How a Private Equity Approach Can Drive Auto Suppliers’ EV Transition

By adopting a PE lens, companies can transition more smoothly from legacy internal combustion engine business to the EV market. 

TAKEAWAYS:
● The $1.9 trillion global auto supply sector will experience a shakeout in the changeover to EVs, and the slowest movers risk losing opportunities or bankruptcy.
● Companies that have hesitated to initiate change can benefit by assessing future options using the relentless, enterprise-value based approach of private equity firms.
● Lessons from early movers highlight the value of planning the funding, rigorous execution and governance, and workforce transformation.  

The global automotive industry is undergoing existential disruption as the world market embraces electric vehicles (EV) over internal combustion vehicles and hybrids. At this point—in the early stages of the transition and with a long way still to go—some challenges facing the diverse auto parts supplier industry are becoming clearer; however, many companies are still figuring out how quickly to embrace those changes.

The market transition to EVs is gaining momentum due to advances in technologies such as batteries and charging stations, and growing buyer interest thanks to the success of Tesla and other electric models. The U.S. and other governments are doubling down on commitments to transition to EVs. Recently proposed federal emissions limits in the U.S. would effectively require two-thirds of cars sold in the country to be electric by 2032; California will require that all new vehicles sold in the state after 2035 be zero-emission vehicles.

Parts suppliers—from gas tanks to fuel injectors—for traditional cars are already seeing their market shrink, and the decline will only worsen. This $1.9 trillion industry will see a painful slowing of growth in coming years as internal combustion engine (ICE)-based product lines are phased out. About one quarter of profits currently generated from legacy ICE components will be the most adversely affected, resulting in a 50 percent decline from current levels by 2030. For some suppliers, the market will eventually resemble a game of musical chairs, with fewer and fewer safe economic places to land—and the slowest movers losing the game.

Segments of the ICE market will remain, such as parts for existing vehicles, and suppliers can continue to earn some revenue in this area long after production of new ICE models is phased out. Also, commercial vehicles have lagged passenger cars in the EV transition, so far, and are likely to offer another “long tail” of continuing opportunity for parts makers.

Identify the Appropriate Operational Strategy Using the PE Approach
Not all traditional product components are expected to decline in the near term. Many product lines can be suitable candidates to pivot to other markets, and some can continue as sources for income that can be invested in new EV product development. Strategic approaches for how companies are managing their existing ICE businesses can be grouped in three broad categories:

• Exit (cash out and focus): One clear option is for suppliers to wind down or sell their ICE products businesses to a buyer that can squeeze value from them, for longer, than the original owners can. The spin-off strategy can reduce exposure to the declining demand for ICE products and can raise capital for reinvestment in new market opportunities.
• Consolidate (double down): Suppliers can prepare for the coming shakeout by consolidating existing ICE-only businesses to create synergies and scale so they can continue to derive value from their operations for as long as possible, with the option to continue to operate them alongside new EV businesses.
• Pivot (parallel pursuit): Companies can wind down their ICE businesses according to a clear step-down plan, while pivoting product lines to new EV products. This may require massive investment in R&D, innovation, and digitization to develop new EV products and services. It could include acquiring EV startups or niche players to expand product portfolios and acquire new skills or technologies.

The Transformation Journey So Far: Signs of Success and Warnings

Quite a few original equipment (OE) suppliers have identified enterprise EV transformation strategies and begun to execute them. Based on these OE suppliers’ track records, other suppliers can ascertain the challenges of redesigning value chains or operating models.

Example: A Supplier Divests ICE Divisions and Invests the Proceeds in EV Partnerships
A German powertrain company with ICE and EV products that was spun off in 2021 is following a two-part strategy of divesting its remaining internal combustion divisions to help fund its growing EV business, which is focused on EV innovation and growth through investments and partnerships.