Auto technology: Investment vehicles

Disruption, by definition, is messy business, and it tends to be all the messier when the status quo has been entrenched for 100 years. It may then be logical that as the dust settles on the global car industry’s latest technological shake-up, investors will face a complex new opportunity set that bears little resemblance to a typical digitization landscape. 

Next-generation technologies in the automotive space represent a unique evolution because transport of the human body is the name of the game. This keeps the physical world firmly in the equation, and means that the convergences of silos around hardware, IT and commerce could be even more comprehensive than in seemingly similar concepts such as the internet-of-things.

The latest investment in Indian auto rental company Zoomcar helps clarify this point. The company, which has received private equity backing from firms including Sequoia Capital India and NGP Capital, raised a INR1.8 billion ($27 million) round this month with participation by Ford Motor and an automotive division of domestic original equipment manufacturer (OEM) Mahindra Group.

The main theme is traditional OEMs transitioning toward services – but the operational details highlight further dimensions. As part of the deal, Zoomcar will incorporate electric vehicle (EV) technology into its business, emphasizing the potential for fleet operators to facilitate high-volume innovation rollouts. As similar crossovers between EV, ride-sharing and traditional equipment supply reverberate across the industry, investors will see a wider range of entry points around services that are yet to be defined.

“The business models around mobility services are evolving rapidly and the industry is still nascent, so I expect there will be much room for future collaboration,” says Paul Asel, a managing partner at NGP, noting industry expectations that software and services will represent as much as 25% of OEM income by the end of the next decade. “NGP Capital believes that most of value – rather than revenues – in the mobility space will come from mobility services by 2030.”

Friends, not enemies

Much of the current competitive friction is expected to simmer into a symbiotic value chain as this evolution unfolds. Some companies will be incentivized to create larger ecosystems with new revenue streams and new customers, bringing together several aspects of the car user experience under one roof. Others will take bets on specific areas, hoping to plug into a still malleable market.

In some instances, companies will be inspired to make surprising operational pivots. This was foreshadowed last month when Chinese e-commerce company Meituan-Dianping launched a ride-sharing app in a direct challenge to local peer-to-peer taxi player Didi Chuxing. The boldness of moves to exploit this segment appears rooted in the notion that service, not the cars themselves, is where the opportunity lies.

Although this mantra implies an advantage for ride-hailing giants over OEMs, the nuances around automotive technology adoption trends make it harder to predict how the market will be carved up. Ride-hailing heavyweights are known to develop technology in-house, but going forward, they are expected to be reflectors of innovation driven by specialized R&D start-ups, which in turn are more likely to be absorbed by OEMs.

For example, Didi’s US counterpart Uber is currently dabbling with plans to roll out an autonomous fleet within 18 months, but investor expectations are muted following the California government’s shut-down of a similar program by the company in 2016 due to technical shortcomings. Meanwhile, General Motors has already begun a government approval process under its recently acquired Cruise subsidiary for a car with no steering wheel or pedals.     

In theory, ride-sharing companies are an existential threat to the OEMs because they reduce the need to buy and own a car. However, car sharing means vehicles will be consistently in use, requiring more repairs and faster replacement – suggesting relief for equipment suppliers. As a result, investors are predicting that whatever balance is achieved between the biggest players in services and hardware, it will be contemporaneous and interactive in nature.

“The future of the car industry will definitely be very cooperative instead of one kind of player like OEMs or services companies taking a leading role,” says John Li, a partner at Cathay Capital Private Equity. “Nobody is sure where these new business models will go, but everyone, including OEMs, suppliers and big service companies, are working hard to make sure they aren’t left behind. They’re fighting for a bigger piece of the pie, but they have to be partners to co-exist.”

Li joined Cathay last year to take charge of the firm’s CarTech Fund, which launched in December with a view to raising RMB1.5 billion ($227 million). The fund will work closely with OEMs, including cornerstone LP Valeo, and make early-stage investments evenly split between technology and service-oriented domains. Target categories include connectivity, autonomous driving, ride-sharing and EV.

CarTech extends a raft of auto-focused fund launches in recent months from the likes of Baidu, which aims to invest $200 million in Southeast Asia, and NIO, a Chinese EV maker reportedly looking to raise $500 million. Most noticeably, Japanese giants Nissan Motor and Mitsubishi Motors teamed up earlier this year with France’s Renault to float a $1 billion vehicle with a strong presence in Asia.

Many private equity investors consider these moves behind trend, however, especially considering that it has been eight years since US-based EV leader Tesla Motors went public. Although most OEMs now have at least one petrol-EV hybrid in their portfolio, they have struggled to secure software talent, particularly in the more advanced disciplines such as artificial intelligence. This slowness has been more acute in Asia, where the Tesla wake-up call rang with less urgency.

Going for grassroots

Nevertheless, ongoing needs for mechanical and offline dealership support are expected to underpin the creation of a new generation of IT-savvy, EV-focused OEMs across Japan and China. As a result, many private sector investors see grassroots start-up ecosystems around both the technology and service ends of the industry as equally prospective entry points.

PE and VC firms are advised to target this space carefully, weighing the knowledge base requirements for participating in any particular segment and acknowledging that companies incubated under the wing of a large strategic player may have a bankable but restricted end-game. Depending on risk appetite, previous demonstration of a product in another sector such as consumer electronics is often preferred.

Lower-risk companies with established operational histories, however, could prove to be too mature for private equity investors looking for worthwhile turnarounds in mobility innovation. As players like Nissan continue to experiment at the cutting edge, it is changing the calculus around how soon is too soon for investing in unproven car technology and service start-ups.  

“Strategics investing is a prelude to acquisition,” explains Jenny Lee, managing partner at GGV Capital. “The OEMs are trying to learn about the market, and when the time is right in the next 3-5 years, they are likely to make acquisitions. If VCs choose to wait until they see market leaders, they may be priced out of the M&As. You do have to get in earlier if you want to get your 3x or more.”

GGV plays across the gamut of new mobility, including whole EV cars, two-wheelers, technological infrastructure, and various grades of autonomous functionality including “driver-assistance.” Much of the firm’s interest lies in the idea that as cars become increasingly connected, they will require the same data processing capacity as smart phones but with the ruggedness of a fully outdoor machine.

Data-based service companies, which span ride-hailing to online car purchasing marketplaces, benefit from their ability to leverage existing resources and set up shop with little upfront capital. Success is capital-driven, however, since it is measured by marketing traction in downloads, subscriptions, and the signing up of associated drivers or passenger-customers.

The technology-focused side encompasses not only autonomous driving software but any pure R&D-type companies, including new energy and EV battery materials developers. These investments are more capital intensive initially, but not considered a capital game on the development front. No amount of money will perfect a widget if the research team is not on the right path.

At the start-up level, technology companies are believed to enjoy a broader range of exit scenarios than service plays, which are considered less palatable to M&A markets and usually required to IPO. To some extent, this setup defines technology as a more reliable exit avenue but arguably less likely to be the source of a homerun.

These rules of motion reflect the pressure on OEMs to move into service models as well as the increasing confidence among services giants like Didi to help carmakers independently monetize data in adjacent sectors. The emergence of ride-hailing companies, in particular, as OEM equals can be seen in Didi’s strong negotiating position – the company was able to diversify a recent supplier partnership across 12 different carmakers, including the Renault-Nissan-Mitsubishi joint venture. 

As a result, the existing lack of knowledge base overlap between ride-hailing apps and OEMs is seen as a possibly insurmountable inhibitor to high-level M&A activity between the two business models. In the immediate term, investors expect continued collaborations between major players on both sides to contrast a period of hesitancy around start-up acquisitions. 

“Mobility service providers want to revolutionize the automotive segment by expanding and leveraging their experience in data businesses," says Huu-Hoi Tran, KPMG’s head of automotive in China. “At this stage, not all are likely to want to become carmakers, as they understand that this is a very heavy asset-based business, and that they might not have the necessary expertise. We may not therefore see a lot of mergers between technology companies and OEMs, also because the valuations are high currently and start-ups in this space don’t want to lose their freedom as innovators.”

A young industry

This reminder that the auto renaissance has barely begun is reinforced by a relatively insignificant level of innovation. EVs and hybrid cars make up less than 1% of the global car market. According to the International Energy Agency, China was by far the biggest EV-hybrid market in 2016, but sales amounted to only 336,000 clean cars during the year compared to some 28 million units of conventional models.

Autonomous driving is likewise seen as being in its infancy, despite the fervor that tends to accompany any new technical breakthrough. This could be both a symptom and result of OEM sluggishness. But perhaps more relevantly, it suggests that strategic investment in the foreseeable future may focus less on progressive software than on attracting new customers by creating new ecosystems.

The matrix of supply chains that bind these ecosystems will therefore be varied but not necessarily unfamiliar. To date, some of the most firmly established areas include traditionally low-tech car services like financing and parking. Recent investment on this front includes a RMB1.5 billion round led by Warburg Pincus for a Chinese carpark operator that aims to develop a mobile reservation service and traffic monitoring systems supplied by garage sensors.

Industries such as retail have demonstrated that consumers are quick to pick up these kinds of modernizations and that the big data benefits can be transformative for companies. Mobility overlays this blueprint with important smart city considerations around urban congestion and pollution. This is especially applicable in Asia Pacific, where intercity driving is relatively rare and metro transport networks are often poorly planned. 

Investors approaching the space with a long-range view have begun investigating in-vehicle technology for cars where dashboards and driving instruments are no longer needed. Ford has been toying around with this concept enough to secure a patent for a video entertainment system that projects across the interior of an essentially redundant windshield

For the moment, though, even early-stage VCs are being conservative in their approach, with the likes of Global Brain backing a Japanese cybersecurity company focused on protecting connected cars. Cathay Capital has also identified potential in the space, noting that the car is no longer a closed system, and therefore as vulnerable as it is adaptable. In this context, a new crop of Didi-sized players in other service segments appears all but inevitable.

“There is a lot of opportunity to create a company the size of Alibaba or JD.com in digitizing aftermarket services because the segment is underdeveloped in China even though it’s the largest-selling automobile market in the world,” says Cathay’s Li. “Companies like NAPA Auto Parts and AutoZone have established the business model in the US; we don’t have that in China yet but we would love to see start-ups become notable players in this field in the near future. That’s something we’re really looking at because if you can digitize aftermarket distribution services, it could be an area as big as ride-sharing.”

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