Federal-Mogul's future questioned after Icahn buys Pep Boys

DETROIT—When Federal-Mogul Holdings Corp. this month scrapped its plan to split in two, it raised eyebrows because it came right after its largest shareholder agreed to acquire the auto parts chain Pep Boys-Manny Moe & Jack.

So far, any connection between the two moves remains theoretical.

But the timing has raised more questions than answers about the future of the longtime auto supplier of engine parts and well-known aftermarket brands such as Champion spark plugs, Anco wiper blades and Moog steering parts.

Federal-Mogul pointed to market conditions as the culprit behind its decision not to split its aftermarket parts division from its powertrain division.

Billionaire Wall Street investor Carl Icahn, an 82 percent stakeholder in Federal-Mogul, won a $1.03 billion bidding war for Pep Boys, and experts believe he'll use the parts retailer as a mainline for Federal-Mogul parts but fear his vertical integration strategy will hurt the company over the long term.

Pep Boys' 800 stores, paired with Icahn's other aftermarket retailer, the 278-location Auto Plus, would make up the fifth-largest retail auto parts chain in the U.S. Even with Pep Boys' stores, Auto Plus would be significantly smaller than rivals Advance Auto Parts Inc., Autozone Inc. and O'Reilly Automotive Inc.

The decision to call off the split and Icahn's Pep Boys acquisition comes in the midst of global financial headwinds faced by Federal-Mogul.

A Federal-Mogul spokeswoman said currency exchange from Brazil, Europe and Asia were the deciding factors in ending the split.

Currency fluctuations evaporated 10 percent of its earnings in the third quarter of 2015, according to an investor conference call.

The spokeswoman declined to discuss whether the Pep Boys acquisition played a part in the decision.

Federal-Mogul announced the split 16 months ago through a tax-free distribution of shares from its aftermarket parts division, which it renamed Federal-Mogul Motorparts in May 2014, to current Federal-Mogul shareholders.

The company began restructuring its aftermarket parts division in 2012. Federal-Mogul historically underperformed in the aftermarket sector, which led to red ink for the company as a whole, including a $161 million loss in 2014, though its aftermarket sales were up 10 percent.

Earlier this year, Federal-Mogul launched its Garage Gurus program to teach auto technicians the value of its aftermarket brands. The program was designed to boost its aftermarket parts sales.

But aftermarket revenue fell an additional 5 percent in the third quarter of 2015.

The U.S. automotive aftermarket is forecast to grow at an annual rate of 3.4 percent through 2017, according to a joint review by the Automotive Aftermarket Suppliers Association and the Auto Care Association. Total aftermarket sales are projected to grow from $238.4 billion in 2013 to $273.4 billion in 2017, according to the group.

Fred Hubacker, managing director of Birmingham advisory firm Conway Mackenzie Inc., said the splitting of its aftermarket business from the rest of the operations made sense at the time, but the market conditions made it an impossibility.

“Obviously market turmoil made this the wrong time to approach the split,” Hubacker said. “It's another speed bump for a company that always seems to be drifting. The company never seems to really go anywhere and isn't considered a great innovator.”

Wall Street also hasn't viewed Federal-Mogul favorably as it struggles to find a strong path to profitability.

Since January 2011, Federal-Mogul shares have plummeted about 80 percent. It lags behind most of its peers, such as Magna International Inc., whose stock has risen 20 percent over the same period, and BorgWarner Inc., which has seen a decline in share price of nearly 14 percent.

Federal-Mogul shares fell another 6.3 percent today to close at $4.47—the lowest closing point for the shares since the Great Recession.

The Pep Boys acquisition by Icahn isn't expected to do Federal-Mogul any favors in the long term, said Tony Cristello, managing director of equity research for Richmond, Va.-based BB&T Capital Markets.

While Federal-Mogul may gain some initial market share from Pep Boys and Auto Plus, larger retail competitors may pull back on Federal-Mogul parts, he said.

“If you're buying from Federal-Mogul and now suddenly they are a competitor, do you really want to be supporting that competitor?” Cristello said. “By buying Pep Boys, (Icahn) has created a huge conflict of interest. I wouldn't be surprised if Pep Boys is the tipping point for Federal-Mogul's customers to look for other options.”

Cristello said the bottom line is that Federal-Mogul makes higher-quality but higher-priced parts than foreign competitors at a time when customers are more price-conscious.

“This has put them in a bad position, and they've got to find a way to overcome that, which they still haven't done,” Cristello said. “Maybe (Icahn) isn't done doing acquisitions, but we're still not sure whether he'll be successful (in making Federal-Mogul more profitable).”