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Hitachi And Honda Combine Their Automotive Suppliers - This Will Create Value

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About: Honda Motor Co., Ltd. (HMC), HTHIF, HTHIY
by: Christoph Liu
Summary

Hitachi Ltd. and Honda Motor Co. Ltd. are combining their automotive suppliers creating a large diversified group.

Honda will acquire Keihin Corp., Showa Corp. and Nissin Kogyo Co. Ltd. all of which it already is a major shareholder and combine them with Hitachi Automotive Systems.

Hitachi will own 66.4 percent of the joint venture.

The merger comes at the right time as the industry faces the need to develop next-generation solutions and growing pressure for consolidation.

The creation of a stronger group will naturally benefit said group's owners and their respective shareholders.

Hitachi Ltd. (OTCPK:HTHIF;OTCPK:HTHIY) and Honda Motor Co. Ltd. (HMC) have announced plans to combine their autmotive supplier operations under the roof of a new company. Hitachi will own two thirds (66.4 percent, precisely speaking) of the joint venture, while Honda retains the remaining third thus having veto power.

This way, Hitachi and Honda, who have partnered before, create a large and diversified group with leading positions in several products. The combined entity will be Japan's third largest automotive supplier after Denso Corp. (OTCPK:DNZOF;OTCPK:DNZOY) and Aisin Seiki Co. Ltd. (OTCPK:ASEKF;OTCPK:ASEKY) - both of which have close ties to Toyota Motor Corp. (TM).

I believe that this moves comes at the right time as it will enable the new company to face challenges posed by the need to come up with next-generation technological solutions and foreseeable consolidation pressure from a position of strength. That in turn will naturally create value for the owners of that business and their respective shareholders. I will elaborate on my thesis below.

Hitachi Automotive CEO Hideaki Seki and Honda CEO Takahiro Hachigo; source: Reuters

Transaction Structure

The merger will be conducted in two phases. In a first step Honda will seek to fully acquire Keihin Corp., Showa Corp. and Nissin Kogyo Co. Ltd.. Notably, Nissin Kyogo's management is has already declared its support for the offer to be made.

At the moment, Honda own 33.5 percent of Showa, 34.7 percent of Nissin Kyogo and 41.4 percent of Keihin. Currently, that is including price spikes in anticipation of the respective tender offers, Keihin has a market capitalization of about $1.76 billion; Nissin Kyogo of about $1.34 billion; and Showa of about $1.6 billion at current exchange rates (¥1=$0.0092). Hence the takeovers are likely to cost Honda approximately somewhere near $3 billion, give or take. The company should be well able to afford that. For comparison: this is not even a third of Honda's forecasted (fiscal) 2020 pre tax profit.

The second step will be the formation of a new group of which Hand will own a third in exchange for contributing the aforementioned subsidiaries. Hitachi will contribute Hitachi Automotive Systems, which accounts for about 9 percent of the company's total revenue, as well as its IoT platform Lumada.

Creating A Leading Player

The fairway transaction will combine four mid-sized suppliers into one large player with a broadly diversified portfolio and considerable financial weight.

Hitachi reported automotive revenue of ¥971 billion (close to $9 billion) and EBIT of ¥85.3 billion ($790 million; this figure includes proceeds from the sale of Clarion) for the year ended March 31st.

Based on the results of their respective latest fiscal years, Honda's suppliers account for annual sales of about $7.59 billion and pre tax profits of nearly $660 million. Nissin Kogyo contributes sales of $1.71 billion and EBIT of $149 million (fiscal 2019); Showa sales of $2.65 billion and EBIT of $280 million (fiscal 2019); Keihin sales of $3.23 billion and EBIT of $230 million (fiscal 2019) to these figures.

The combined company would account for more than $16.5 billion in annual sales and technological leadership in various fields. For example, Hitachi Automotive Systems is particularly strong in the development and manufacturing of electronic control units. Nissin Kogyo is a leading producer of braking systems, especially for motor bikes where it comfortably leads the pack in terms of global market share. Keihin's core competence is power control systems. Showa's portfolio spans various steering solutions, including steer-by-wire systems.

The group will count most of the largest car producers among its customers and will be particularly strong as a supplier for the manufacturers of motorbikes.

Right Timing

I believe that the merger comes at a right time. The autmotive sectors faces the imminent need to come up with solutions for more environmentally friendly and more autonomous transportation. All four companies have independently been developing self-driving and other next-generation technologies. Together they can achieve synergies in terms of development cost as well as profit from their bundled competencies. That way they might be able to develop better solutions at a faster pace and lower cost.

Furthermore, its sheer size will give the combined company more leverage in negotiations with customers. Since car producers are increasingly squeezing suppliers in order to cut cost, this aspect should not be underestimated.

A larger company will also be better positioned to actively participate in further consolidation inside the automotive industry. Notably there is not only ongoing M&A activity but also some high profile spin-offs coming up. For example, German Continental AG (OTCPK:CTTAF;OTCPK:CTTAY)will be spinning off its powertrain division Vitesco Technologies. If the merger between Fiat Chrysler Automobiles NV (FCAU) and Peugeot SA (OTCPK:PEUGF;OTCPK:PUGOY) proceeds as planned Faurecia SE (OTCPK:FURCF) will be fully spun off as well. Coincidentally, Hitachi sold its stake navigation and infotainment system producer Clarion to Faurecia not too long ago. Within a sector that is set to change its face rapidly going forward, size and financial firepower will be of significance.

Conclusion

I believe that the combined company bundling Honda's and Hitachi's respective automotive suppliers will be better positioned for the future as its parts would be on their own. And this certainly makes it more valuable than the sum of said parts in the long run.

This creates value for shareholders of both partners. This value might be unlocked in the future by way of a separate listing. Notably, Toyota took a similar approach with Denso and Aisin Seiki.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: All research contained in this article was done with the utmost care. However, I cannot guarantee accuracy. Every reader is advised to conduct his or her own due diligence and research.

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