January Auto Tech: can M&A in the Auto Tech sector get any hotter?

David Riemenschneider

If you’re reading this blog, there is a good chance you already know that M&A activity in the auto technology sector is hot, increasing not only in value, but also the volume of deals completed.

As we researched and presented in our December Automotive Technology Spotlight report available here, there are big deals happening in the sector from both strategic and financial buyers, but the more interesting trend we’re seeing is the increased focus on micro-deals.

Why the focus on micro-deals?

We’re seeing an intense focus from OEMs, T1s and new auto sector entrants (e.g., Apple, Google) in auto tech, specifically in ADAS and autonomous driving technology, in addition to a few extra hot sectors.

Some of the recent deals have been in hardware that make the technology above work (e.g., radar, sonar, camera hardware), but most of the activity is in the embedded software and services side of auto tech. Many of these innovative firms are (very) small by automotive M&A standards, often with a limited customer base and tend to be tucked away in or near university towns where the technology was born. It’s no wonder why it’s often difficult for those looking to acquire this type of technology to find it, and also of interest, why some of these small firms often struggle to find advisors to represent them; the usual financial metrics that are typically used to assess value (and how worthwhile it will be to represent one of these firms) do not apply as many of these firms are breakeven at best and/or the advisors don’t understand the dynamics of this industry.

We define micro-deals in automotive as those with an enterprise value of less than $10m. We all read about the larger deals taking place in the sector, those in the $250m-$1b plus region that tend to consolidate supply chains and merge technology to create a large technology hubs, but it is often the same OEM or T1 M&A team that are out hunting for these micro-deals, which is something they often struggle with as the deal size is too small to get their attention and focus.

Why micro-deals? It’s all about IPR and securing technology in-house. The technological push toward autonomous driving solutions and enhanced safety has few standards, so it’s a bit of a free-for-all out there. While ISO 26262 does bring in some basic standards into design and verification, how technology is developed and deployed is often OEM centric, and these proprietary solutions depend on unique set of code, often sourced from a small local supplier. The motivation of T1s and OEMs in pursuing such small acquisitions can often be the need to secure this IPR to ensure stability in their vehicle design and advanced electronic feature go-to market strategy, but often of equal importance, to prevent a competitor from obtaining the technology.

100m lines of code

We heard a recent CES 2016 presentation that some advanced vehicles are now approaching 100m lines of code. While this is often compared to the NASA Space Shuttle program to help understand the magnitude (which stood at about 400k lines of code), I’m not sure we should be comparing a 2016 BMW i8 to technology that was essentially designed in the 1970s. The message, however, is clear that cars are getting more complex, more interactive, and even more intuitive, and all of this relies heavily on embedded software engineering.

Where vehicle system complexity does mean something is in system integration and performance within the on-board vehicle network, because this much code must be designed, developed, simulated, tested and deployed at a cost affordable to the consumer.  This complexity, once designed, needs to be stable, and acquisitions within this technology supply chain makes sense by bringing the IPR in-house, where it can be further developed, and more importantly, protected from others looking to develop a same/similar set of features.

What technology is hot?

As already mentioned, those firms producing hardware, software or supplying essential services such as embedded software testing, simulation and/or verification are likely acquisition targets.

Other sectors that are seeing a sharp uptick in activity are those in advanced display technology, such as HUD and augmented reality, combining the use outboard cameras to project displays on interior glass surfaces to remove blind spots (see this LandRover video for good example). We are also seeing an increased focus on interior display technology with the likes of NVIDIA making a big push into advanced instrument panel display features.

Even navigation software, a bit passé over the last few years, is getting a boost from augmented reality features providing far more content to the driver than just location.

Auto Stats

Steadily increasing valuations in the automotive software space since 1H2014 may not sustain much longer, especially as transaction count continues to rise as well

Non-traditional buyers

Not only are the likes of Apple and Google driving acquisitions in this sector as mentioned earlier (they’re also poaching a lot of engineers from T1s and OEMs), but we are seeing the telecoms and semiconductor firms enter the sector, both trying to add value to their hardware to ensure they stay relevant.

Market timing

It is our belief that for at least the first half of 2016, this sector will continue to be very hot, which will maintain or even further push valuations.

There are, however, a few clouds on the horizon. Vehicle volumes in the US are at record levels and many feel it will be challenging to maintain this momentum in 2016. In Europe, volumes were reasonably strong in main Western Europe markets during 2015, but several European OEM CEOs see white-water ahead in 2016 as the market will begin to contract (again).

At Hampleton, we’re interested to see whether the sales volume downturn will spur an increase or decrease in R&D spend, the push for added electronic feature content, and whether this will curb spending on areas of research like autonomous driving. It also remains to be seen how the regulatory environment will impact autonomous driving spend, although regulators seem to be easing restrictions that should help.

We think it will be interesting to see how consumers continue to react to the introduction of autonomous features because the reaction to the last hot trend (vehicle electrification) has been lukewarm at best, which has had an impact on M&A in that sector. The question we see as open is whether consumers are willing to commit with their wallet to autonomous features, when autonomous driving is available everywhere, from Detroit, to San Francisco, to Mumbai. We at Hampleton believe it is still a seller’s market and will continue to be that way for the next 6-9 months, so companies looking for an exit may want to consider starting a process now.

If you would like more information about industry trends or activity in the market, please contact me at davidr@hampletonpartners.com.