There’s Something About A Powertrain That’s Magic- Delphi(DLPH) To Spin Off Powertrain Business

In case you haven’t noticed, the automotive space is undergoing a few changes. New players are muscling in and the entire supply chain – from the OEMs all the way down to the Tier 3s – are under siege. As a result, everyone is scrambling to secure their part in the automobile of the future which many expect to be autonomous (or mostly so). Intel’s (INTC) recent purchase of Israeli technology company MobilEye cost nearly as much as Fiat-Chrysler’s (FCAU), an OEM, entire market cap despite the company generating just ~$350m in revenue last year.

The bottom line is electronics and components have become ‘hot’ and the market is reacting accordingly. The latest follower of this trend is Delphi (DLPH), a 1999 General Motors (GM) spinoff, which recently announced plans to spinoff its Powertrain business. The once bankrupt auto supplier is pursuing this strategy because it wants to focus on its electronic components segment which is much more popular these days. This was made pretty clear in the press release:

“Today’s announcement represents an exciting opportunity for our businesses by creating two independent companies, each with a distinct product focus, a proven business model, and the flexibility to pursue accelerated investments in advanced technologies that solve our customers’ most complex challenges,” said Kevin Clark, president and chief executive officer. “At a time of unprecedented industry change, the underlying strength of both our operating businesses and strategic partnerships will allow each company to focus even more sharply on its unique opportunities, continue to develop the very best advanced technologies, and help our customers navigate the road ahead.”

The convergence of technologies underpinning industry megatrends is driving greater demand for advanced electronics and increased computing power to meet consumer preferences for more safety, efficiency, and connectivity. At the same time, regulations for emissions and fuel economy are becoming increasingly stringent globally, requiring advanced engine management and electrification systems to enhance vehicle performance and meet customer demand.

“Looking ahead, new mobility will be defined by the convergence of automated driving, increased electrification, and connected infotainment, all enabled by exponential increases in computing power and smart vehicle architectures,” Clark added. “As a result of our strategy to grow and expand through organic investments, acquisitions, and strategic partnerships aligned to the safe, green and connected industry megatrends, our Electrical/Electronic Architecture and Electronics & Safety businesses are well positioned for significant growth as the only global provider of an integrated ‘brain and nervous system’ of the vehicle. We have the advanced technologies, engineering capabilities, and cost structure to be a global leader in the rapidly evolving mobility sector.”

‘Megatrends’. ‘New Mobility’. ‘Brain and nervous system of the vehicle’. That’s a lot of buzz, but fits with the movement in the industry. The electronics business is expected to be more valuable so it’s no surprise that Kevin Clark, the current CEO, is staying there. It also is involved in advanced safety systems and autonomous vehicles which have a much brighter future. He estimates that the company’s advanced electronics business ‘accounts for about 75% of Delphi’s current market capitalization and is therefore worth around $17 billion based solely on current revenue.’ Eh, no one looks at revenue for valuation, but it’s the bigger business.

The Powertrain business has 20,000 employees worldwide and generated ~$4.5b of revenue in 2016. Margins have historically been in the 10-12% range which is a tad lower than the electronics business. The new company will be led by Liam Butterworth who is currently an SVP of the overall company and President of Powertrain Systems. Tim Manganello, an independent director on Delphi’s board, will become the powertrain’s company’s non-executive chairman.

Dephi’s stock surged on the news, but it remains to be seen whether or not the spinoff actually takes place. Many have speculated that the company has already had discussions with rival Continental AG (CTTAY) about combining their respective powertrain businesses. Mr. Clark declined to comment on that subject to the WSJ, but did note that the spinoff announcement doesn’t ‘preclude somebody approaching us regarding the powertrain business’. Many recently announced spinoffs have ultimately ended up being sold instead and it wouldn’t be a surprise to see that happen here. Perhaps a combination could be structured in a way that maintained a spinoff though.

An initial Form 10 is expected to be filed in June with the spinoff being completed by March 2018. We will keep you updated as the situation progresses, especially the big name reveal. Apparently, one company will retain the ‘Delphi’ name, but management hasn’t decided which one it will be yet. My bet is on the powertrain business and they come up with something new and snappy for the electronics business. What are you betting on?

Disclosure: Author holds no position in any company mentioned.