Apollo and Cooper – is this the start of the expected wave of consolidation?
Is this the opening shot in the anticipated round of consolidation within the tyre industry? Or is it merely an expression of courage, or cockiness, with Indian tyre manufacturer Apollo in the role of a predator, seeking to grasp the much-larger rival Cooper as prey and in doing so exposing itself to the risk that the US$2.5 billion price will land it in debt above its head? Is attack the best form of defence or has the Indian company overreached with this ambitious and financially-edgy expansion plan?
Analysts, banks, hedge funds and financial speculators long for deals such as this, deals that involve large sums, attractive consultation fees and commissions from multi-billion dollar credit transactions. As at the casino, the banks win most of all. And the pulses of the target company’s shareholders race faster upon receiving an offer of the share price plus a hefty premium. When rumours of a takeover first circulated in autumn 2012, Cooper shares traded for around $20. Within half a year the share price had risen to $25, and Apollo’s 40 per cent premium on top of this led to an offer of $35 per share. Cooper shareholders were thrilled about a 75 per cent increase in value, took the money as quickly as possible lest the deal fall apart, and staged an exit. This means: if the deal had gone through half a year earlier, Apollo could have saved itself half a billion dollars.
Apollo’s shareholders, on the other hand, have voiced their misgivings about holding a stake in a highly indebted company that in coming years will have its hands full dealing with the acquisition and ensuring repayments and interest can be covered on time. Apollo shareholders are concerned they won’t receive an adequate dividend and many have decided it best to sell their shares while it’s still possible to do so. At the time of writing, Apollo’s share price is displaying a downward trend. And the outlook seems bleak for the newly-enlarged tyre company’s staff as they’ll carry the burden of the acquisition and be required to pay for the fact that the “predator” Apollo has reduced the much larger competitor Cooper to “prey” and let Cooper’s shareholders leave the scene with a haul of booty. As stock exchange experts discover time and again; money never disappears, it merely finds a new home.
Apollo justifies its pricey acquisition by referring to synergies. This term, which originated in biology, suspends simple arithmetic, as two plus two should suddenly equal five. Acquisition costs are calculable, but synergy is all a question of faith, drawn according to the principle of hope. The value of synergies can be worked out to be either high or low, depending on how a company chooses to view them. And it remains at all costs unmentioned that, in almost every case, utilising any existing synergies requires further upfront investment. This in turn increases the pressure to seek out means of reducing costs; what was previously achieved must be managed in the future, but with fewer personnel. And at every level and stage it is asked whether certain processes should be executed in parallel. Thus it may be decided, for example, that core research needn’t be carried out twice. And as Apollo doesn’t wish to become merely Cooper’s workbench, it will quickly become clear which region will, through cost-cutting measures and potential savings, fall through the grate. It all sounds easier than it is, though. From where then should accumulated research and development expertise come from? From Apollo? From Cooper? From Vredestein or Avon? Or must the new number seven on the world rankings first of all exert a lot of technological effort in order to catch up? And how much would that cost?
Anxious voices from the financial world can already be heard describing the entire deal as highly risky. And these sentiments aren’t based on thin air. In recent years every tyre maker has painfully experienced how high the fruit hangs on the tree in mature markets such as the USA, how hard it is to generate sufficient profits there. And if even a small cyclical reversal occurs, finances could quickly become very tight for Apollo as its debts will still exist. Nevertheless, management at Apollo and Cooper propagate optimism. The deal is in both parties’ best interests and a tremendous future beckons. Or, pithily said, it is a win-win situation. But it takes humour to believe this. Look at Apollo and Cooper’s turnover and revenues and the respective opportunities these present, and one fact becomes quite clear: the American firm must pay for its own takeover.
Value for money, expensive, too expensive?
How expensive or how cheap is the acquisition? US$2.5 billion in cash! Kudos then, if this was all. Sixty cents for every dollar of turnover. And then further burdens plus debt and pension commitments must be added to the equation along with various “legacy issues”. And what’s the situation, for example, in the factories – are they truly “state of the art” or will it first be necessary to clear an investment backlog? Others already have their experiences when it comes to acquiring American tyre makers. Bridgestone could only whip rundown Firestone plants back into shape through very large investments and thus had to effectively pay for them twice. It was a similar situation at UniroyalGoodrich, and in the 90s this even led to an existential crisis for the Michelin Group.
At any rate it shows there is only one way to solve problems caused by a lack of or underinvestment: Catch up as quickly as possible. If this isn’t feasible at an acceptable cost, then the threat of plant closures arises. As Michelin and Bridgestone were already global technological leaders, plant modernisation, rationalisation and automation was rapidly implemented. In both acquisition cases it was crystal clear who had taken over whom, who could learn from whom and who set the bar when it came to research, development and product quality. And Bridgestone and Michelin’s management knew precisely the value of brands and also know how to cultivate a brand.
The brand environment
With Firestone, a resilient, middle-price positioned global brand fell into Bridgestone’s hands. That could be seen at the start of the Millennium when the Japanese tyre maker was compelled, regardless of cost, to undertake a fairly rigid and also relatively unfair recall of Firestone SUV tyres in North America. The Firestone brand was considered a write off as a result. This, and how it recovered, strongly testifies to the brand’s strength. With Uniroyal, Michelin hadn’t taken over a strong US brand yet it was nevertheless well known, and in specialist areas, particularly off-road tyres, BFGoodrich was considered a top brand.
A cautionary and complicated example of acquisition can be seen in Continental’s takeover of General Tire, a situation that is, with some exceptions, comparable to what Apollo now proposes with Cooper. In a speculation-fuelled takeover euphoria, Continental allowed itself to become bedazzled at what seemed a favourable moment. Parent company GenCorp needed to defend itself against a corporate raider and summarily sold its subsidiary to Continental. Both tyre makers were very familiar with each other through their ‘technical agreement’, yet management in Hanover then learned a painful lesson. Following a thorough examination, Continental’s board members described General Tire as a “cashed out company”, its factories as “ramshackle” and their machinery as “scrap”. In the following years General Tire was upended and set back on its feet again numerous times and changes constantly made in its leadership until finally the bleeding could, to a degree, be stemmed. Until the start of the current century the 1987-acquired General Tire experienced nothing but seven, eight and nine-figure losses. And each time the company appeared to at least be heading towards a “black zero” on the balance sheet, management in Hanover were over the moon. Yet production costs remained too high and the “critical mass” elusive, the General brand was unknown, or at least unimportant, outside of Ohio, and the top brass in Germany knew the US market purely from hearsay. Supply chain, logistics, marketing – none of this was seen to be positively influenced by the acquisition. How could it? Continental was as good as completely absent from the world’s largest national market, and was unable to do anything that would lead to a strengthening in any of these points. Is anything different when it comes to Apollo and Cooper?
It was first in 2006/2007, 20 years after the acquisition, that a change was seen. It only came after most General Tire factories in the US were decommissioned and what was then still the world’s largest national market was supplied with tyres produced in Mexico, Ecuador, Brazil and even Malaysia. Naturally, Continental was very much aware that this situation couldn’t continue in the long-term, and in the following years it erected a large plant in South Carolina. This clean sheet of paper allowed it to build one of the most modern tyre factories in the world, a plant without any “legacy issues”. Young, competent and trained personnel could be recruited. Repair work became a thing of the past and an “architectural phase” began, in which the fundamentals of playing a major role in the difficult US market were implemented. A vital aspiration, in the medium to long-term, is to exclusively and successfully supply the US market with “domestic production” rather than to depend upon low wages in other parts of the world. Continental has developed into a global brand, a leading, premium brand and, first and foremost, a manufacturer whose technological expertise is indisputable. And despite this, due to intense competition and the aftereffects of the recession it remains hard to earn well in North America. Granted, life has become even more difficult for Continental’s competition – but Conti is fairing well in North America despite, not because of, the General Tire acquisition.
The European footprint for the new global #7 remains manageable. The small factory in Melksham, UK (previously Avon Tyres) certainly poses no threat to the European tyre market, and the same applies to the small but capable Vredestein plant in the Netherlands. But many years have passed since Holland and Great Britain were attractive production countries for tyre makers. Costs in Central and Eastern Europe are much lower. Vredestein is recognised by the market as having achieved acceptable product quality even though its investment in R&D is low. Thanks to a focus on demanding market segments and on high performance tyres, adapting production capacity to sales opportunities plus an intelligently thought out marketing strategy, Vredestein has proven its ability to sustain its profitability. In comparison, Cooper has higher name recognition in Europe yet product quality is arguably not sublime. While, for example, leading automotive publications rate Vredestein products as “satisfactory” and sometimes “recommended” or “highly recommended”, Cooper achieves no more than a “conditionally recommended”, and on two occasions the German automotive magazine AutoBild failed Cooper tyres and said they were unable to compete with those from the top suppliers.
Should the deal go through, the question is now – what has Apollo purchased? The Indian company’s management still know relatively little about the condition of the factories, outsiders know even less and journalists nothing at all. And does an investment bottleneck exist? If it does, how large is it? And what would it cost to clear this and how long would it take?
And what is the situation in terms of production? And with brands? In contrast to within Europe, Cooper’s product quality is not called into question in North America. Cooper is not really on the same premium brand level as Bridgestone, Michelin and Goodyear, the result being that its products don’t command the same premium prices. And it absolutely cannot be overlooked that Cooper branded tyres only account for a percent of the tyres the company produces, and alongside these it manufactures and markets numerous private and house brands, products with which it is difficult to generate sufficient profits. In mature markets such as North America and Europe, whoever is able to, strives to constantly improve product mix. A premium brand is required to achieve this, and outside of India, this is something Apollo-Cooper lacks.
However, Cooper is not in desperate need of restructuring. In the preceding years the company mostly performed very well and competed effectively against strong competitors. The reason it did so well, quite simply, is because of the people it had on board – having the right people makes all the difference. Cooper’s management had decades of background in Findlay and the surrounding region. People knew each other, went to school together, started work and climbed the corporate ladder together, were proud that they asserted themselves against large competitors time and again and they went the extra mile to guarantee success. Cooper and its brands were a favourite of tyre dealers as it was felt they offered a balanced partnership. This was a tyre maker that knew what its dealers needed and supplied it. But times have changed. As, using America’s leading tyre maker as an example, the idea of the “Goodyear Family” is long gone; this change in consumer sentiment also applies to Cooper, albeit only more recently and not to the same extent. Connections with businesses are loosening and partnerships must be renewed each year. However, it can be seen that Cooper enjoys continued strong support from American tyre dealers. People – employees at all levels and management – still make the difference. The fact that a relatively small purchaser from – taking a US perspective – an emerging country is taking over the much larger Cooper rubs against the sense of self worth held by dyed-in-the-wool Cooper dealers. It has little to do with rational considerations and a lot to do with emotion. Cooper’s status as a US tyre maker stirs the feelings of its countrymen. Amazement, annoyance and, most of all, a sense of insecurity and upheaval within the dealer base must now be dispersed and overcome. This is by no means an impossible task.
Cooper’s original equipment activities have always been and remain minor, as only companies that command top prices can generate sufficient profit from the original equipment business, and instead the firm is more of a follower that strives to recreate new dimensions that enter the market and bring them to market as quickly as possible. These days, tyre failure is a very rare event and mileage has increased significantly, in part because motorist desire qualities – comfort, quiet ride and reduced rolling noise – that are amiable to long tyre life. The targeted “follow-on from original equipment” is beginning increasingly later and often first takes place years after a new car is purchased. And as the time between buying a new car and needing replacement tyres grows longer, the weaker the “follow-on” becomes. It is therefore no longer possible to offer reduced prices in the original equipment business in order to fuel replacement market demand and maintain a presence there with much higher prices. And there is also no way around the fact that only tyre makers that can fulfill the requirement for participating in this market are those with leading technology.
The original equipment business is not an end in itself. You can’t simply declare your intention to participate in this market and to supply manufacturers. A look over previous decades will surely confirm this. What then must a tyre maker promise and be able to offer vehicle manufacturers? How deep an involvement is required and which technical knowledge must be shared? Brand also plays a major role in OE business. Why should a car maker select a relatively unknown tyre manufacturer with no established image when it can offer its own customers a product with better brand power?
What is driving Apollo along the path of expansion?
It’s clear that Apollo knows the game “eat or be eaten” and has given unmistakable signals about which rules it wants to play by. Having the tables turned by a company from an emerging market and seeing them pursue their own interests is taking Americans and Europeans a bit of getting used to. Through smaller acquisitions, Apollo has already reached an annual turnover of 1.8 billion euros, a figure that’d require substantial patience were it attempted purely through organic growth. A spectacular acquisition will drive growth much more rapidly; as long as it goes well it will turn a company, in this age of globalisation, into a global player.
But how do you become a global player? A tyre maker is dependent upon vehicle manufacturers. Back when the major US auto makers outgrew their domestic market and expanded car production into other parts of the world, their suppliers also set up shop in new countries. The same pattern was followed with the European and again years later with the Japanese automotive industry, the other two so-called triad markets. Then the Korean automotive industry and suppliers such as Hankook and Kumho followed suit. The moment the potential for further sales at home reached a dead end, new markets were sought.
Most recently, China has developed into the world’s largest automotive market with breathtaking speed. Amongst the 20 largest tyre makers worldwide are five Chinese companies, all with billions of pounds turnover even though their names were virtually unknown outside China a decade ago. Alongside these are hundreds of other tyre makers within the People’s Republic. Consolidation is necessary there, and many firms will disappear, however one thing is clear: it won’t always be just five Chinese manufacturers within the top 20. As the Chinese market is currently easy to supply there is little pressure to enter new markets, but it is only a question of time before Chinese cars are pushed onto European and American markets. And the largest Chinese tyre makers will accompany them.
Against which backdrop should Apollo then be seen? Due to its infrastructure, radialisation in India still lags way behind. Indian cars are small, unassuming and must therefore be affordably priced. The technical demands upon tyres correspond with this. In other words: Apollo will neither in Europe nor North America be sought out as original equipment, and wouldn’t be even if all technical hurdles were overcome. It lacks a dazzling brand. And it won’t be any different in the new company as it, along with Vredestein and Cooper, don’t have what it takes to participate strongly in the original equipment business. It is also surprising that the Indian company has consciously chosen to execute its expansion drive in the hard-fought European and North American markets, where you can only survive through cut-throat competition, even though Asia, along with the BRICS (Brazil, Russia, India, China and South Africa) countries are expected to offer sizable rates of growth for years to come.
The coming years don’t look like they’ll be easy ones for Apollo. The cost of the acquisition will hang like a millstone around the company’s neck for years to come. The Apollo brand, although well-respected in India, will not play a major global role for some time yet and brands such as Vredestein, Cooper and Mastercraft are not suited for marketing in the highest-priced segment. And companies are made up of people and are driven by people. It will be very interesting to observe whether the differing corporate cultures can be brought together under the one roof.
And last but not least…Does this mark the start of a global round of consolidation? If so, who would be drawn towards whom? And, most importantly, would action be taken from a position of strength or will change only come under pressure? Continental sees itself as being large enough to achieve growth organically. The German company is already present where the music is playing – it operates sizable factories in low-wage countries such as Romania, Slovakia, the Czech Republic and Portugal, and now also plays a first-rate role in the BRICS countries and is constantly improving its position through new plants and capacity increases. Bridgestone and Michelin are hardly candidates for spectacular takeovers; at most a realignment may be seen.
That leaves Goodyear, Sumitomo Rubber (Dunlop) and their joint-ventures which have not achieved major success. In the past decade Goodyear has needed to fight damned hard, in part due to problems of its own making but also because of long-term economic problems in its domestic market, and as a result of this it lost ground on its two major competitors Bridgestone and Michelin, the only firms that can offer a compete tyre portfolio in all segments. Should Goodyear’s problems resurface, its joint-ventures with SRI may also once again be put to the test.
And Pirelli? In hindsight, the company lost its shareholders a lot of time through involvement in its now-discontinued telecommunications interests. Had this not been the case would Pirelli, in contrast with in past years, have been ready for a merger with a competitor even if it didn’t hold the upper hand? But all of this is pie in the sky. In the short term, acquisitions and mergers of smaller tyre makers will most likely take place in Asia. There is actually no minimum size required for business success, as the extraordinarily successful Nokian demonstrates; its secret is to limit itself to what it is best at and also to limit itself geographically.
One question hasn’t been raised until the very end, however it is actually decisive: What benefits does a merger bring? Let it be understood that this doesn’t relate to the benefits of those who want to merge, rather the key question is whether a merger delivers any benefit to the market, to market participants, suppliers and customers. What will improve for Cooper in its North American home market? The fewer the arguments that can be raised here, the more critically should the takeover be viewed.