Preparing for the Mobility Revolution
Mobility Revolution Triggers Corporate Restructuring in Auto Industry
The automotive industry is undergoing a profound transformation with rapid electrification, the emergence of autonomous driving and the development of mobility as a service. These three megatrends lead very different business profiles compared to an industry based internal combustion engines (ICE) and privately owned, driven vehicles. R&D expenditures grow, the timing of future revenue is uncertain, business and technical risks are significant, but margin are potentially higher than the status quo. As a result, several incumbent players have — or are planning to — engage in massive reorganizations or split current vs. future tech, such as Autoliv, Delphi, Continental, GM or Daimler. Let’s analyze what is happening.
R&D expenditures are surging
Vehicle electrification is kicking into high gear, which requires the development of electric motors, e-axles, power electronics as well as battery and charging tech. The range of solutions is broadening from mild hybrid, to 48V, plug in hybrid, to 400V and soon 800-1000V full electric. Autonomous driving (AV) presents a much more difficult set of technical challenges. It requires the development of sensors (Lidar, camera, radar, localization tech), HD/3D maps, compute hardware, software stack, development tools, V2X connectivity and a massive amount of testing and validation. Whereas electrification solutions are by and large developed by individual companies, autonomous driving tech is increasingly the object of resource pooling in the form of partnerships or open development platforms such as the ones led by Baidu/Apollo or Lyft, given the magnitude of the task at stake. On the other hand, new mobility solutions such as ride-hailing, car-sharing, subscription model or others “only” require the development of software platforms as far as R&D is concerned.
The commitment of Tier 1s to electrification and/or driving autonomy has resulted in signifiant increases in R&D budgets. Their share of sales grew over 2 percentage points over the past 2-4 years, with a direct impact on profitability. At Continental (supplier #4 in global sales), the R&D budget increased from 7.9% of sales in 2013 to 10.1% in 2017. For ZF (#5), the ratio went from 4.8% in 2015 (first year with TRW) to 6.1% last year. For Valeo (#9), it went from 4.7% in 2014 to 6.1% last year. It is interesting to note that the R&D budget of Valeo’s Comfort & Driving Assistance business group — the entity responsible for their AV activities — represented a high 11.6% of sales last year.
Delphi (ex #12) finalized its split into Aptiv (AV, mobility on demand, new architectures, connectivity, data) and Delphi Technologies (powertrain incl. electrification) in Nov 2017. The R&D profile of the off-shoots shows interesting trends. Aptiv’s R&D budget increased from 8.2% in 2015 to 8.4% last year whereas Delphi Tech’s dropped from a high 10% to 8.7% in the same period (retreated perimeters). Similarly, Autoliv (ex #22) completed the spinoff of Veoneer (AV focus) in June 2018. The latter’s R&D budget represented 19.3% of sales in S1 2018, up from 16.3% in S1 last year. This compares with 7.1% for pre-spinoff Autoliv as a whole in 2017.
Timing of future revenue streams of new tech is uncertain
Electrified and autonomous vehicles as well as shared mobility are definitely coming, but how fast? Whereas most OEMs have announced the introduction of electrified versions across their ranges over of next 5 or so years, the industry remains uncertain about their penetration growth. The sales of plug-in vehicles, i.e. plug-in hybrids and full EVs, are growing at about a 50% annual rate, yet they represented only 1.4% of global sales last year. Future growth will depend largely on CO2 regulations, incentives and customers’ sheer interest. Several projections put plug-ins at 25-30% of global sales by 2030, but all players must be ready to adapt their mix over time. This mix is critical for a supplier like Delphi Technologies whose CEO recently said they generate content worth about $300 per vehicle for an ICE or a 48V hybrid, $1500 for a full EV and $1800 for a 400V hybrid.
Autonomous vehicles are at their infancy stage. A handful of trials with actual customers are currently taking place. Waymo has announced the launch of a ride-hailing service using AVs later in 2018 and has placed frame contracts with FCA and JLR for 80.000 vehicles to deploy their service. GM, VW and others has made similar yet less ambitious announcements. Deployment will first take place in geofenced areas and spread as the tech matures and 3D/HD maps become available; we are still a long way to offering AV to the individual buyers. In addition, the general population is mostly reluctant to board such vehicles. Growth rate will depend on technical maturity, customer acceptance and the regulatory frameworks which tend to lag behind the tech.
Lastly, shared mobility has already gained significant ground, as demonstrated by the 25+ million and 15+ million rides operated daily respectively by ride-hailing giants Didi and Uber. The trend towards more shared mobility and less vehicle ownership will intensify. Millennials are less interested in getting their driver’s license as evidenced by the drop of 28% over the last 10 years for Germany’s 18-25 age olds and 21% for the UK’s 17-20 year olds.
Corporate reorganization and spin-off
Businesses focused on current technologies and business models aim for incremental productivity and product performance gains. Their R&D budgets are covered by current revenue and their future revenue is reasonably predictable. Lastly, their organizations are typically built around rather silo’d product groups with limited shared resources.
By contrast, businesses focused on new technologies and business models aims for innovative solutions and step changes in productivity and business performance. Their R&D is fueled by capital injection with the expectation that they will enable future revenue, with the timing uncertainty seen earlier. Finally, product development is much more based on software (and increasingly AI), for which resources are pooled. This dichotomy between current and future tech results in two very different risk profiles, business structures and management styles. Consequently, large companies that embrace current and future businesses are (considering) re-organizing or breaking up their organizations to maximize efficiency on all fronts.
As mentioned above, Delphi was split into Aptiv (“longer” term tech and mobility solutions; $12bn in sales) and Delphi Technologies (powertrain, including vehicle electrification; $4bn) last year. In June 2018, passive safety leader Autoliv spun off Veoneer (AV focus; 1bn€). This past July, Continental announced a major restructuring, breaking up the company into Automotive (20bn€), Rubber (18bn€) and Powertrain (8bn€), with a plan to IPO Powertrain in 2019 and possibly Rubber in the future. The same month, ZF announced the spinoff of Car eWallet, a business focused on in-vehicle transaction services. In July 2018 still, Daimler announced a new 3-pronged corporate restructuring, breaking up into Mercedes-Benz, Daimler Trucks and Daimler Mobility— the latter will be built on the current Daimler Financial Services. Finally, Faurecia sold off its Automotive Exterior business (2b€) to Plastic Omnium in 2016 “to accelerate investment in value-added tech for sustainable mobility and enhanced life on board.”
Risk and investment profiles lead to contrasted valuation trends
Investments in AV tech have skyrocketed. In 2016, GM spend $600m to acquire AV startup Cruise Automation, now valued at $11.5bn after SoftBank bought a 20% stake for $2.25bn. GM is now considering having Cruise go public. Intel bought Mobileye in 2017 for $15bn. That same year, Ford committed to investing $1bn over 5 years in AV startup Argo AI. The Dearborn-based OEM recently announced the creation of Ford Autonomous Vehicle LLC to host Argo and other AV and new mobility-related activities, which opens the door to financial independence.
In addition, the financial markets have reacted to the differentiated business profiles described above. Stocks have performed quite distinctively. As of August 31st, Delphi Tech. and Aptiv had lost respectively 38% and 1% since they were listed separately last December. In parallel, Autoliv had lost 11% when Veoneer had gained 13% since their independent listing in July 2018.
And so what …
Whereas EVs, AVs and shared mobility are exciting and certainly coming, we cannot throw away the current tech and operating models quite yet. ICEs will most likely be around in large volumes for over 30 years and will have to abide by increasingly stringent CO2 regulations. Likewise, people will be turning the steering wheel of their own cars for many more years. And the replacement parts business based on current tech will still enjoy many profitable years thanks to market inertia — fleets’ average age is 10-12 years in Europe or the US. Nevertheless, incumbent players must give themselves the necessary leeway to develop tomorrow’s radically new tech, and accept the associated risks, or their years are numbered!
In addition, increasingly connected vehicles have started to bring about a plethora of new services to OEMs, drivers, fleet managers, insurance companies, etc., with short term business opportunities. Incumbent players are not best positioned to develop these services. However, they can retain control of the vehicle’s gateway — and hopefully develop valuable services — provided they transform their culture and significantly build their software and data management expertise. Here again, incumbents may have to establish independent organizations to force the transformation. Exciting times ahead!
Managing Director, Orsay Consulting