How Johnson Controls’ Exit From The Automotive Seating Business Impacts Its Stock

Continuing with its spree of strategic reviews and divestitures, Johnson Controls (NYSE:JCI) recently announced that it was looking to exit its Automotive Seating business. ^[1] The business involves the manufacturing of complete automobile seating systems, foam, metal components and mechanisms. This announcement comes after Johnson Controls had entered a definitive agreement with CBRE Group (NYSE:CBG) to sell its Global Workplace Solutions (GWS) business for $1.475 billion in cash. ^[2]

Johnson Controls’ divestiture spree is the result of the company’s strategic decision to exit low-margin businesses and focus on businesses where it could attain a leadership position. To this end, the company has also divested its automotive electronics business and spun off the majority of its automotive interiors business.

Johnson Controls did not reveal how or when it will exit the business. By exiting the Automotive Seating business, Johnson Controls would be letting go of the segment that makes the largest contribution to its revenues. Despite this, investors responded positively to the news, sending the company’s stock up 5% during pre-trading hours on the day of the announcement. In this article we take a look at why the company intends to exit the business and how various exit options may impact the company’s value.

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Why Johnson Controls Wants To Exit

Johnson Controls is the world’s leading automotive seating manufacturer, occupying 29% of the market. In fiscal 2014, its Automotive Seating business generated $17.5 billion in revenue, contributing more than 40% of overall revenues. ^[3] However, the business has very low operating margins, around 5.0% in fiscal 2014, the lowest of all the segments. Building Efficiency had an operating margin of 6.6% and Power Solutions’ was 15.5% during the same fiscal year. The low margins temper Johnson Controls’ bottom line and cash flow, which is the primary reason it wants to exit the business.

However, exiting the Automotive Seating business would mean a loss of up to 40% of the company’s revenues. It would also lead to a reduction of 28% of its assets. On the flip side, the move should decrease Johnson Controls’ depreciation expenses by around 50% and increase operating margins by 5%.

What Are The Exit Options?

Option 1: Sale To Other Players

One option for exiting the Automotive Seating business is to sell it to other automotive seating manufacturers in the market, such as Magna International or Lear (NYSE:LEA). Players such as Toyota Boshoku or Faurecia might not be interested in the purchase since they generally serve only a couple of major clients, who are also investors in the companies.

Analysts value Johnson Controls’ Automotive Seating segment at around $9 billion. Taking into account this potential cash value, if Johnson Controls were to sell the segment by next year, its stock could see an additional upside of around 5%.

Option 2: Spin-off

There are some issues that could make an outright sale difficult for Johnson Controls. To start with, the company may have a hard time finding a buyer that could purchase its entire Automotive Seating division since there are only a few players in the automotive seating industry that can afford to pay $9 billion. If any of the potential buyers did agree to purchase the business, there is also a chance of running into problems with regulatory authorities. Since Johnson Controls occupies around 29% of the global automotive seating market, any prospective buyer that purchases its Automotive Seating division, would become the dominant player in the market with significant control over market dynamics. For example, Lear is one of the potential buyers that can afford to purchase Johnson Controls’ Automotive Seating business. Lear itself has a market share of around 21%. If Lear was to purchase Johnson Controls’ Automotive Seating segment, it could boost Lear’s market share to around 50%. Regulatory authorities could raise antitrust concerns regarding the competitive environment within the automotive seating industry if a prospective buyer such as Lear expressed interest in purchasing the Automotive Seating segment.

Johnson Controls has the option of spinning off the Automotive Seating business into a new entity. In this case, there won’t be any antitrust issues or the need to spend time searching and negotiating a sale. However, the downside would be that Johnson Controls would not be able to generate the full cash value of the business, as it would likely have to retain a stake in the entity. This cash value – worth up to $9 billion as previously mentioned – could have been used to expand its remaining business lines or acquiring other businesses.

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1. Automotive Review Conference Call, June 10, 2015, Johnson Controls’ News Release [↩]
2. GWS Sale Conference Call, March 31, 2015, Johnson Controls News Release [↩]
3. Johnson Controls 10-K 2014 SEC Filing, November 19, 2014, SEC’s Website [↩]