OUTLOOK FOR ELECTRIFICATION OF THE AUTO INDUSTRY

Keith Spacapan, Vice President of Hilco's Automotive Practice, discusses plans by global auto manufacturers for continued aggressive expansion of their electric offerings, as well as the technologies that are competing for dominance in the market right now.

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Steve Katz:

Hello again and welcome to the Hilco Global Smarter Perspective Podcast Series. I'm your host, Steve Katz. Today, we're speaking with Keith Spacapan, Vice President of Hilco's automotive practice about plans by global auto manufacturers for continued aggressive expansion of their electric offerings, as well as the technologies that are competing for dominance in the market right now.

Steve Katz:

Just as a little quick background, ABLs and manufacturers alike have achieved a high level of success across numerous industries in partnership with Hilco Valuation Services, based in large part upon its disciplined process, industry-leading bench strength, systematic and collaborative approach, and other factors that you'll hear about when Keith jumps on the podcast with us.

Steve Katz:

Throughout the pandemic, HVS has amassed critical insights and data that are enabling delivery of highly accurate valuations across automotive manufacturing and the associated supply chain during this highly volatile period. With that said, welcome to the podcast, Keith.

Keith Spacapan:

Hi Steve. Thank you for having me.

Steve Katz:

Great to have you on. I know you and I have spent a lot of time talking about a lot of these automotive topics over the years, and it's great to get you on and share some thoughts with us, so welcome.

Steve Katz:

So Keith, as we look into this EV topic, it's been about 10 years since Nissan first launched it's all electric Leaf, which my neighbor has one of them sitting in his driveway. At that point, they became the first auto maker to mass produce a vehicle of that type. So multiple manufacturers have indicated that they're planning to eliminate new vehicles with gasoline and diesel engines entirely in the next 15 years, it's worth noting that many longstanding brands have yet to fully commit to an EV platform-based future.

Steve Katz:

So with that said, it seems like things are progressing very slowly, and I think a lot of people are wondering how prolific are EVs going to be? My question is who's on board from manufacturing side, who's not, and why is it taking so long to achieve an electric future on the road?

Keith Spacapan:

Thank you, Steve. I'd say that at this point, everyone in the industry is on board to some extent. As we highlighted in the report, GM committed $27 billion to the cause, Volkswagen committed to do what's necessary to be the world's largest manufacturer of electric vehicles, and Volvo committed to an all EV lineup by 2030. However right now as it stands, Tesla is the only mass market manufacturer of electric vehicles that is 100% committed to the technology.

Keith Spacapan:

While Tesla sold a record 200,000 vehicles, thereabouts, in the second quarter worldwide, electric vehicles still represent less than 10% of all vehicles sold in America, and that includes hybrids and plug-ins. If we only look at pure electric vehicles, that number's closer to only 2%. So I agree with you, it seems like we're moving slowly. If we want to move electrification more quickly, then we need to set that bar higher.

Keith Spacapan:

Steve, I'd like to turn the table around for a moment and ask you a question. Would you buy a car without airbags to save $225 on the sticker price?

Steve Katz:

I would not.

Keith Spacapan:

Right answer. I think your life is worth more than $225.

Steve Katz:

It is.

Keith Spacapan:

But in 1974, not as many people shared our view. In 1974, General Motors developed the first commercial airbag system, and I remember it, and offered it as an option on certain luxury models for as little as $225. The cost of the system was significantly more than the price of $225, but the market research they had done at the time indicated that the perceived value to consumers was significantly less, so they couldn't afford to charge more.

Keith Spacapan:

So that being the case, if their system had been made standard, as opposed to an option, then General Motors would have run the risk of losing a lot of customers. Even though they felt it was a competitive advantage, they would have lost a significant amount of customers, because customers would have been, based on their market research, interested in buying a competitor product in order to avoid that big premium of $225. It's a good thing they didn't do it, because in the end only 10,000 customers ever opted for the airbag system over the course of three years on several models before GM decided to pull the product altogether from the market.

Keith Spacapan:

So, the reason I bring this up here is because airbags would still will be just a concept without a viable business case if the US auto industry in conjunction with the US government hadn't set the bar higher. General Motors' early foray into airbags I feel was evidence there was no way manufacturers were going to voluntarily add the expensive systems such as airbags to vehicles without knowing their competitors were going to do the same thing. They couldn't afford to.

Keith Spacapan:

Remember at the time, consumers were resisting the cost of relatively inexpensive seatbelts and the idea of adding an airbag and all the expense, again, that was only $225 they were going to charge the customer, but probably cost five times that much to actually put it in a vehicle. That was just simply a non-starter. However, as the auto industry in conjunction with the US government increased the vehicle safety requirements for all manufacturers and thereby leveled the playing field, the additional cost to build that safety into every vehicle was not seen as a penalty, but as the cost of doing business. I've oversimplified that story, there's a lot of steps along the way. It occurred over many years, but that is the Reader's Digest version of it.

Keith Spacapan:

So in summary, if we wanted the development of electric vehicles to move more quickly, then we need to take a page from the industry's playbook for the implementation of safety restraints. That is, if we want development of electrification to happen faster, then we need to set the bar higher. The European Commission just proposed 2035 as the cutoff date for internal combustion engines. I am confident that American ingenuity can achieve the same thing.

Steve Katz:

Great analogy there and the historical references, it's really relevant. It's hard to imagine a time, and I do unfortunately remember it because of my age, seatbelts weren't the norm and people resisted that. So jumping over that next hurdle of airbag and pretty closely following that, guess a lot to ask, but today it doesn't seem like such a leap at all and I appreciate that. That was a great way to get us started.

Steve Katz:

In a lot of industry, it seems like a great deal of the pressure for US manufacturers is being pushed along right now by what's happening in China on the Chinese automotive market. They're very aggressive, the government's backing a lot of these efforts related to EV development. Can't remember how many of these companies they have there, but there's a significant number of companies producing vehicles already.

Steve Katz:

I read recently their projected rate of growth for new energy vehicles in 2021 is something like 40%, which is huge. Ford has some big pickup news recently, maybe you can talk about that and the importance of other announcements that we've seen domestically already this year that are either in response to what's going on in China or just US ingenuity.

Keith Spacapan:

So I know that I want to focus my response, Steve, on Ford, and I want to focus my response to what's going on here in the US. But I think before I do that, I think we need to note that none of the global manufacturers can avoid what's going on in China, let alone in Europe. China alone represents a third of all new vehicles produced today and what they require and demand of the manufacturers, that's going to have a follow on impacts in terms of what happens in the US and in Europe.

Keith Spacapan:

When it comes to your comment about the 40% growth, electric vehicles still represent, as we indicated earlier for the US and it's not that much different for China at this point, still represent a relatively small percentage. When you're coming off a really small base, it's much easier to get a 40% increase than when you got to mature a market to get 40%. You won't see it anymore. But the fact that they're growing by 40% is just an indication of just where it's coming from right now and how fast this thing is moving.

Keith Spacapan:

But getting back to your question about Ford and their announcement. At that time we published our article, Ford had just unveiled an electric version of its popular F-Series pickup, and five years ago Ford used that very same platform to introduce the general public to the versatility of aluminum body vehicles. Ford is now using that very same F-Series platform to introduce the general public to another much more far-reaching development, and that's electric vehicles.

Keith Spacapan:

There are now 300 million registered cars and trucks on American roads today, and at an average annual build rate of 15 million cars and trucks per year, it would take us two decades to replace that current car park with all electric vehicles. That timeframe assumes that every vehicle sold is electric. However, at the current adoption rate which is much slower than that, it would take probably closer to four decades for us to actually transform completely from internal combustion engines to electric.

Keith Spacapan:

The shift to electric is just not going to happen by us introducing high-end niche expensive electric vehicles. To make real progress, like the percentages you mentioned earlier, high volume vehicles need to make that leap to electric. For the US market, there's no higher volume vehicle than the F-Series pickup. Boston Consulting Group estimated that the Ford F-Series platform generated $42 billion in revenue in 2019 from selling nearly 900,000 vehicles in the US. To put that into perspective, that is more revenue than McDonald's, Nike, Coca Cola or Netflix.

Keith Spacapan:

Initially Ford is not proposing every 150 be electrified, they're taking the approach that they're going to let market demand dictate just how fast this transition happens. But to me, it seems appropriate that Ford start this process, this journey of electrification with the vehicle it finally refers to as the company's foundation.

Steve Katz:

Very interesting. Let's shift the discussion a little bit and talk about emissions, because I know what's at stake in terms of the environment is huge here, and that's driving a large part of what's happening in the development of these EVs. So reducing emissions is a top priority for most manufacturers, but determining how to accomplish it in the best way really remains a topic of some significant debate. What thoughts can you share with the audience on the competing technologies that are at play moving forward and whether one is really going to win out over the other?

Keith Spacapan:

Thank you, Steve. I want to respond to that by first narrowing down that question, because I don't think the question is internal combustion engines versus electric. Because compared to internal combustion engines, if you look at an electric motor, they're quieter, they're cleaner, they're lighter, they're simpler in terms of how many parts are involved. I saw one number where the average electric motor has less than 20 parts, whereas the typical combustion engine, depending how many cylinders you have, has an average of 200 parts. Considerable difference. They're faster, they're stronger and they're more efficient.

Keith Spacapan:

So if it wasn't for the battery, there would not be much argument as to whether electric propulsion or combustion wins, it's electric propulsion hands down. Unfortunately for now at least, the batteries are expensive, they're heavy and they're time-consuming to charge. For that reason, I think future of electric vehicles hinges on what battery technology will win out in the long run. So to me, the critical question about this technology and who wins out is all about the battery and what battery wins out.

Keith Spacapan:

Now Tesla, we talked about them earlier, is the most high-profile company in this space, and they have placed their bet on lithium-ion batteries. Now, Tesla shows an established technology. Lithium-ion batteries have been a reliable source of energy for computers, power tools, cell phones, but for these applications, they weigh less than a pound, they can be recharged in an hour, which doesn't seem long considering what application they're being used for, and then they can be replaced for less than $10.

Keith Spacapan:

However, a 75 kilowatt lithium-ion battery to power a car a minimum of 250 miles weighs more than 1,000 pounds, takes nearly a half a day to charge at home and cost at least $10,000 to replace. The good news is there are many alternatives to lithium-ion batteries that are currently being worked on, many competing technologies. The bad news is every single one of these has an Achilles heel of one sort or another, but the good news is that means we're only one breakthrough discovery away from solving the problem.

Keith Spacapan:

Look what happened when all the world's brightest put their minds to solving one of the greatest calamities in modern times, not only did they develop one vaccine in record time, but multiple. Right now, there are a lot of very smart people with billions of dollars of funding working on electric transportation solutions on battery, and some solutions don't even require a battery. Personally, I can see the day when the fine print on the window sticker says electric car, batteries not included.

Steve Katz:

Keith, I love the way you come at these answers. I mean, you come with your own angle on it and it's really so poignant in terms of what's going on. It certainly helps me to crystallize what lies ahead, so that's why I love having you on here.

Steve Katz:

So I guess my next question is, with the pace of electric vehicle adoption overall just continuing to increase at a pretty rapid rate, it seems like there will be some major implications for the commodities industries that supply the automotive industry, such as mining and metals and the energy sector. What are your and the automotive team's thoughts in terms of what we're going to see in the future in terms of that?

Keith Spacapan:

In a word, turmoil. What we are witnessing, I think, is tantamount to a paradigm shift that will transform the market for personal transportation in the same way smartphones transform personal communication. As we discussed in the article, the journey began before you and I were born, but it's developed is just now approaching its tipping point. In 1995, the United States was the largest producer and consumer of lithium. Lithium carbonate, which is the mineral they mine for its lithium content sold for $5 per kilogram. Global annual mine production was only 6,000 metric tons, and when you looked at its list of uses, batteries didn't show up.

Keith Spacapan:

Now fast forward 25 years, global annual production exceeds 85,000 metric tons and practically none is mined in America. The market value is approaching $10 per kilogram, so it's generally been up. Although more recently it's been very rocky, more like some of the other commodity markets we're seeing, and 75% of it is used for batteries. So there has been this dramatic shift in the last 25 years, but the question remains, is lithium part of the long-term solution?

Keith Spacapan:

The market for carbon fuels in their applications evolved over many years and matured. For now, the industry will continue to squeeze, I think, more from lithium technology, but I suspect it may be nearing its practical limitations. As we discussed earlier, there are many competing technologies being pursued and only time will tell which one wins.

Steve Katz:

Okay, let's turn the discussion toward two critical things that have to occur in order to enable a true EV future for automobiles. First is the build out of a widespread user-friendly infrastructure, which is no small task, and of course consumer adoption, right? Two things that are obviously not mutually exclusive.

Steve Katz:

I know the new administration has prioritized national EV charging network, and many of the people personally that I know, that's one of the top complaints is that they get on the road, they feel that there just aren't enough of these charging locations that they can map out and they can use based on where they're going, particularly when they're taking longer trips. What else is taking place to move the infrastructure forward and what are going to be the biggest challenges for adoption in your viewpoint?

Keith Spacapan:

Well, just staying with the charging network for a moment. The infrastructure bill just passed by the Senate does include $7.5 billion to build out a national network of EG charging stations. Originally they were looking at a network of 500,000 charging stations. They're only getting 7.5, they were looking for 15, so maybe the charging network is half that size. That's a huge number, much larger than our current network of gas stations, but when you consider how long it takes to charge a battery, as opposed to the 90 seconds it takes to fill a gas tank, maybe there needs to be that many more.

Keith Spacapan:

But there's a whole lot of issues tied up into that, and I don't want to get too much into that, it's probably in a whole nother podcast. But suffice to say, in that bill there's $7.5 million. Yes, pointed out the absence of a charging network on a scale we're accustomed to with gas stations is an issue, but I don't think it's the most immediate issue. It's one of them, I don't think it's the most immediate.

Keith Spacapan:

As discussed earlier, the form of the battery takes in the future is still evolving, so I don't know that we really know what form the infrastructure can take until we know exactly what those battery, what form they take. Chemistry, what geometry, do we even have a battery? Do we do battery swapping? There's so many options. In the end, I think that the capital involved to construct a charging station is relatively small and very scalable. Not in total, but for each individual station it's relatively small and scalable, and I don't think when the time comes there'll be any lack of capital available to build that out as appropriate in a relatively quick fashion. I think that can respond pretty quickly, I don't think probably need a lot of government intervention.

Keith Spacapan:

In contrast, I recently did some research and saw an estimate that the cost to replace the country's electric grid is $5 trillion. That is a five with 12 zeroes after. I'm not used to seeing numbers that big. I actually typed it out and I had to count it, and I don't know how much time I spent getting my mind wrapped around that, but we're going to see that number more often it appears. But assuming that the average useful life of the equipment is 25 years, the cost to maintain and upgrade that system is a minimum of $200 billion annually. These are real global numbers, I want to set a framework, but the current infrastructure bill only includes $73 billion to upgrade the aging electric grid.

Keith Spacapan:

Another fun fact that I stumbled upon is that a recent Department of Energy study found that the annual power outages alone nearly cost that much. Our economy spends nearly $73 billion a year just to compensate for the outages, let alone upgrade the system. So bottom line, my perspective, the proposed $73 billion spending bill over multiple years, that's not for one year, that's over multiple years, is a fraction of what we should be spending if we want to maintain the country's competitive status in this global economy.

Steve Katz:

Yeah, that's quite a discrepancy. Just add that to the list of complexities associated with evolution of EV technology, and getting the adoption that's going to be necessary, plus and add to that all the autonomous vehicle technology, the chip shortage now going to happen moving forward with those resources as we continue to move forward.

Steve Katz:

So to wrap us up, I know you have some critical takeaways you wanted to share with the audience, specifically with lenders who have current portfolio exposure to the automotive industry. What are those?

Keith Spacapan:

In the article, we're urging lenders to actively engage with their borrowers to, number one, ensure that a company's strategic plan anticipates electrification, to assess the leadership's sense of urgency with respect to electrification. It's one thing to have a plan, but no sense of urgency. Does it matter to determine the percent of the company's research and development budget that is related to electrification? In other words, you may have sense of urgency, you may have a plan, but if you ain't putting your money behind that plan, again, it's pretty empty. Along those lines, to determine the percentage of the company's capital expenditures that are related to electrification.

Keith Spacapan:

Finally, we're urging lenders to assess strategic partnerships that a company engages in. There's no way given the complexity, and we only just kind of touched on a bunch of issues, and I was so tempted to go off in many different directions, you keep corralling me, thank goodness. There's no way you're going to solve all these issues unless you have partners. So, what are they doing about the strategic partners? What are they doing about identifying these issues that they can't address themselves internally and relying on a strategic partner to address them?

Keith Spacapan:

Now Steve, to stay informed of the market for automotive parts, I hope our listeners are following the Hilco Parts Index. The Index includes the largest public companies in this space. As part of that exercise, I listened to the quarterly earnings calls of each of the companies involved, and I have to say, I'm underwhelmed with the attention given to the developments in electrification. I could count on one hand the number of times I've heard the word electrification or any derivation of it referenced in one of these earnings calls.

Keith Spacapan:

Given this lack of attention, it's hard for me to imagine that they have a strategic plan for electrification and if they are implementing with any sense of urgency. Electrification of transportation is in our past and is in our future, there's a lot of money invested in the development of electrification and the rest of the world is committed to the transformation with or without us. We can't afford to be left behind.

Steve Katz:

Great points, Keith. Yeah, I think following the Index is a great idea, specifically because you're kind of doing the heavy lifting on that, really monitoring those calls and encapsulating all of the key thoughts into those. So yeah, we encourage everybody to look at those, and they're up on the Hilco website as well for those who don't already know that.

Steve Katz:

Everything Keith just said is a great reason, for those of you who are listening today, to reach out to Keith and the automotive team at Hilco for discussion sooner than later. With that in mind, Keith's email is keithspacapan@hilcoglobal.com. That's K as in Keith, S-P-A-C-A-P-A-N@hilcoglobal.com.

Steve Katz:

Keith, great stuff as always. Thanks so much for sharing your perspective on the EV market and developments that you see coming down the pike, and obviously some of the potential roadblocks that are in the way right now. Really appreciate it.

Keith Spacapan:

My pleasure, Steve. I hope it was helpful.

Steve Katz:

It definitely was. Listeners, we hope that today's Hilco Global Smarter Perspective Podcast provided you with at least one key takeaway that you can put to good use in your business or share with a colleague or client to help make them that much more successful moving forward. Until next time, for Hilco Global, I'm Steve Katz.