Auto Parts Firms Start to Split Replacement, OEM Channels: Dana’s sell-off signals a breakdown in compatibility between selling into the aftermarket and selling to Detroit

Restructuring and consolidation remain works in progress in the auto parts sector as major players consider unbundling their replacement parts operations from the components manufactured directly for Detroit. Increased potential for opening a separate channel to the automotive aftermarket has emerged even while key suppliers struggle to complete the basic rationalization triggered in the 1990s by changing demands from the big automakers. A signal of separation was flashed in early July when Dana Corp. sold its aftermarket business to Cypress Group for $1.1 billion. Experts believe that more firms with their feet in both the replacement and OEM markets soon will be executing similar sell-offs. In effect, they say, the two have become entirely different businesses, and the best rewards stem from sticking with the OEMs. While the replacement business once offered a cushion from the cyclicality in the new-car sector, it has lost much of its zing. “I think separation is a coming trend, although we haven’t seen much of it to date,” says Jeff Zaleski, an auto industry transaction services partner at PricewaterhouseCoopers. “Companies are realizing that there are not a lot of synergies between the aftermarket and OEM markets. The OE standards are much higher, the customers are completely different, and the value proposition to customers is different than in the aftermarket.” Higher-quality parts dampen aftermarket sales The product mix, he adds, has shifted to lower-margin, commoditized products and growth has slowed because most new parts don’t wear out as fast as they did in the past and drivers are trading in their old cars and buying new ones more frequently. “The reliability and durability of OE parts in general have improved over the years,” says Nick Galambos, a Vice President and auto industry expert at A.T. Kearney & Co. “So you’re not seeing a corresponding rise in the aftermarket.” Another complication is the shift of the primary customer base in the replacement market from independent distributors to big-box retailers, which exert strong price pressures. “The retail-specialty channel is characterized by very astute buying behavior – playing out in their ability to realize price,” Galambos says. Both Zaleski and Galambos say that private equity firms like Cypress could be among the key buyers for replacement parts operations. Financial buyers could “use an aftermarket business as a launching pad for additional acquisitions, grow the business, and exit in three to five years,” notes Zaleski. Galambos reports that an A.T. Kearney study to classify a wide range of businesses through a number of financial, market, and other measurements has surfaced an interesting finding about aftermarket players. They are among the best performers in cash flow returns on invested capital, partially due to low requirements for invested capital and modest R&D demands, but these traits make the area almost ideal for private equity invasion. In addition, several sectors of the aftermarket business are fragmented, which suggests that a savvy financial buyer can “acquire several firms, join them up, enjoy scale advantages, and then get out of it.” Galambos adds that there are some aftermarket “growth pockets” such as SUV and truck brakes. Both experts anticipate more m&a activity, spurred by carmakers’ desire to deal with fewer vendors, and their demands that Tier 1 suppliers provide them with complete systems. Copyright 2004 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com