Goodyear Bosses Breathe a Sigh of Relief
In the first few years of the new millennium Goodyear made losses of around $2.2 billion (£1.2 billion), but now the management can breathe deeply for the first time in years because CEO, Bob Keegan and president Jon Rich seem to have made a turnaround in Goodyear’s North American home market.
After a successful second quarter the Goodyear group’s largest business unit is heading towards a balanced result at the end of the year. The same is true for the rest of the group. By the end of the first half of 2004 the company had still had a loss of $51.8 million (£28.8 million) so, with a bit of luck, the profit and loss account for 2004 could be written with black rather than red ink. The year before Goodyear made first-half losses of about $250 million (£140 million), which by the end of the year had grown to more than $800 million (£445 million). Bob Keegan, who left Kodak to join the already debt-burdened Goodyear in October 2000, now has one priority: to reduce the mountain of debt the company has accumulated. By this stage the company simply could not afford the enormous interest payments it would have to pay in the long term. In order to achieve his target of reducing debt levels Mr Keegan is going to be forced to sell company assets, but which assets?
After all the setbacks of the new millennium, which were intensified by the events of ‘9/11’ and the subsequent market crash, it became clear that without a good deal of fortune coming from the market itself it would be difficult to make a return to profitability in North America. It has to be stressed that this is true for Goodyear’s rivals, which were also holding out for better market conditions. But let’s not forget that Goodyear has been singled out for punishment by many tyre dealers because of its dealings with the likes of Sears and Wal-Mart. Obviously Jon Rich’s sales force did a good job in winning back customers and Bob Keegan never got tired of speaking at dealer events. The erosion of the company’s market share has now been stopped and, according to the management, Goodyear has also set aside some contracts in its hunt for a better product mix and for the leading brands instead of private brands. The cost reduction programme is bearing fruit now. More and more high performance tyres are sold to the original equipment market and, importantly, the enterprise has been able to achieve better prices for its tyres. Now there are developments that signify that better times are around the corner.
Jon Rich’s personal success has the effect of delivering CEO Keegan with the much-needed time it takes for his restructuring plans to happen across the whole group. This is not to deny that the North American market is probably the most competitive tyre market in the world and is still a place where the Midas touch will continue to elude manufacturers. Goodyear is no different and has to, and most likely will, improve the company’s operating margin drastically. This is a job in which Mr Rich should succeed. His success is of the highest importance because without an ongoing improvement in the home market, Goodyear will fail to pass the finish line in this race. Now there is a growing number of observers who believe that the company will succeed.
In comparison with archrivals Bridgestone and Michelin, Goodyear starts from a weakened position. While Bridgestone is earning excellent profit levels in the Japanese domestic market (44 per cent of the company’s $10.6 billion half-year turnover comes from Japan, 63 per cent of its $848 million of operating profit comes from Japan), even in problematic times for the company in North America, Bridgestone as a group will probably show a net profit of about $1 billion by the end of 2004. Goodyear has nothing to compare with this in its own home market for the reasons described above. Therefore the US is likely to continue to be the most competitive tyre market, and a place where earning large margins is difficult.
Compared with Michelin, Goodyear faces similar disadvantages. For the first six-months of 2004, Michelin posted a turnover of 7.8 billion euros ($9.49 billion), an operating profit of 694.8 million euros ($846 million), which resulted in a net first-half profit of 328.9 million euros ($400 million). Michelin traditionally earns much more on its home European market, especially in France. The fact that the French tyre manufacturer is earning operating profit in double digits from truck tyres (first half turnover of 2.07 billion euro and operating profit of 14 per cent compared with 13 per cent from the year before) is proof enough. Michelin not only sells tyres, but uses marketing and technical programmes (regrooving, retreading, fleet services, breakdown services and costs per mile) to fight for market influence making it very difficult for competitors to succeed where Michelin is present. In fact, the stability with which Michelin dominates the truck tyre market is fascinating. Due to the fact that it is a complex business and is not commodity based, there is nothing to gain with cheap prices. This gives Michelin the impetus to defend its position, perhaps not easily, but clearly.
On the downside, Michelin is sitting on its own debt mountain, with 3.4 billion euros (£2.3 billion) accrued so far. Of course this is not as much as Goodyear’s $5 billion (£2.78 billion), not to mention Goodyear’s unfounded pension fund. But in contrast to Goodyear, Michelin, thanks to its excellent operating profits, can afford the necessary interest payments easily and due to their excellent credit rating, the conditions are significantly better than Goodyear’s. Furthermore it needs to be stressed that Michelin needed money for future investments. Such investments include building a base in Asia, especially in China and Thailand, and acquiring Europe’s biggest independent tyre equity last year. Currently Michelin has a 10 per cent share in Indonesian manufacturer, Gajah Tunggal and a three per cent share in Hankook, with the option of another seven per cent in the future. In other words, there are good reasons for all the credit it will have to pay off in years to come. Michelin has not been forced to finance losses, but to finance its expansion into Asia, the biggest and most promising future tyre market on earth.
At the end of August, when Bob Keegan visited Germany, he showed himself to be relaxed and confident regarding the group’s future. He expressed his satisfaction with the results the management was able to achieve but hinted that much work still needs to be done. In interviews with Germany’s leading daily newspapers, FAZ and Handelsblatt, the Goodyear CEO and chairman shared his conviction that he and his team now have enough time to restructure the group. Alluding to the unfounded pension fund and the company’s high levels of debt Mr Keegan granted that “much work still has to be done to improve our balance sheet.” He also gave journalists a time frame: “at the end of 2006 Goodyear should be a totally different company.” An improvement of this nature is only plausible if Goodyear is able to sell some of its assets for good prices – even the best improvements in North America will not help them avoid this necessity. But, the better the North American improvements are, the more time there is left for the management to take the appropriate steps and avoid any undue pressure.
So which assets are for sale? Bob Keegan described passenger car tyres as well as truck tyres as core businesses; everything else could come under the microscope. He also denied the possibility that he would sell off the chemical group.
This business unit produced a turnover of $735 million (£408.98 million) and an operating income of $85.1 (£47.3 million) in the first six months this year. The management has decided to keep the business because it is worth more to the group than a possible sale, according to Bob Keegan. That may be so, but it is not absurd to suggest that the chemical business is relying on its biggest customer, namely the Goodyear group and that this may have put off potential investors from making a bid, which reflects the business’ 11.5 per cent operating margins.
Therefore observers have to take a look at the Engineered Products business unit (first half turnover $712.7 million [£397 million], operating profit $54.6 million [£30.4 million]). Rumours regarding this part of Goodyear have been flying high for many years and the sword of Damocles is plain to see. An enterprise that is able to produce an operating income that is 7.5 per cent of turnover should be able to find an investor. But, could it be, that this unit is also relying on business with Goodyear? Who knows? One argument still remains: When engineered products and chemical products have been sold they no longer provide operating income to the group, which could be worth more. It is possible that Bob Keegan wants to keep these businesses so Goodyear can achieve better results. Whilst speaking to journalists, Goodyear’s CEO mentioned another possibility, the possibility of building partnerships and joint ventures. Unfortunately exactly what this might mean remains a mystery, and there is no other information available which could clarify this point. But, anyone can play the ‘guess-the-strategy’ game, the fact remains that the group will have to come under the microscope and will have to show what it has to offer.
Goodyear’s first wildcard: a functioning European business
It is widely known that Sumitomo Rubber Industries (SRI) holds 25 per cent of Goodyear Dunlop Europe and the Japanese company has, according to sources who do not wish to be identified, the right to increase the share to 50 per cent. Last year this part of the group achieved an operating income of 3.3 per cent, which is not good compared with competitors like Bridgestone, Michelin, Pirelli, Continental and Nokian. But this has been improved in the first half of this year. But, again, an operating income of $125.5 million (£70 million), which equates to 5.8 per cent of the total turnover $217 billion (£121 billion) is not that good compared to the competitors mentioned earlier. Let’s not forget, the bulk of all this is carried by the German Operations, which has been the most profitable member of Goodyear’s stable for years. For many years Goodyear has obviously been going through a problematic period in the UK and in France as well. Significant improvements are not easy to see. According to observers this is a “very polite description of the reality in France and the UK.”
To evaluate the European business in a fair manner it is necessary to include in this picture the company’s Eastern European activities as well. Goodyear produces tyres in low cost countries like Poland (its Debica factory is the biggest and most efficient Goodyear plant in Europe) and Turkey, where is has two plants, but sells the bulk of what is produced in the saturated western European markets. Having said that, it should be pointed out that from 2004 on Poland also belongs to the European Union.
Goodyear’s competitors also made the decision to go east many years ago. Continental, for example, is producing up to two thirds of its production capacity in so called ‘low cost countries’ like the Czech Republic, Slovakia, Romania and very soon Russia. For Continental it does not make a difference whether the profit is made in east or west. It is not quite the same scenario with Goodyear.
The Eastern European Business Unit (which includes the Middle East and South Africa, itself a low cost country where the government grants tax relief for exports) managed a turnover of $583 million and an operating income of $88.4 million in the first half of 2004. When these units are added together, for the purposes of this article only, it makes a combined total of $2.755 billion and an operating income of $213 million for the first half of 2004, an operating margin of 7.7 per cent. This is still not as good as Goodyear’s competitors Michelin, Continental and Pirelli, but it is at least sufficient.
Goodyear’s argument for separating east and west is purely semantic. Bob Keegan’s predecessor, Sam Gibara, explained how important it was to leave people from the east to work in their culture, to give them the freedom they need to develop their countries. This argument makes as much sense as looking for a Republican to work as a Goodyear sales director in California, a Democrat to work in Louisiana and someone who is not interested in politics at all in Florida. Of course this is an exaggeration, but it gives the right impression. The only reason for Goodyear to keep east and west separate is that SRI hasn’t got any shares in the East European activities, when it does in the west. Therefore the group is forced to continue with the separation.
It shouldn’t take too long until changes are forced. The enterprise cannot manage European activities in the long run with 18 different sales companies in the west and another 10 or 12 in the east. Conflicts of interest are bound to be on the agenda and SRI must have a serious interest in having a stake in the east’s activities because that is the region where the profits come from. Competitors like Michelin and Continental have already integrated Austria and Switzerland into the German operation and will probably do the same with the Benelux countries. Spain and Portugal have been integrated into the French operation and further consolidation is sure to come.
The pressure, coming from sources in Eastern Europe is growing all the time. Nokian is building a new factory in Russia, so is Continental and, of course, Michelin. As far as Bridgestone is concerned it will happen in the future, the near future. What about Goodyear? Goodyear does not have the financial resources to take the necessary steps at the moment. To cut a long story very short: Goodyear has to do something in Russia or it will lose its competitiveness. In light of all of that, it would be much better if SRI were partners in the east as well. The Japanese company won’t be interested in marketing tyres and not earning much. Surely it is more interested in marketing tyres that come from Goodyear’s East European operations where it can earn more money. The Japanese know that profit is the name of the game.
One important question remains: Is SRI willing to invest to take these steps. Why should a company, which has the money (in this case SRI) be interested in buying just 25 per cent and leaving the remaining three quarters in Goodyear’s hands, leaving it unable to take control? On the other hand, if Goodyear is thinking of making any joint ventures in Europe they can’t do much without SRI!
The second wild card: profitable business in Asia
What might the Asian market solution look like? In Asia Sumitomo Rubber Industries maintains a presence of four factories in Japan, one in China and another in Indonesia. SRI holds the rights to the Dunlop brand in Asia with the exception of Malaysia, Singapore and India. During the first six months of last year Goodyear’s Asia Pacific Tire business unit achieved a turnover of $290 million and an operating income of $25.9 million, 8.9 per cent of turnover. During the first six months of this year the turnover was boosted up to $649 million because of the consolidation of Pacific Tire (Australia, New Zealand). The operating income rested at a stable $26.6 million, which equates to 4.1 per cent of the turnover. This can definitely be improved. Asia is and always will be Sumitomo’s home market. SRI could adopt the role of an industrial leader in Asia under the roof a joint venture and at the same time force the financially indigent Goodyear to play the role of junior partner. The Asian market is booming, Michelin is particularly strong and runs several factories in Thailand and China as well as one factory in Japan. And Bridgestone already has a strong hold in Asia in general and in China in particular and it is regarded as only a matter of time before the German Continental group produces tyres “made in China”. For Goodyear, building a factory in China is out of the question, simply for financial reasons. It has to be stated that the Americans have been present on the Asian market for decades now with production plants in Thailand, Malaysia, Taiwan, Indonesia, and India but have only reached a disappointing annual turnover of $300 million (excluding Pacific Tire).
Wild card number three: Latin America allows excellent earnings
Goodyear announced a turnover of $594 million for the first six months of this year and a fabulous operating income of $123 million, which is 20.7 per cent of the total turnover. Without belittling these achievements it has to be noted that Pirelli was able to earn big money in the same period of time and that the market conditions in Brazil are absolutely fantastic at the moment.
It seems that even this Goodyear stronghold has come under fire recently. It has to be accepted that the product portfolio of the American tyre manufacturer is getting a bit out of date and a complete new line of products is needed. Goodyear managers deny this necessity in public but behind the curtain they have identified this as one of the biggest problems in the near future. Short of money, Goodyear cannot keep up with the pace of Latin American market developments while Pirelli is just about to invest $250 million into the expansion of its factories (the market structures have existed for a long time) up to a daily capacity of 20,000 passenger car tyres and 5,000 truck tyres. Michelin is going to invest $100 million into its Brazilian truck tyre factory, while Continental is to invest $250 million into the construction of a completely new tyre factory in Brazil. Granted, Continental and Pirelli are going to ship tyres on a large scale from Brazil into the US, something that cannot be done in big numbers by Goodyear because of the recently agreed contract with the unions in the US. But Pirelli as well as Continental are concentrating on the almost 200 million people in Brazil and its market. Something else that should be kept in mind: Sumitomo Rubber owns the rights to the Dunlop brand in the whole of Latin America except Mexico.
Keegan hasn’t played all his trump cards
Bob Keegan still has some of his best cards tucked up his sleeve, hidden in case of unforeseen circumstances.
With more than $5 billion debt and a gap in its pensions fund, Goodyear certainly still has a big deficit to work through. Interest rates are even more important. Every day, even Christmas or Easter, Goodyear has to pay about $1.5 million into banks in order to pay the interest on all the money it has borrowed. As a result, it can be taken for granted that there are considerable investment lapses that Goodyear will have to catch up on. The competitors may have paid out profits and dividends to their shareholders, but at the same time they have invested much more than Goodyear. And these investments will not be in vain. While it is only rescheduling and conversions that are buying the company time to solve its financial problems, there won’t be any automatic improvements on the investment side. It is likely that Goodyear’s main competitors, Bridgestone and Michelin, invested something like four times as much as Goodyear has in the last three-four years, if not more.
Under Bob Keegan and Jon Rich Goodyear has gone through a cost savings programme that sincerely deserves respect. Although there will be even more possibilities to save money, the potential of further decisions to reduce costs is decreasing. Goodyear has further increased prices but was struck by increased raw material costs like anybody else in the industry
Indeed Goodyear continues to have disadvantages in terms of costs compared to Bridgestone and Michelin in the American marketplace. The reason is Goodyear couldn’t afford a strike last year on its domestic market therefore had to accept an unfavourable contract with the unions. This disadvantage stems from the mid-90s when the company mistakenly believed it could compensate for higher costs with higher volumes.
Goodyear has the worst credit rating among the group of big tyre manufacturers by far. This could be seen again in August when the company was negotiating new loan terms on credit worth $680 million: 4.5 per cent above “LIBOR” (London Interbank Offered Rate) plus additional bank charges of between 1.5-2 per cent. A company like Bridgestone would have only accepted a rate of less than one per cent more than LIBOR. These are burdens the present management did not cause, but that they nevertheless have to carry. In the company’s own strength, or rather with the earnings derived from its own business, this will be impossible. This is why Goodyear announced willingness to sell off assets.
Now Bob Keegan has to work on the balance sheets of the company, reducing debts, and bringing in new capital and “fresh money” to the corporate group. Whether banks or investors have a say in this process makes a huge difference. Isn’t it better to have a partner who takes an interest in the business rather than leaving it to banks which are more concerned with interest rates?
With a partner like SRI, Goodyear would not be too bad off. In Europe, any other partner is unthinkable. Although long-term Dunlop staff dream of a return of the Japanese, it is difficult to imagine that they can take over the management in Europe again. As has already been pointed out: Nobody knows whether SRI would invest into a joint venture in which the partner be the leader. However, the question of industrial leadership can only be answered according to the different regions of the world, leading to a situation where Goodyear in Asia will be de jure what it already is de facto – a junior partner that lets SRI take the lead.
All this is nothing but a scenario, a what if? Nobody knows exactly what will happen, but one thing is for sure, “In 2006 Goodyear will be a different corporation,” says Bob Keegan.
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