Private Equity International: A Q&A with our Mobility Thesis Lead
Driving Towards Opportunity in Mobility. Electrification and other tailwinds mean that investors can access a host of opportunities in the automotive supply chain, says Partner and Mobility Thesis Lead Justin Steil.
The automotive sector is experiencing nothing short of a revolution. Electric vehicles (EV) – which just a few years ago were a fringe technology – have become mainstream. The International Energy Agency reports that EVs accounted for 14 percent of global new car sales in 2022, up from just 5 percent two years earlier. Justin Steil, a partner at MiddleGround Capital, explains how private equity firms and investors can access opportunities from electrification, as well as from the development of lighter-weight materials and the growth of autonomous and connected vehicles.
Q: What is your investment thesis for the mobility sector?
Right now, we are looking at a once-in-a-lifetime opportunity in the mobility industry. I grew up in Detroit, the Motor City, and two of MiddleGround Capital’s founding partners spent a large part of their careers working at Toyota. From our vantage point, we can see that the automotive industry, which is often seen as a very mature industry, hasn’t experienced this level of change since its beginnings. Our investment thesis is built around taking advantage of what we see as four key trends in the industry. The most obvious one is the electrification of the powertrain. Added to that, we see opportunities in the growth of lightweighting technology, the rise of connected car technology and advances in autonomous vehicle technology.
Q: There are differing views on the pace and extent of electrification that will happen in the auto industry. Where do you stand?
Electrification is happening at a rapid pace – much faster than people would have believed a few years ago. The steady climb in EV adoption is just remarkable. If you rewind the clock to 2020 and look at the forecasts being made for EV demand, we are now well ahead of what was being forecast then. In the US, about 8 percent of vehicles on the road are EVs. But the number of EVs being sold is increasing at 50 percent a year – which means that EV penetration has gone from almost 0 to 8 percent in just the last three years. That is nothing short of remarkable, given this industry is known for being so mature and entrenched.
Furthermore, in pockets of the country EV adoption is much higher. About one-third of cars in parts of California are EVs, for example, which shows what can be achieved with a progressive regulatory regime and significant investment in charging infrastructure. Costs are going to continue coming down, both for EVs themselves and for home charging infrastructure. With each passing day, the industry is innovating. Battery technologies are improving. EVs are getting more and more miles out of a single charge. We expect all this to continue at a very brisk pace. Ultimately, electrification is a more sustainable source of propulsion for vehicles. It reduces emissions. Consumers are much more conscious of those things than they were 10 or 20 years ago. So electrification of the powertrain is real, and there are tangible benefits to both the driver as well as the planet for us to continue along the EV adoption curve.
Q: To what extent are you seeing co-investment appetite from LPs in the mobility sector?
We are attracting co-investors that have developed their own interest in this space. Often, as institutions, they are focused on reducing their carbon footprint and they see mobility as an avenue to put their capital to work. Then we have other co-investors who know about us, and our Toyota roots, and our experience around the automotive sector, so they view it as our sweet spot.
Alongside our flagship fund, which is a diversified fund focusing on manufacturing and distribution businesses in general, we decided to raise a dedicated mobility pool of capital. This acts as an overage fund, meaning that when we invest in mobility, some of that investment will go in our flagship fund and some of it will go into our mobility fund. The mobility fund acts as a way to do more without over-concentrating the flagship fund with mobility investments.
A lot of our LPs, ever since we established MiddleGround Capital, have expressed interest in co-investing. It helps them stay closer to the investment and it helps them put more dollars to work on a more economic basis. The fees and the carry with co-investments are lower than they would be in a private equity fund. At the same time, those co-investors give us additional firepower to do more, go bigger and look at different kinds of profiles within automotive and mobility. Our co-investors have helped us take fuller advantage of this opportunity set while balancing mobility with the other industries that are in our flagship manufacturing and distribution fund.
Q: Why is lightweighting important?
Lightweighting is a big trend right now, and it goes hand in hand with electrification, because reducing a vehicle’s weight allows for either longer distance or higher speed on the same amount of fuel – in this case, a battery charge. One of the biggest impediments to even faster adoption of EVs is that people are concerned about the battery range. They might only be able to drive 200 miles before they run out of charge, so they worry about getting stuck. Historically we have talked about miles per gallon – we’re now talking about miles per charge.
Material science is advancing rapidly. Whether it’s plastics, composites, aluminium or high-strength steel, never before have we been in a position where we can really innovate to this degree in replacing heavier materials from legacy designs with newer materials.
Q: Why do you see opportunities with autonomous and connected car technology?
When we talk about autonomous vehicles, people tend to think of driverless cars. But there are a lot of applications being supported by increased innovation around autonomous vehicle technologies. These include blind spot monitoring or parking assistance, which are increasingly adopted in today’s cars. Again, this trend is happening faster than was anticipated just a couple of years ago. We probably aren’t going to get driverless cars as fast as people may have hoped – but the driver experience, the command of the vehicle and the safety of the vehicle are all being supported by autonomous technologies today.
We are also seeing rapid changes in connected car technologies. If you have a smartphone, you can probably connect your phone to your car. The technology already exists today for your car to connect to the traffic light system, for your car to connect to cyclists and pedestrians, and certainly to connect to other cars.
There must be some level of infrastructure investment to support a broader rollout of these connected technologies. But in the future, safety is going to be enhanced by connected technologies. Cars could be alerted that there is a pedestrian in the road, for example, or these technologies could help create more efficiencies on highways by connecting traffic flows with stoplights.
Q: As a mid-market-focused private equity firm, how do you access these opportunities?
The automotive sector can be very challenging. Your customers can be tough, your vendors can be tough. But we are a long-term investor in manufacturing businesses and, given that a lot of our leadership trained within Toyota, we have significant experience in the automotive sector and we know how to operate profitably. Up until quite recently, the automotive world was all about steady but relatively small rates of growth. The focus was always on incremental operational improvements to enhance profitability. Now, because of the trends that we have talked about, there is a lot more opportunity. We are continuing to focus on operational efficiencies, but we are also benefitting from tailwinds to accelerate revenue generation. This is a very exciting time to be investing in mobility and automotive.
For example, we are invested in a company called Plasman, which produces painted plastic parts for the automotive industry. All of a sudden, after an already long history, Plasman is in much greater demand in the marketplace, because there is much more painted plastic on an EV’s exterior, and many of the sensors that support autonomous vehicle technologies go onto painted plastic parts. This is a great example of a long-established business that is benefitting from faster growth because it is well-positioned to support the adoption of EVs and autonomous vehicles.
Q: What are the key risks to manage in the mobility sector?
If any industry has gone global in the last few decades, it is automotive, and we learned during COVID-19 that globalization can bring challenges. Now, in response to that, there is some reorganization in supply chains. Nearshoring and reshoring are definitely happening.
The supply chain disruption, which in the automotive sector mainly came from the semiconductor shortage, gained steam in 2021 and was largely mitigated by the end of 2022, although inflation also picked up during that period, presenting another big challenge. Overall, production volumes are still well below pre-COVID levels, but we have seen stable and steadily growing production volumes over 2023, which is helping companies in the supply chain.
A lot of the risks in the industry can be opportunities for us. There are meaningful opportunities around near-shoring, as supply chains come back to North America. There is constrained liquidity in the sector because of the COVID and post-COVID disruption, which has led to what we call ‘good company, bad balance sheet’ situations. We can help with that because we have dry powder and we are very much on the hunt for good companies. We can help ease their financial constraints and help them go after this opportunity set.