October 22, 2018 / 12:30 PM / 10 months ago

Breakingviews - KKR throws autos shareholders into a spin

A Fiat Chrysler Automobiles sign is seen at the U.S. headquarters in Auburn Hills, Michigan, U.S. May 25, 2018. REUTERS/Rebecca Cook

LONDON (Reuters Breakingviews) - KKR’s $7.1 billion splurge on a Fiat Chrysler-owned supplier is sending auto industry valuations into a spin. The buyout group is paying 16 times next year’s earnings for Magneti Marelli, which will be merged with KKR portfolio company Calsonic Kansei. That’s double what publicly traded car-parts peers are worth, according to Refinitiv data. Meanwhile, shares of marquee manufacturers trade at an even bigger discount. 

Shareholders have reasons to be downbeat about the sector. A slowdown in China and worries that new fuel-economy standards will hurt demand in Europe have led to a number of profit warnings in recent months from suppliers like Continental and Michelin, paints specialist PPG Industries, and carmakers Daimler and BMW. 

So it could be that KKR overpaid. In fact, its return on invested capital may be as low as 10.7 percent by 2023 assuming it cuts 300 million euros of costs – or 2 percent of combined revenue – grows operating profit 3 percent a year and pays 28 percent in taxes. That’s a humdrum return for a private-equity deal, putting the onus on KKR and Calsonic to slash more expenses, boost revenue or hunt for more deals. 

The deal is certainly a coup for FCA Chief Executive Mike Manley who took over both the company and negotiations with KKR in July after his predecessor, Sergio Marchionne, fell ill and later died. Manley now gets to choose how to divvy up the proceeds between shareholders and investments in electric- and autonomous-vehicle technology, where FCA lags. 

Still, the vote of confidence from a typically savvy investor contrasts with how public investors feel about the sector. All the major carmakers trade well below 10 times earnings. Daimler and General Motors now trades below six times 2019 estimates, while FCA, Renault and Volkswagen languish around five times. That suggests shareholders reckon the bottom line will shrink drastically. 

Worse still, it looks like investors are assuming some carmakers will soon be worthless. FCA, for example, should generate 10.5 billion euros of free cash flow in the next three years, using Refinitiv estimates. Even if it shrinks by 5 percent a year after that, FCA would earn its current enterprise value in free cash flow by 2027 at an 8 percent discount rate, implying it has no value whatsoever after that point. That already looked over-pessimistic. KKR is helping to make the point.


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