7th issue Outlook April 2013 October 2013 Capital Confidence Barometer Automotive industry Growing forward An imperative to act: seizing first-mover advantage as confidence returns About this survey Ernst & Young s Capital Confidence Barometer is a regular survey of senior executives from large companies around the world, conducted by the Economist Intelligence Unit (EIU). Our panel is comprised of select Ernst & Young clients and contacts and regular EIU contributors. This automotive subset of our findings gauges corporate confidence in the economic outlook and identifies boardroom trends and practices in the way companies manage their capital agenda. Profile of respondents Panel of almost 1,600 executives surveyed in February and March 2013, including 147 automotive executives Companies from 50 countries 794 CEO, CFO and other C-level respondents 912 companies would qualify for the Fortune 500 based on revenues The Capital Agenda Based around four dimensions, it helps companies consider their issues and challenges and understand their options to make more informed capital decisions. 1. Preserving capital: reshaping the operational and capital base 2. Optimizing capital: driving cash and working capital and managing the portfolio of assets 3. Raising capital: assessing future capital requirements and assessing funding sources 4. Investing capital: strengthening investment appraisal and transaction execution Our seventh Capital Confidence Barometer in the automotive industry shows a clear rebound in corporate confidence. After years of conservative decision-making, executives are steadily trending toward an investing agenda. The companies that are looking to create differential value will be those that take action in a market gaining momentum compared to those that sit on the sidelines and wait for a full recovery to occur. Expectations for global economic growth, corporate earnings and credit availability are at some of their highest levels in two years. Unlike our global survey covering all industries, our automotive subset of the survey shows a clear correlation between confidence within the industry and respondents willingness to take action. Although macroeconomic risks still exist, such as the Eurozone crisis, US sequestration and slowing emerging markets growth, automotive respondents have a clear interest in capturing growth, which is the focus of 55% of respondents versus only 4 six months ago. This focus on growth is expected to drive M&A activity in the sector, with of respondents expecting to pursue an acquisition in the next 12 months, the highest level in over a year and up from 19% six months ago. Automotive respondents also have their sights set on larger, more transformative deals; 77% of those that plan to do a deal expect the value to be in excess of $50 million versus only 48% six months ago. With the majority of companies in the sector focused on growth, there seems to be an imbalance between the number of buyers and the number of sellers in the market. While 55% of respondents are seeking acquisitions, only of respondents expect to pursue divestments in the next 12 months versus 25% a year ago. History suggests that this disparity will be short-lived as greater demand will drive higher valuations and lead to an equilibrium of buyers and sellers. We have reached an inflection point in which there is a window of opportunity to seize first-mover advantage. With M&A valuations trending up, only of respondents expect to see a decrease in valuations in the next 12 months, and greatly increased expectations to pursue acquisitions in the next 12 months, now may be the time to invest and grow. Pip McCrostie Global Vice Chair, Jim Carter Americas Automotive Industry Leader, Automotive survey highlights: think the global economy is improving, up from 22% six months ago. 55% of companies are focused on growth, the highest level in two years. 5 view credit availability as improving compared with six months ago. Appetite for M&A increased to from 19% in October 2012. 70% expect M&A volumes to improve in the next 12 months. Only of respondents expect M&A valuations to decrease in the next 12 months compared to six months ago. Intention to divest is down to from 25% a year ago.
Economic outlook Rebound in global economic confidence Overall economic confidence at the global level has improved significantly over the past six months. In total, 92% of automotive respondents view the global economy as either stable or improving up from both October 2012 (80%) and April 2012 (87%). What is your perspective on the state of the global economy today? 58% 29% 1 22% 58% 20% 40% 8% Apr 12 Oct 12 Apr 13 Declining Stable Improving of automotive respondents view the economy as improving compared with 22% in October 2012. Confidence spans leading economic indicators Our respondents increased confidence spans every leading economic indicator included in the survey. At 6, positive sentiment for global economic growth is at its highest level in two years and nearly triple that of six months ago. More than half of respondents are positive on credit availability, employment growth and corporate earnings. Confidence in short-term market stability has also increased significantly, from a year ago to. Please indicate your level of confidence in the following at the global level: Economic growth Credit availability Employment growth Corporate earnings Short-term market stability 6 21% 26% 2 40% 45% 41% 5 5 5 6 Apr 13 Oct 12 Apr 12 of respondents are positive about global economic growth, compared with only 26% in October 2012. Confidence in local economies improving In line with global economic confidence, confidence in respondents local economies is also improving. Fifty-two percent of automotive executives cited an improving economic environment at the local level in April 2013, the highest level in more than a year. What is your perspective on the state of the local economy today? Apr 13 15% Oct 12 31% 5 15% Apr 12 47% 4 9% Improving Stable Declining of automotive respondents believe the local economy is improving, compared with 31% in October 2012. 2 Capital Confidence Barometer Growing forward
Low single-digit economic growth anticipated In total, 8 of automotive respondents expect to see some growth in the global economy, but most recognize it is unlikely to reach peaks last seen in 2006 07. The economic uncertainty that followed that period has been so long and pervasive that typical cyclical behaviors have changed. With regard to employment, which of the following does your organization expect to do in the next 12 months? 45% 22% 45% Create jobs/hire talent By how much do you think or expect the global economy to grow in the next 12 months? More than 5% 5% 2% 68% 47% 46% 8% 10% 9% Apr 12 Oct 12 Apr 13 Keep current workforce size Reduce workforce numbers 1% 2.9% Zero growth 69% 45% of respondents expect to create jobs or hire talent, compared with 22% in October 2012. Negative growth Global economic risks persist Global market risks are well known by corporate boards. Eurozone issues and slowing growth in emerging markets pose material challenges to their businesses. In response, many companies have adjusted their strategies to compensate for these risks, while others view them as a source of opportunity. What do you believe to be the greatest economic risk to your business over the next 6 12 months? Stagnation in the Eurozone Slowing growth in emerging markets US debt ceiling challenges 18% Job creation signals planned growth 40% 42% Forty-five percent of automotive respondents expect to hire talent or create jobs a strong improvement from 22% in October 2012. Plans for workforce reduction remain at all-time lows, further signaling expected growth. Viewpoint The growth dilemma When does risk aversion itself become a risk? Over several Barometers, we have observed a disconnect between macroeconomic conditions and corporate action; improving confidence and strong deal fundamentals have not led to a rebound in M&A. This corporate caution is understandable. The global financial crisis has been drawn out, with moments that suggested turnaround that never materialized. Amid this persistent crisis environment, the current generation of corporate leaders has largely pursued growth through organic measures or optimization efforts. They have largely been rewarded by boards for these conservative instincts. However, we may be nearing the point where this sustained caution itself becomes risky. Organizations in search of growth may need to take an informed risk to achieve their strategic objectives and to outpace competitors. First-mover advantage is a constant, even in today s markets. Leading companies are laying the groundwork for taking action when the time is right. That means honing their capital agenda: fine-tuning the capital structure, defining core businesses, executing divestments when necessary and putting in place proper risk management and governance. Most important, it means answering the questions, Where do you want to grow? and What will it take? Capital Confidence Barometer Growing forward 3
Access to capital Confidence in credit availability improves significantly In addition to having an improved outlook on the global economy, companies are more confident about their ability to access the credit markets. When asked about credit availability, more than half (5) of our automotive respondents see improvement, the highest level in two years. Only report a decline. What is your level of confidence in credit availability at the global level? Apr 13 5 What is your company s current debt-to-capital ratio? 41% Less than 25% 5 59% 3 25% 49.9% 2 18% 50% 74.9% 11% 7% 75% 100% 5% 6% Oct 12 45% 2 Apr 13 Oct 12 Apr 12 Apr 12 15% Improving Stable Declining 41% of respondents have a debt-to-capital ratio less than 25% compared with 59% of respondents in April 2012. 5 of automotive respondents view credit availability as improving, compared with in October 2012 and in April 2012. How do you expect your debt-to-capital ratio to change over the next 12 months? Availability of leverage continues to grow in automotive 22% 16% 25% Since the downturn, automotive respondents have been cautiously increasing leverage. This trend is expected to continue as 25% of respondents plan to increase their debt-to-capital ratio over the next 12 months compared to only 16% six months ago. With greater access to capital and continued low interest rates, respondents should be able to opportunistically fund acquisitions as well as organic growth. 35% 51% 47% 4 28% Apr 12 Oct 12 Apr 13 Decrease Remain constant Increase 25% of respondents plan to increase their debt-tocapital ratio up from 16% six months ago. 4 Capital Confidence Barometer Growing forward
For the next 12 months, those companies that plan to refinance debt (29%) say they will focus on refinements, including extending maturities, reducing interest and removing covenants. Refinancings to optimize the capital structure have declined significantly, from 29% in October 2012 to 16% in April 2013. What will be the primary purpose of your refinancing? If you have excess cash, which of the following will be your focus over the next 12 months? 59% 37% 51% Extend maturity (short-term debt extension) Reduce interest cost Retire maturing debt Optimizing the capital structure (non-stressed situation) Remove restrictive covenants 29% 5% 16% 10% 26% 19% 25% 2 19% Apr 13 Oct 12 Apr 12 29% of companies expect to refinance loans or debt obligations. Cash dominates near-term deal financing The predominant use of cash to finance transactions is indicative of an ongoing cautionary mindset. 29% 4 19% 22% Apr 12 Oct 12 Apr 13 Equity Debt Cash Viewpoint Credit availability as leading indicator Our survey shows a higher number of automotive companies expecting an increase in their debt-to-capital ratio, from 16% in October 2012 to 25% in this Barometer. Coupled with a large increase in those citing greater overall availability of credit (from to 5), this signals that respondents appetite for leverage will continue to rise. Throughout the economic crisis, companies in preservation mode came to view the use of credit as a sign of weakness. However, the reputation of credit, like the economy at large, is slowly being rehabilitated. After several Barometers where more than half of respondents reported low debt-to-capital ratios, this Barometer reports that metric falling to 41%. At a time of ample credit availability and historically low pricing, leading companies are coming to view credit as a tool to fuel their growth agenda. More than half of respondents point to cash as their primary source of deal financing over the next 12 months. Twenty-seven percent say they plan to use debt as their primary source, despite reporting abundant credit availability. Capital Confidence Barometer Growing forward 5
Growth Appetite for growth rebounds As confidence in the global economy returns and credit availability improves, companies are reporting an increased appetite for growth and a steady move toward investment. When asked about their focus over the next 12 months, more than half of automotive respondents (55%) cited growth a major rebound from the decline experienced over the last two years. Even amid this growing optimism, however, nearly one-third of companies () remain focused on cost reduction and operational efficiencies. Companies focused on either stability or survival have decreased significantly (1) from six months ago (25%). Which statement best describes your organization s focus over the next 12 months? Plans for excess cash shift toward growth strategies Companies with excess cash are deploying it toward growth and away from returning it to stakeholders. In total, 57% of automotive respondents are pursuing either organic or inorganic growth with their excess cash; organic growth continues to be the major preference (42%). Only 4 in total say they are focused on returning cash through paying down debt, paying dividends or buying back stock a drop of nine percentage points since October 2012. If your company has excess cash to deploy, which of the following will be your company s focus over the next 12 months? Invest in growth % focused on growth 89% Organic growth (e.g., investing in products, capex, talent retention, R&D) 39% 42% 5 55% 55% 50% 4 Inorganic growth (e.g., acquisitions, alliances and JVs) 10% 15% 1 Apr 11 Oct 11 Apr 12 Oct 12 Apr 13 Return to stakeholders 4 2 55% 2% 10% Oct 12 Apr 13 Growth Cost reduction and operational efficiency Maintain stability Survival Pay down debt Paying dividends Buy back stock 5% 9% 8% 19% 2 3 55% of respondents are focused on growth, the highest level in two years. Apr-13 Oct-12 Apr-12 6 Capital Confidence Barometer Growing forward
Organic growth driven by balanced risk portfolio Companies are largely focused on lower-risk growth strategies much more cautious approaches than one would expect given increased confidence and credit availability. This has become the new normal in the post-financial crisis world; growth activities perceived as higher-risk are more cautiously pursued. Companies will want more and longer-lasting evidence of an upturn before making major investments. What is the primary focus of your company s organic growth over the next 12 months? Lower risk More rigorous focus on core products/ existing markets 29% Viewpoint Boardrooms balancing governance and growth Boardrooms are currently focused on the fundamentals: risk management, efficiency, cost control, regulatory issues, capital allocation, people, corporate governance and investor relations. All of these agenda items, which were cited by half or more of our respondents, point toward companies building greater stakeholder accountability. Riskier growth measures, including research and development, are lower on the agenda. However, the findings in this Barometer point to a window of opportunity for accelerated growth. Economic confidence, credit conditions and valuations, along with a recent rise in shareholder activism, all signal an imperative to act. Prudent discipline and governance are necessities. But now may be the time for boards to achieve first-mover status. New sales channels Higher risk 2 How do you think the boardroom agenda at your company has changed from a year ago? Increasing R&D/product introductions 17% Risk management Efficiency and cost control 6 6 10% 10% Changing mix of existing products and services 15% Regulatory issues 59% 35% 6% Exploiting technology to develop new markets/products Investing in new geographies/markets 6% 9% Capital allocation People (attracting/ retaining talent) Corporate governance 56% 51% 36% 37% 11% Investor relations 50% 40% 10% Growth new geographic markets 49% 38% 1 Growth innovation R&D 47% 41% Greater focus today Stayed the same Less focus today Capital Confidence Barometer Growing forward 7
Mergers and acquisitions outlook Global deal volumes and appetite expected to improve There is a strong consensus global M&A volumes will increase as confidence in the overall economy climbs. In total, 70% of automotive companies expect global deal volumes to improve over the next 12 months. What is your expectation for global M&A/deal volumes in the next 12 months? Return to historic highs Improve 2% 68% The improvement in acquisition plans (), which places automotive as the second highest sector within our survey for expected acquisition activity, is largely driven by an increasing number, and a higher quality, of acquisition opportunities along with respondents appetite for growth amidst stabilizing production volumes. Thirty percent of companies say there are quality acquisition opportunities available, compared with six months ago, and 46% feel more confident about the number of opportunities available, versus only 35% six months ago. Level of confidence in acquisitions at the global level Likelihood of closing acquisitions Remain the same Decline 26% Quality of acquisition opportunities The expectations of our automotive respondents to pursue acquisitions increased significantly over expectations throughout the past year. Thirty-three percent expect their company will pursue one or more acquisitions in the next 12 months, compared with 19% in October 2012 and 22% in April 2012. Do you expect your company to pursue acquisitions in the next 12 months? 39% Number of acquisition opportunities Apr 13 Oct 12 Apr 12 35% 37% 46% Deal sizes move toward the upper middle market The focus on growth combined with increased credit availability has resulted in a shift from pursuing lower middle-market transactions six months ago to the current expectation to pursue larger transactions. Those expecting to pursue deals over $50 million have increased to 77% from 48% in October 2012. Within this, expect to pursue acquisitions greater than $500 million compared to only 6% in October 2012. What is the expected deal size? 25% 22% 19% 8% Over US$1bn Apr 11 Oct 11 Apr 12 Oct 12 Apr 13 of respondents expect to pursue acquisitions in the next 12 months, up from 19% and 22% six months and a year ago, respectively. 42% 65% 2 Oct 12 Apr 13 77% US$501m US$1bn US$51m US$500m US$50m or less expect to do deals greater than $50 million, up from 48% in October 2012. 8 Capital Confidence Barometer Growing forward
Valuations increasing Expectations for increased valuations improved from October 2012; 39% of automotive companies expect prices/valuations to rise in the next year, up from 31% six months ago. Just of companies expect valuations to decline, compared with in October, suggesting the market has stabilized. What do you expect the price/valuation of M&A assets to do over the next 12 months? 42% 31% 39% 25% 39% 57% Apr 12 Oct 12 Apr 13 of respondents expect valuations to decrease over the next 12 months, compared with in October 2012. Valuation gap has narrowed Most respondents (8) say the valuation gap is 20% or less, compared with 76% in October 2012 and only 6 in April 2012. This trend is expected to continue, as 22% of respondents anticipate that the valuation gap will contract over the next 12 months compared to only anticipating the gap will widen. Do you believe the valuation gap today between buyers and sellers is Increase Remain at current levels Decrease Do you expect the valuation gap between buyers and sellers in the next 12 months to: Contract Stay the same Widen 22% Viewpoint 39% 47% Apr 13 Oct 12 Apr 12 56% A possible inflection point in asset valuations A contributing cause to the ongoing slowdown in deal-making is a perceived gap in asset valuations between buyers and sellers. Companies pursuing divestments are seeking high valuations for their assets, while potential buyers are primed for discounts and reluctant to pay a premium. However, we may now be nearing equilibrium between what buyers will pay and what sellers will accept. This equilibrium is vital, signaling that deal valuations are at an inflection point and ready to rebound. The pendulum is primed to swing the other way toward growing prices by buyers and more profitable exits for sellers. This also suggests a comeback in market fundamentals, corporate health and a stable foundation for deal-making. With 39% of automotive respondents expecting M&A assets to increase in value over the next 12 months (and only anticipating a decrease), companies should consider taking advantage of this inflection point now. 66% Less than 20% 6 8 76% 21% Over 19% 5% Apr 13 Oct 12 Apr 12 Capital Confidence Barometer Growing forward 9
Where will the deals be done? Investment destinations continue to evolve as companies challenge their growth strategies and underlying risk tolerance. Whereas six months ago respondents were cautiously managing risk and looked to Germany and the United States as their top investment destinations, a shift has occurred back to the emerging markets of China, India and Brazil. Although these markets have a higher risk profile, they also offer increased growth prospects over mature markets. Top automotive sector investment destinations Oct 12 1. Germany 2. US 3. China 4. India 5. Mexico Apr 13 1. China 2. India 3. Brazil 4. US 5. Mexico Divestment activity remains low in automotive The number of automotive companies planning to make divestments continues to decline from its peak 12 months ago. For the past several years, automotive companies have optimized their portfolios and divested assets that did not fit their overall strategic objectives. Companies are now focused on the core both performance optimization and growth. Is your company likely to make an asset sale/divestment in the next 12 months? Value expectations and fear of business disruptions deter divestment activity Companies are being more strategic when considering divestments than they have in the past. Favorable market conditions have led companies to take an opportunistic approach to divesting non-core assets and only transacting when valuations are in line with their expectations. In the meantime, companies are accessing debt and using cash balances to pursue growth as opposed to raising capital through the sale of assets. What are the reasons for you not pursuing divestments? (select two) Ability to realize price/value expectations Disruption to core/ongoing business Inability to execute divestment Exposure to adverse market reaction 15% 31% 48% 46% % saying yes 2 25% 17% 16% Apr 11 Oct 11 Apr 12 Oct 12 Apr 13 10 Capital Confidence Barometer Growing forward
Survey demographics What are your company s annual global revenues in US dollars? What is your position in your organization? $5b or more 28% C-level executive $1b $4.9b Head of BU/dept 31% $500m $999.9m 20% Less than $500m 20% SVP/VP/Director 17% What best describes your company ownership? In what region is your company based? Publicly listed 66% Western Europe Privately owned 26% Asia-Pacific Family owned Private equity portfolio company Government or state-owned enterprise 1% North America Latin America Eastern Europe Middle East and Africa 1% 6% 2 Capital Confidence Barometer Growing forward 11
Ernst & Young Assurance Tax Transactions Advisory If you would like to discuss the survey results, please contact your existing Ernst & Young advisor or any of the contacts listed below. Name Telephone number Email Americas Jim Carter Americas Automotive Industry Leader Mark Short Americas Automotive Transaction Support Leader Europe, Middle East, India and Africa (EMEIA) Christian Uphaus Partner Far East and Oceania Tony Tsang Far East and Oceania Automotive Industry Leader Japan Peter Wesp Partner +1 313 628 8690 jim.carter@ey.com +1 313 628 8760 mark.short@ey.com +49 89 14331 13120 christian.uphaus@ de.ey.com +86 21 2228 2358 tony.tsang@cn.ey.com +49 61 96996 27282 peter.wesp@jp.ey.com Additionally, please feel free to contact Ernst & Young s Global Automotive Center through the contacts listed below. Name Telephone number Email Mike Hanley Global Automotive Leader Jeff Henning Global Automotive Markets Leader Acknowledgements +1 313 628 8260 michael.hanley02@ ey.com +1 313 628 8270 jeff.henning@ey.com Our special thanks go to the global Capital Confidence Barometer panel* for their contribution to the survey. * The global Capital Confidence Barometer panel comprises an EIU panel of senior executives and selected Ernst & Young clients and contacts who participate in the Capital Confidence Barometer on a biannual basis. The surveys are conducted on an independent basis by the EIU. About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 167,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com. About Ernst & Young s Transaction Advisory Services How organizations manage their capital agenda today will define their competitive position tomorrow. We work with our clients to help them make better and more informed decisions about how they strategically manage capital and transactions in a changing world. Whether you re preserving, optimizing, raising or investing capital, Ernst & Young s Transaction Advisory Services bring together a unique combination of skills, insight and experience to deliver tailored advice attuned to your needs helping you drive competitive advantage and increased shareholder returns through improved decisionmaking across all aspects of your capital agenda. How Ernst & Young s Global Automotive Center can help your business The global recession reset the automotive industry landscape. As the industry recovers, automotive companies across the value chain must focus on profitable and sustainable growth, financial and operational stability, investments in new technologies and seizing opportunities in high-growth markets. If you lead an automotive business, you need to anticipate trends, identify implications and make informed decisions that support your business goals. Our Global Automotive Center enables our worldwide network of more than 7,000 industry-focused assurance, tax, transaction and advisory professionals to share powerful insights and deep sector knowledge with businesses like yours. These insights, combined with our technical experience in every major global automotive market, will help you to accelerate strategies and improve performance. Whichever segment of the automotive industry you are in from component suppliers to commercial or light vehicle manufacturers or retailers we can provide the insights you need to realize your potential today and tomorrow. Visit ey.com/automotive for more information. 2013 EYGM Limited. All Rights Reserved. SCORE no. ED0078 This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.