BWA.N) are selective in dealmaking and may well stick to business segments where they already operate.
For example, Johnson Controls' unsolicited $1.25 billion offer in May for Visteon was only for its auto interior and electronics units and excluded its thermal business, where Johnson Controls is not a player. Visteon rejected the offer and in October emerged from 16 months in bankruptcy.
"What JCI was privately hoping for was someone like Delphi and Valeo (VLOF.PA) would stand up and say, 'Well, I want the thermal business," a source familiar with Johnson Controls' strategy said. "That's the kind of consolidation we might see."
Reporting by Soyoung Kim and Deepa Seetharaman; Editing by Mike Miller, Bernard Orr