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BorgWarner Inc. (NYSE:BWA)

February 20, 2013 10:35 am ET

Executives

James R. Verrier - Chief Executive Officer, President and Director

Ronald T. Hundzinski - Chief Financial Officer and Vice President

Ken Lamb

Analysts

Brian Arthur Johnson - Barclays Capital, Research Division

Brian Arthur Johnson - Barclays Capital, Research Division

Good morning. I want to welcome BorgWarner management team. BorgWarner is a company we have traditionally always liked. We have an overweight on it because it's really -- and one reason it belongs down here in Florida, it's really a technology leader in the area of high-efficiency powertrain. Pleased to have with us today: James Verrier, the President and CEO; Ron Hundzinski, the CFO; and then Ken Lamb, who many of you know is Investor Relations. And as time is limited, why don't we dive right in? Just to kind of baseline the room, let's bring up the audience response to question #1 to get a sense of the ownership in the room. So keypad, you've seen this before. You pick it up, you'll have 6 seconds to vote once I say [indiscernible]. Just simply if do you own the stock or not, one, overweight or no. Vote when I say ready to vote, which is ready to vote. We'll have 6 seconds.

[Voting]

Brian Arthur Johnson - Barclays Capital, Research Division

And these will be baselined across all the companies, so we'll be getting some feedback. Okay. So what we call a lot of prospects out here. And I'll bet a few people shorted.

Question-and-Answer Session

Brian Arthur Johnson - Barclays Capital, Research Division

Why don't we dive right in? Just a question for James. How is -- give us an update -- you certainly guided a couple of weeks ago, but maybe just give us an update on how 2013 is looking. Has anything really changed in the last month since your earnings call and the auto show?

James R. Verrier

Okay. Yes, just if we go back a few weeks or so, when we were back in Detroit, we gave that guidance in and we were pretty comfortable with where we were at then. When we went through our recent earnings call just a few days or so ago, I would say we still feel pretty good with where we're at. So no real change. If I look at it maybe a little more around the world, I see the area that probably gives most people a little bit of anxiety is Europe. I think we feel, I think everybody generally feels pretty comfortable with North America. Europe is where there continues to be a little bit of volatility. And I'm guessing we'll probably get into that a little bit more, Brian, through the conversation.

Brian Arthur Johnson - Barclays Capital, Research Division

Well, let's maybe go into that. So can you give us a sense of how Europe is evolving in terms of your order flow, your expected production rates? Remind us what you guided to the year, I think it was minus 3%, where it's tracking against that and sort of how do you see the quarters playing out?

James R. Verrier

Yes, you're right. The outlook for 2013 was for European light vehicle production down 3% versus 2012. What we're seeing -- well, first of all, Q4 was a decent indicator. Q4, I think, in general and for BorgWarner also came in maybe a little better than what we imagined it would several weeks ago. So that was somewhat of a good sign, I would say a positive sign. The next kind of landmark event for us was what transpired as the automakers came back onstream in January because you never know, are they going to put some delays in return or take some ships out or whatever. And that all played out pretty well as expected. So the automakers came back, cranked up pretty much on schedule as we anticipated. And I would say we're, what, 4 to 5 weeks in. And it's running about as where we thought it was going to be. You may get a little bit of nuance in OEM-to-OEM or platform-to-platform. But in general, I would say it's about where we thought things would come out so far.

Brian Arthur Johnson - Barclays Capital, Research Division

And do you see that production pace improving through the second half? Or is it just the comps get easier in the second half?

James R. Verrier

I think our view of the world is if you look at it first half and second half as opposed to quarterly sequential, we see a little bit of an uptick in the second half of the year. Now it's not like any kind of cliff event. It's a little bit of an incremental ramp-up second half to first half. And that's after you've normalized for daily sales and working day rates. But it's not a big event. It's just a little bit of sequential improvement in the second half versus the first half. And that translates into a BorgWarner view, as well as a market view.

Brian Arthur Johnson - Barclays Capital, Research Division

And how you do get comfort in that view, given the January pan-European sales numbers of down 8.6%? The ATA noted that, that was the worst January since they started measuring auto sales in 1990.

James R. Verrier

Yes, that's fair. I think for us as BorgWarner, the comfort for us probably comes from what we're actually seeing and whether that is what we're seeing in our schedules, 30 to 60 days out. It's what we see a little bit in our January actual rates, our revenue rates. And they're pretty solid for us. And one of the things that maybe the frame for the room here because I think this is an important distinction, a lot of the negativity or the bad news about Europe -- so Europe is going to be down 3% this year. Q1 could be double-digit down versus 2012. BorgWarner is still growing in Europe. And that's kind of an important distinction that I think it's worth reminding the audience around, so we continue to see growth in Europe, absolute growth and we continue to see pretty decent outperformance of our growth versus the market growth. So it's just an important context that if you're not close to our story, it's worth knowing that.

Brian Arthur Johnson - Barclays Capital, Research Division

And a question for either you or Ron. We know your end customer profile tilted towards Volkswagen. But if you looked at of the roughly 50% that's in Europe, what's roughly the sales mix that's, a, exported? And if so, is it U.S. or China? And b, within Europe, what are the most retail end markets we want some forward visibility that we ought to be looking at the retail market then?

James R. Verrier

Yes. I think Volkswagen is our biggest customer globally. It's about -- I think about 14% of our worldwide revenue, so they are a key customer. But the other part I would make, we're balanced in Europe. So yes, Volkswagen is a big guy for us, but we're across the board with Ford, BMW, Daimler, Renault, PSA. So one of the good things for us is we're pretty well-balanced across, not just the customer base but the segments as well, so whether it's small vehicle or mid-size or larger vehicles. So one of the good things for us is we're a relatively balanced portfolio. And I think that certainly plays out well for us actually. I mean, are we seeing -- I think your other question...

Brian Arthur Johnson - Barclays Capital, Research Division

In terms of retail markets, should we be looking at a Germany, a France versus a Spain or an Italy or a Portugal?

James R. Verrier

Yes, I mean, I think in general, as I said, we're well-balanced. We're probably a little weighted to the higher-contented mid-sized and large-sized vehicles versus the smaller A segment, B segment and the French, Spanish, Southern European OEMs. So we're a little bit more weighted that way. And I would say what we're seeing so far is pretty good strength around the German vehicles, particularly larger-contented, higher-mix vehicles.

Brian Arthur Johnson - Barclays Capital, Research Division

Let's talk a little bit about each of the key business segments. I'm going to start with Drivetrain just because everyone always starts with Engine. We've seen some decent margin expansion there. Can you really give us maybe 2 things? One, what's kind of driving that margin expansion? Well, 3 things. 2, where could it go? And 3, does this get to the point where it stands alongside Engine with those kind of margins? Or does the lower CapEx needed in Drivetrain mean it's going to be a bit lower?

Ronald T. Hundzinski

Yes, Brian. Drivetrain margins probably hit their lowest point in recent history in first quarter of '11. And we disclosed that we were aiming for a 9% margin from about 7% in that first quarter of '11 within the year. And as we progressively went through 2012, we saw improvement in the margins in the Drivetrain business. But one of the fundamental problems was that we have a product, which we call dual-clutch transmission, that was in Europe where the capacity that we've installed wasn't quite where the customers were taking the product. I think the customer was having great success in the marketplace in adapting that technology. And we've capitalized ourselves to their requirements, but they didn't anticipate how good that product was going to be received. So we kept chasing capacity. And when you do that, you incur a lot of what we call noncompliant costs as far as expedited freight, extra labor. It's not an efficient way to run when you're chasing the customer on capacity. And we continued to struggle with that for some 12, 13, 14 months. But we got better. And as we got better, we ended up with 9.1% margins for 2012, I believe it was. And so most of that improvement came from that capacity catching up with the customer finally. As far as where margins go in that segment, all of my margins are really driven as a function of my sales from a base case right now. So I'm sitting at 9%, 9.1%. Margin is going to go in relation to sales. If my sales expansion is 8%, for example, I have a more likelihood of chance of expanding margins. In our business, we incur 1.5% to 2% pricedowns from customers. I incur material inflation, labor inflation. And all those negative inflationary items take as much as 2% to 3% margin points away in the auto industry. This is common for us. So I need this extra sales plus productivity measures to combat that. And typically, we've said that we need a higher 8% sales to start expanding our margins. So where margins go is a direct function of where my sales go from this point.

Brian Arthur Johnson - Barclays Capital, Research Division

So are those issues in terms of keeping up with DCT capacity behind you?

James R. Verrier

I would say to Ron's point, we're pretty well past that. I mean, are we perfect? Do we have everything coming as we want in Drivetrain right now? No, no. But I think what Ron was describing a year or so ago, it was not particularly great performance, and we're past that. We're doing well. But I guess, I and the team, we're not satisfied. We want to keep driving for further improvement.

Brian Arthur Johnson - Barclays Capital, Research Division

And could you update us maybe on the DCT joint venture in China? That seems to always be around the next corner in terms of when it gets into gear. No pun intended.

James R. Verrier

Yes. No, it's a good thought. And that's a really strategic joint venture for us in China, in terms of around dual-clutch technology that we will put into China. And for those in the room that maybe don't have that history, it's a joint venture with the majority as BorgWarner and with a coalition of Chinese OEMs. And that forms the joint venture all around dual-clutch technology for China. The story is pretty similar to where it was a few months ago. And what that is, is tremendous desire for the technology. There's no indication at all of anybody backing off. There's a tremendous commitment to implement our technology into China. The challenge has been is getting the technology ready for the market. And that's honestly not a surprise for us. I mean, the European OEMs that have fantastic experience went through a number of years to get that product ready for market. And that's what you're seeing in China. And this is in a market where the knowledge base is probably a little less than the traditional German and European OEMs. So it's coming. That's the good news. It's taking a little longer. It has nothing to do with BorgWarner, by the way. It's more just them making sure that, that technology is ready for the market. So with all that said, we will launch this year, 2013 will be the year of launch with SAIC. And then as we go into '14 and '15, we'll be rolling out additional programs with FAW. So it's a good story. It's right on track. It's just we're as anxious to get producing as...

Brian Arthur Johnson - Barclays Capital, Research Division

And that's in your backlog, it's consolidated revenue, it's wholly owned?

James R. Verrier

Yes. It's majority owned.

Brian Arthur Johnson - Barclays Capital, Research Division

Majority owned. Okay. And in terms of the capacity costs, has there been a drag on driveline in terms of start to try having that capacity ready before the customer was, kind of the opposite of what you had in Europe?

Ronald T. Hundzinski

I would say that's one item that's been in there for a while. And yes, that would be a drag on that margin. We're carrying a plant that's not producing product right now. So that's fair, yes.

Brian Arthur Johnson - Barclays Capital, Research Division

Well, moving on to Engine. Within Engine, you've got great margin performance, do you see the 16% and 17% as basically peak margins? Or are there rooms for it to inch up beyond that?

Ronald T. Hundzinski

Brian, like I was talking about earlier, margin expansion is a function of my sales again. If I were to get 15% sales increase in there, I can expand those margins. In a slower growth environment, might maintain margins more difficult, like what you're seeing in 2013 from our guidance. So I wouldn't put any numbers on as far as limits or anything like that. It's going to be driven by my sales increase. Typically, BorgWarner has an internal measurement that for every incremental dollar I get in sales, we strive to get 20% incremental income. So I could model something out that if my sales were to increase 20% incremental income in the more developed market. Sometimes in our Asian markets, we don't quite get 20% because we're putting it in investments. But that's been a -- we've talked about this incremental margin perspective for many, many years, and that still holds true with BorgWarner.

James R. Verrier

I agree with what Ron said. I think the other thing though that you have to think, you're running 16-ish percent operating margins in the Engine Group, which is, for me, a fantastic performance. Ron described that the one element that will contribute to margin expansion or not. The other one that we're always conscious of in BorgWarner is if the customer can find, let's say, an alternative technology at a lower total cost than BorgWarner delivers, that's the risk that they can deploy that technology versus the BorgWarner technology. And so my message is we have to be somewhat conscious of that. I don't think -- I wouldn't tell you there's an unlimited margin expansion. It's just not practical in our industry because the customers are going to find something that gives them the same fuel economy and emissions but at a more competitive total cost. So we just have to manage that equation.

Brian Arthur Johnson - Barclays Capital, Research Division

Anything on the horizon there or anything that BorgWarner is doing that could maybe obsolete BorgWarner?

James R. Verrier

Well, that's what we've done for a long time. That's kind of our mantra is never ever can we get outtechnology-ed is probably the phrase I use. So the way to think of it is in our core products that we're in today, we're always kind of ahead on working on next-generation advanced technology. So turbochargers are one that are on a lot of people's minds. And we are working on some very innovative technology that will be coming to market that would assist the customers in transient response. For those in the room that maybe are not familiar, transient response is just the ability for the vehicle to accelerate quickly as it pulls away and there's no kind of lag in the driving performance. And there are things you can do with a turbocharger, for example, lighter materials, spin the turbo faster, spin the turbo quicker. If you can do those types of things, that will be an advanced technology for turbo that we'll bring to market that can assist, not only with the fuel economy but also driving performance through transient response. So you'll see some of those technologies that will be coming out in the next 2, 3, 4 years. And that's one example. The other one I always cite is we see more and more interest from our customers on the emissions products that we're involved with. So our EGR valves and our EGR coolers, we're seeing a continued, in a push actually around, I'll say, integration and a more systematic approach to those types of products. So we're seeing a little bit of a trend now, where more and more business has been sourced on a valve cooler combo as opposed to 2 discrete components. And BorgWarner is the only guy in the world that brings the valve and the cooler. So that's just a couple of examples that come to mind. But Brian, that just applies across all of our portfolio in terms of next-generation technology. And then we're always looking, is there a little bit of white space that we don't play today that we could play with either organically or through M&A.

Brian Arthur Johnson - Barclays Capital, Research Division

Well, in the turbo market, a lot of people will ask questions. So I'll ask about the entry of 2 German firms, Bosch and Continental AG into the turbocharger market. We've seen how Ford is bringing the 3-cylinder Conti-powered engine to the market in the U.S., as well as Europe. Where do you see those guys fitting in? Are they a threat to the current margin levels, as maybe it's not new technology but a cheaper source of supply for some of your customers?

James R. Verrier

Yes. I mean, where we see things right now -- first of all, to put it into a large perspective, the turbo, the number of engines that are turbocharged today is about, roughly about 30% of the world market. And that's going to increase to 40% or beyond. So if you think of that mathematically, that's 10 million, 15 million turbochargers more that the customers are going to need. And there's a little bit of discomfort from our customers that there were only really 2 principal players, BorgWarner and Honeywell. So the introduction of these guys is to enable a little bit more of the capacity in the industry rather than relying on 2 guys. And the point there is -- so BorgWarner, it wasn't called punishment for us or we didn't do anything wrong, it was a strategic direction from the OEMs. So here we are 6 or 7 years later, and now those 2 guys are in production, both Bosch and Conti. And where we see things right now, they're 2 competitors we respect, very much so. They're entered into this space with what we would term standard technology, so they've not come to market with a breakthrough turbo or something brand-new and innovative. It's relatively standard technology. And our view of the world is that they will be gradually ratcheted up from a volume perspective. We don't see them coming in and getting huge takeup of volume. There's too big a risk in our view to the OEMs. So they're going to incrementally gain some share of course, but remember that turbo market is growing quickly. And how that translates to us is we're about 1/3 of the turbo market today globally. And looking out, we're very comfortable that we'll maintain that position.

Brian Arthur Johnson - Barclays Capital, Research Division

Any questions so far from the audience? So you can use your BlackBerry-like things, as you know, or there's microphones going around. While people are thinking their questions, let me throw up ARS question #8. Let's get some feedback on the Engine business from the group. And the question is: Where do you think, given what you've heard the BorgWarner Engine business unit market, engines will go above 16%, stay around 16% or fall below? Start voting now.

[Voting]

Brian Arthur Johnson - Barclays Capital, Research Division

Okay. So some people -- very few people think it goes below 16%. 73% think this is about as good as it gets. But 20%, I wonder if those are the 20% who own, think it could go above 16%. While we're doing this, let's pull up question #10, please? Get the sense of the group on where Europe is. So IHS and Borg forecast a 3% decline. This is pan-Europe, including Eastern Europe and Russia. Where are your heads at in the audience, more than 3%, about 3% or a less than 3% decline in Europe? Vote now.

[Voting]

Brian Arthur Johnson - Barclays Capital, Research Division

Okay. So it seems like the group is a little bit more conservative. 57% think it will go up. Interestingly, 33% think that perhaps the bottom is in. So kind of an interesting split of opinion there. Make anything of that? Or I guess, the question, I mean, do you think that you really have enough -- you know I'm a ex-consultant. So did demand change visibility to feel comfortable when you're looking at these production schedules that the OEMs are kidding themselves?

James R. Verrier

Yes, I do. I have a couple of comments. My guess is if we had done this same poll 2 months ago, my belief is that, that spread was much wider. It's just our opinion. I think when we were in the fourth quarter and everybody was trying to figure out '13 [ph], I was hearing numbers it's going to be down 10%, it's going to be down 12%, it's going to be down 1%. But I think that spread is kind of closed. So now I think you hear maybe 1%, maybe 5% is on the low end. So that for me is encouraging actually that I think that spread has come in. I think the key point again for us is if you assume Europe is down, our view of 3% -- let's just say we go with the audience and it's maybe down 5%, a little worse. What that will mean for BorgWarner likely is that we'll be growing a couple of percent, again just to reinforce that. So what that means for us is from a running-the-business perspective is we just have to manage and adopt and adjust a little bit of our growth rate as opposed to cutting deeper because of the business falling down.

Brian Arthur Johnson - Barclays Capital, Research Division

So to get to a question. I mean, is your capacity in Europe fairly well utilized? What is your cap utilization? You may be different than other suppliers, who have empty gap, empty holes in their factory and their idled workforces?

James R. Verrier

Yes. I mean, it varies a little bit plant-to-plant or region-to-region. But I would say we've always targeted to be in the 80% to 90% type of range of utilization. And that's about where we are. If you think back to Ron's question or Ron's answer earlier, it's not that long ago, we were working 6 and 7 days in some of our facilities in Europe to keep up with the dual-clutch production. I would say that's come back a little bit. So particularly in Europe, we're pleased actually with where our utilization rate is. I mean, it varies a little, but I'd say it's in that 80% to 90% range.

Brian Arthur Johnson - Barclays Capital, Research Division

Now in terms of your guidance, I think as far as some of us, in terms of margins, are there things you're doing to offset the slower growth or lack of growth in Europe that are deferred investments? And when those come back, does it affect the formula Ron and Robin often talk -- or used to talk about, around the 20% incrementals more or less?

Ronald T. Hundzinski

We've always said that we needed a higher growth rate in order to maintain our margins, so for the people in the audience here. We've maintained that we needed around 8% to maintain margins, and now we're in an environment of 3%, 4%, 5%. So the discussion centers around, "Well, how are you going to able to maintain your margins?" Because we gave guidance 11.5% plus for 2013 and we finished '12 at 7.7%. So that's the concern for everybody. When I refer to investments being postponed, they're not capital investments. I need to maybe more clear on that, Brian. What I'm referring to more is maybe SA [ph] and old type investments. And that R&D, we're on our path of SAP implementations, for example, in our plans for trying to go into 1 platform. We can defer those types of investments a little bit. We can also maybe -- I have corporate offices regionally, which I talked about in the fourth quarter. We have 1 in Germany and we have 1 in Shanghai. And those investments I was gearing up to add treasury people there or finance people over there, I can postpone a couple of those things. So I'd say it's more back-office, operational, IT maybe related investments. It has nothing to do with capacity for manufacturing products. I want to make sure that's clear. So it's those types of activities there. But then also the manufacturing folks know that it's a slower growth environment. They can also -- some discretionary spend in their areas, they can pare back. Maybe they had some plans in the plant to do something, they can defer some of those items.

Brian Arthur Johnson - Barclays Capital, Research Division

Questions from the audience? Okay, why don't we talk a bit about the use of cash, the balance sheet and acquisition strategy and maybe just throw it out there? A lot of companies have a high-level philosophy on cash. Maybe remind us of the rough level of free cash flow generation. We're modeling about $500 million. And then where do you see as uses of that?

Ronald T. Hundzinski

I'll start that, and then we'll probably go into an M&A discussion, and then James can [indiscernible]. So BorgWarner generates about $1 billion plus, $1.1 billion of cash. Of that, our capital spending to support other programs that we have to launch with our customers' CapEx and tooling, I should add, is roughly $500 million. I'm going to round the numbers. Our guidance is $450 million to $500 million, but nice round number, which means there's about $500 million of cash that's generated after that. That cash, our primarily objective is to take that cash and do M&A activity. That's been our objective for many years, and we did do transactions 2 consecutive years in '10 and '11 and we did not have a transaction close in '12. So therefore, cash starts to build up. My ideal situation would be to have a transaction every year in this $300 million plus or minus a little bit every single year. But James is going to talk a little bit about M&A. And that's just not possible to always have those transactions exactly like the finance people would love, every single year, right? So in 2012, we didn't have a transaction, cash built and we were very much aware of our balance sheet. Net debt to equity is 10%. So I have to be extremely proactive in the meantime to do something with that cash. And I think 2012 was a good example. We purchased over 4 million shares in the year. I did 1.5 million just in the fourth quarter alone. And I think you can expect that behavior. As we look at our M&A transactions' timing, you can expect that behavior to continue. I have to be aggressive and proactive on it. But maybe we should talk about the M&A activity, which is where the cash needs to go.

James R. Verrier

Yes. Maybe I'll just make a few comments on M&A. As Ron said, that's our primary use of cash. So the question really is, well, then go do one and that solves that, right? So that focus when we look to do M&A is pretty clear. We really are very, very focused on acquiring companies that add technology to the portfolio. We're not interested in going out and buying commoditized, maybe potentially distressed asset and fixing it. That's not our focus. We go to market as a technology leader, and that's our story. So we really, really want somebody that's focused on technology that can help us deliver the type of growth that we do. Now there are companies that -- many companies that fit that profile. The challenge for us is they're not for sale. And they're not for sale for the simple reason that they've got great technology. They've usually got great operating performance. And so they're not really interested in selling. So the challenge for us is to help them, the owners, convince them that it will be better to become part of the BorgWarner family. And examples of that are they may be very brilliant from a technology point of view. They're smaller companies. They're family owned. And maybe they're concentrated in a region, Germany or Western Europe or Europe. And the customers are now saying, "We love this technology and we want it now in China and we want it in North America." And they just either don't have the desire or the resource or the capability, in some cases, to make that global reach. So becoming part of BorgWarner, we can obviously do that in a system. So that's kind of how we do this. But that's what causes the kind of lumpiness, as Ron has described it, in the M&A activity is that it's just challenging for us to get these guys over the line to do the deal. But I don't want anybody in this room to think that we're not vigorously pursuing internally and with external targets M&A activity because we're spending a lot of our time and energy and resource on focusing on that and trying to get people into the portfolio.

Brian Arthur Johnson - Barclays Capital, Research Division

This question comes up is: Why buy in Europe given the -- even if it is sort of bottoming out, the lack of robust growth in Europe?

James R. Verrier

Yes. I think that the primary reason -- a couple of reasons why a lot of our targets have historically been in Europe and we continue to look in Europe. In general, the center of powertrain innovation and technology tends to be oriented more to Western Europe. Now if you look at the real technology leaders in our space, you think of the Volkswagen Group, you think of the BMWs. And they've built up over the decades and centuries, in some cases, supply base that's in that region. So they are Europe. The reason we buy is because we get that technology, and then we can take it globally. That's the real key secret. And if you think of the 2 recent examples of that, Haldex and ENSA, they are both perfect examples of that, both very strong in Europe. And now when you look at our backlog, you'll see a lot of our EGR core growth is showing up in North America and it's showing up in China or in other parts of Asia. So it's a great example of kind of how we want to do this.

Brian Arthur Johnson - Barclays Capital, Research Division

So do you have guidelines on what you'll pay? In terms of multiples, are you paying for current earnings or normalized earnings? Or certainly, there are acquirers out there that think it's good role models, who will give the seller a benefit of future synergy.

Ronald T. Hundzinski

Well, we have to be disciplined because when we talk with these individuals, they have a very high, inflated value of their organizations, and we don't quite frankly want to go there. But there's limits, right? I think we want to make it accretive to ourselves, right, when we purchase this asset and we can take it globally. So we can't overextend ourselves, Brian, as far as what their values are. I won't throw out some numbers. But some of them are just -- there'd be an owner and he just has really high expectations on what the value is. And just techniques to use, we can use third parties to get down his expectations. And it takes time with these individuals. We just have to be reset as far as what's a reasonable price for their business. And there's a process we go through to do that.

Brian Arthur Johnson - Barclays Capital, Research Division

So in the absence of a deal, then what does it imply for share buybacks? And in particular, is there a target capital ratio you might be thinking about that would allow you to say, "Okay, we can return more cash to shareholders in the interim, but then if we need to buy something, brings additional earnings power into the group so we can then go borrow at that point"?

Ronald T. Hundzinski

I think the way I would say this is that share buybacks allows me to be flexible. So what I can do is like what I did in 2012. Knowing that a transaction was not going to be closed in '12, I could be flexible and I purchased 4 million shares. I have that option today. I can remain flexible, and then I can time it with my M&A activity and switch that cash from share repurchases over to the M&A activity when the transaction gets closer. So I look at share repurchases as a flexibility tool for me right now for my cash until an M&A activity transaction can get closed.

Brian Arthur Johnson - Barclays Capital, Research Division

Do you have to save up for that M&A? Or can you return the cash when the M&A goes up, like you did with Haldex, allow leverage to drift up?

Ronald T. Hundzinski

Well, I mean, depending on the timing of the transaction, I can either do all cash or I could leverage up a little bit on that transaction, Brian. I mean, it can't be perfect and say all transactions are going to be cash, right? So it depends on when the transaction gets done. It also depends on quite frankly -- everybody don't talk about it, we do a little bit, is where in the world this transaction gets done. If it gets done in North America or in Europe or in Asia, I have -- everybody's aware of the tax issues and the multinationals. It depends where my cash is sitting. It might be I have to leverage up in one area even though I've got cash sitting in another area. So it's quite complex as far as where the cash comes from or where I leverage up. But at the end of the day, the share repurchases is a way of me returning capital, right, to the investing group that still allows me my primary objective of M&A because I can remain flexible in that area. One more question, you talked about leverage, right? BorgWarner has been leveraged up into the 30% range, net debt to capital in the past. And I'm not adverse into going into that 30% range. That's not an issue, it's just that we're not there yet, okay?

Brian Arthur Johnson - Barclays Capital, Research Division

Okay. Let's hit some of the ARS questions. Let's go back to #2 and get through some of these, and have a few questions, if people have them. General bias towards the stock. Why don't you vote now? Positive, negative, neutral?

[Voting]

Brian Arthur Johnson - Barclays Capital, Research Division

Okay. It's probably the 20 -- the 19% negative may track the 20% that thought Europe was going to get worse. Now this is anonymous, so we can't do all those correlations. I don't think -- #3, through cycle EPS growth, above, in line with peers? Peers, why don't we define as the auto parts sector as opposed to the other folks here. Or actually, let's make it tougher, I'm sorry. Let's define it as the broader industrial group. So just compared to the other folks down here in Miami because we know they'll grow faster than autos. Do you see it kind of in line with industrial peers, below industrial peers or above industrial peers? Vote now.

[Voting]

Brian Arthur Johnson - Barclays Capital, Research Division

Give you a tougher peer group. Yes. Feel free to vote. Okay. It's interesting. I mean, even defining it as above as an industrial group, you have 48% that see it above. Well, why don't we skip to #5 then because it falls right from here. Okay. So the group down here, you all know what the multiples are, 15 to 17x in industrials. Where do you think that where Borg ought to trade, given at least half of you think it will grow faster than the other companies, 10x, 10 to 12x [ph], 13 to 15x? Why don't you go vote now?

[Voting]

Brian Arthur Johnson - Barclays Capital, Research Division

Your current multiple is 14.4x.

James R. Verrier

Right.

Brian Arthur Johnson - Barclays Capital, Research Division

Okay. So you have 40%, 45% think you ought to trade above 15x. And I saw like 40% think you belong with those multi-industry peers. But 35% say it's about right, and then 20% say, "Get back to the Detroit conference, you don't deserve this."

James R. Verrier

We like #5.

Brian Arthur Johnson - Barclays Capital, Research Division

Yes. So why don't we go to #4? What should we do -- what should Borg do with excess cash?

Ronald T. Hundzinski

I was going to ask you to do that one, Brian.

Brian Arthur Johnson - Barclays Capital, Research Division

Bolt-on M&A, larger M&A, repos, dividends, debt paydown, internal investment, which you're already doing, so...

[Voting]

Brian Arthur Johnson - Barclays Capital, Research Division

So it's interesting, a bigger vote for bolt-on M&A than for share repurchases. I also want to say it'd be interesting if we could differentiate long-term only from hedge funds, I think.

Ronald T. Hundzinski

That, too, is interesting.

Brian Arthur Johnson - Barclays Capital, Research Division

Yes. Larger M&A, I don't know if that's 5 [ph]. What would you consider a larger M&A? I mean, you say $500 million, you sound big. Now there's companies walking around...

James R. Verrier

For me, it would be about $1 billion revenue. Annualized revenue would be $1 billion. We consider that right.

Brian Arthur Johnson - Barclays Capital, Research Division

But we've seen deals in the industrial space where it's 1/4 or 1/3 of the market cap. Where is Borg's thinking on those kind of deals?

Ronald T. Hundzinski

I think the $1 billion mark would be larger. I wouldn't say 1/4 of our market cap.

James R. Verrier

Yes. If you think back to our criteria, technology leader, technologically driven, growth ahead of it. Then you start thinking of how many are in the space, the powertrain space, $2 billion, $3 billion, you get to a pretty small list.

Brian Arthur Johnson - Barclays Capital, Research Division

Okay. Let's do #6, most significant investment issue. These first 6 are the common ones, so you'll be benchmarked to the other industrials: core growth, margins, capital deployment, execution? So vote now.

[Voting]

Brian Arthur Johnson - Barclays Capital, Research Division

So margins. I don't if that's drivelines, worry about Europe, 53% said margin performance. 21% [ph] said capital deployment. Pull up question #9. So you've typically gone 8% to 10% above the level of light vehicle market. And what we're asking people here: Do you think they continue to outgrow by 10%? Will it narrow to a 1% to 8%? Will it just be right on top of it? Or there's something out there, like BlackBerry and smartphones, where you might actually lag the light vehicle production? So vote now.

[Voting]

Brian Arthur Johnson - Barclays Capital, Research Division

So 33% think you can continue to outpace by 8% to 10%. About 57% say it will be somewhat less of a margin. So you have a task there. It sure fits with the bolt-on M&As of can you figure out ways to sort of give people confidence back. That can happen. And then finally, question #7. Do you think the current guide of $5.15 to $5.45 is aggressive, conservative or just right? So vote now.

[Voting]

Brian Arthur Johnson - Barclays Capital, Research Division

Okay. 50%, just right, 38%, conservative. So it's skewed a little bit more to the upside. So I'd love to ask what people feels. So anything about this particularly jump out at you?

James R. Verrier

I think it's a good process.

Ronald T. Hundzinski

Yes, I think I do.

Brian Arthur Johnson - Barclays Capital, Research Division

I guess, it gets to a question and as you sit down here with people you don't see in the auto show circuit, I mean, why is it that a Borg trades at a 14x and other industrials with similar growth rates and margin performance trade around 17x? What are you and your board discuss around that? Or does that issue not come up because you're still trading at a premium to the auto parts growth?

James R. Verrier

No. It does come up. And obviously, it goes without saying, we think although we're an automotive company, which is what we play, I mean, all the fundamentals of how we perform and how we deliver value are much, much more in line with an industrial group than an auto space. The issue is we only play in Europe. And so as much as we may want to keep maintaining, we are more like an industrial group from a performance point of view, we can't help where we play. And we're proud of where we play because the auto space is a great place to be. So I don't know. There's not a lot you can kind of do, to be candid, other than we'll keep executing the story. And if we keep executing the story, yes, the multiple can move on, I mean.

Brian Arthur Johnson - Barclays Capital, Research Division

Good. Any questions from the audience? I'll throw out one last question since the other -- we do have machinery companies down here. I mean, how important is commercial vehicle? We know it's 20% of your revenue. But is it more of your earnings power? I mean, does big turbos and big EGRs caught [ph]? And are there sort of things going on with Cummins getting more aggressive about pushing its engines into customers like Navistar that we ought to be worried about there? Or is things we're seeing normal noise of just kind of macro headwinds in U.S. and Europe?

James R. Verrier

I think the quick way to think of this is the commercial vehicle space is very important to BorgWarner and it's a very intentional strategy. So I don't want people to think that our products are generally light vehicle products and, oh, we could sell them in commercial vehicle spaces. Well, that's not at all the case. We view it as a very key area. And the reason we view it as a very, very key area is the adoption rates for technology in that space around fuel economy and emissions are very, very aggressive. And the types of technology that we have are absolutely going to be needed in those areas. So we believe that we can deliver the type of growth performance in the commercial vehicle space just as we can in light vehicle. And the other tradeup benefit we get there is it just diversifies us a little more. So we're not just purely a light vehicle play. So it's a very important space for us. And people sometimes misread that it's not the forefront of technology, and that's not the case. In our view, it's absolutely a forefront of technology. That's kind of a quick view of it, Brian.

Brian Arthur Johnson - Barclays Capital, Research Division

Okay, great. I want to thank you, James, Ron, Ken.

James R. Verrier

Yes, thanks, Brian.

Ronald T. Hundzinski

Thank you.

Ken Lamb

Thanks very much.

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Source: BorgWarner Inc. Presents at Barclays Industrial Select Conference, Feb-20-2013 10:35 AM
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