Chinese Interest in Detroit Creates a Win-Win Situation

by Tony D'Altorio

Chinese Interest in Detroit Creates a Win-Win Situation

by Tony D'Altorio, Investment U Research

Monday, December 13, 2010

North American automakers have begun demanding price reductions from parts suppliers. The industry takes up that controversial practice whenever it wants to improve profit margins in a highly competitive market.

Auto parts maker Johnson Controls (NYSE: JCI) notes the added "pressure for price reductions, as would be expected after a downturn and a return to profitability of the carmakers and supply base." Management also recently said its customers wanted cuts of up to 56% in annual contract negotiations... up 2& to 3% from before.

And it doesn't like that anymore than its competitors, like Magma International (NYSE: MGA), Dana Holding (NYSE: DAN) and Lear (NYSE: LEA) do.

During the 2008 to 2009 slump, automakers eased their demands because of falling sales. Yet Michigan-based Original Equipment Suppliers Association estimates that 62 such companies still filed for bankruptcy in 2009 alone, while many others were liquidated.

But now, they're ready to get back to business as usual. And they're prepared to push parts makers to the brink as they do...

Thing is, many companies are choosing to sell out to Chinese buyers instead...

Chinese Interest in Detroit

The most recent deal involved General Motors (NYSE: GM) selling its steering division, Nexteer, to Beijing's Pacific Century Motors. The price tag: $450 million.

Notably, Nexteer faced liquidation not that long ago. Right about the same time, in fact, a Chinese consortium paid $100 million in 2007 for one of the then-bankrupted Delphi's brakes and transmissions businesses.

Auto parts maker Tempo was part of that grouping, and also helped buy Nexteer. One of its executives, Woody Zhou, said, "We realized there were tremendous resources here in Detroit - the technology, the talent and the customer."

That pretty much sums up Chinese interest in Detroit, which consists of two goals. They want access to both western automotive technology and foreign markets, as automakers adopt global vehicle platforms sharing common components.

But it's the global platforms that they're most interested in.

The Global Vehicle Industry is Changing With the Times...

After the financial crisis shook the auto world to its foundation, the global vehicle industry is now changing. The producers who survived will be the ones making a wide variety of cost-efficient vehicles with increasingly universal parts.

This "platform sharing" is hardly a new tactic.

  • In the past, it meant using the same rigid physical chassis to build similar cars with the same size wheelbase and suspension.
  • But now automakers can plug in different modules and build differently shaped and sized cars at the same plant on more flexible platforms. Advances in the field allow for new options on production lines, which the biggest producers can really use.

Anthony Pratt, head of the automotive area at PricerwaterhouseCoopers, likened the plan to Wal-Mart (NYSE: WMT). "Automakers' adoption of the global platform strategy is similar to Wal-Mart's ability to keep costs low by realizing economies of scale."

Yet it requires high-quality auto parts. One defective piece could mean recalling millions of vehicles.

Just ask Toyota ADR (NYSE: TM), which had to recall over 12 million in the past year.

Will China Help Detroit Bounce Back?

In the end, the Chinese companies snapping up Detroit's auto parts assets look set to do very well in the future. But it's also putting Detroit in a good place as well...

  • That's especially true since the United Auto Workers (UAW) union smoothed the way for the Nexteer deal by compromising on an array of issues, including a wage cut.
  • And local governments sweetened the pot with financial incentives. Nexteer's new owners will get $71 million in state tax credits over the next decade, on top of hefty municipal tax breaks.

The chairman of Pacific Century Motors, Zhao Guangyi, believes the UAW is "becoming more competitive." But he pointed out that Tempo still makes all its parts in China since "labor costs here [in Michigan] are still higher."

Obviously, their main interest is in the companies' technology, but it's still progress. Nexteer no longer faces liquidation and the workers there still have jobs.

A win-win.

Good investing,

Tony D'Altorio

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