George Simpson has got Lucas back on track - news of his appointment was enough to send its shares into orbit. But without faster change and geographical expansion the company may not be strong enough to remain independent. Andrew Lorenz
George Simpson hit the ground running 16 months ago, when he left his dual posts as deputy chief executive of British Aerospace and chairman of Rover group (which he had just sold to BMW) to take over as chief executive of Lucas Industries. There was no leisurely, easing-in to the role for which he had been headhunted. Arriving, fortuitously, at the start of Lucas's annual strategy review, Simpson got straight down to business.
He summoned Lucas's top 100 managers and gave them a tough message. Lucas was recovering from the battering it had taken during the recession, Simpson said, but the pace of revival 'must be dramatically accelerated'.
'Without faster change,' Simpson told his audience, 'a long-term successful independent Lucas Industries is an unlikely outcome.' Then he personally took command of the group's under-performing motor components division, the key to the group's turnround because it accounts for almost 75% of its £2.5 billion-plus annual sales.
Simpson knew that he had no time to lose if Lucas were to avoid being stranded by the rising tide of globalisation and consolidation in the company's motor and aerospace markets. Lucas's margins were, by a mile, worse than any of its British peers. Its financial record since the onset of the Anglo-American recession in 1990 was appalling. Having squandered the £250 million-plus proceeds of two rights issues in four years during the second half of the 1980s, the company had only been saved from disaster by obtaining High Court approval to use £90 million from its over-funded pension fund to finance essential cost-cutting. Its share price halved from more than 160p to just over 80p late in 1992. Bid speculation drove it back up again, but it was news of Simpson's appointment that sent the shares into orbit. They soared above 220p before settling back around the 200p mark earlier this summer.
Given Lucas's track record, that is still a remarkably elevated rating, discounting - as Charles Burrows, engineering analyst at James Capel, has pointed out - at least two years of profits outperformance. It is effectively a vote of confidence in Simpson's highly regarded abilities. But to grow the share price well beyond this point over the next few years is asking a lot of him. Simpson, 53, will be a very rich man if he can do that. He has a total of almost 1.5 million options in two long-term incentive schemes at prices of 177p and 194p a share. If he can drive profits to a level which pulls the share price up to £3, he could make more than £1.7 million. But Simpson has already encountered some skeletons in the cupboard.
He has the support of a sound management team, notably Frank Turner - previously with Rolls-Royce - who runs the aerospace division, and John Grant, the former Ford and Jaguar executive who is finance director. Sir Brian Pearse, the former Midland Bank chairman, was a happy choice to succeed Sir Tony Gill, who as executive chairman had dominated the group for almost a decade before his retirement in December. But Simpson, who will soon have to find someone to assume command of the automotive business while he focuses more on the group's strategic development, is the key man. One former colleague at BAe says simply: 'George is a great team leader with a sharp financial brain, but he can be as hard as nails if he has to be. That is a rare mixture of qualities.' Simpson's combination of the clinical and the visceral is epitomised by the phrase he favours when giving an underperforming manager a last chance. 'It is time', Simpson says, 'to put your cock on the block.' When he joined Lucas, the group was in danger of suffering a painful fate. Gill had spent most of the 1980s trying to expunge the 'prince of darkness' tag with which Lucas had been stigmatised because of the unreliability of its products - including headlamps - during the 1970s. The Lucas chief was ahead of the game in streamlining Lucas's sprawling range of motor components to focus on higher-added-value areas or businesses where Lucas had an international position. He made a break from Lucas's past by selling the lighting business - which originated in the bicycle lamp company founded in the 19th century - and moving the group from its ramshackle Victorian headquarters in Birmingham to a business park near Solihull.
But Gill then made the cardinal mistake of trying to build a modernistic empire of his own by massively expanding Lucas's other divisions: aerospace - where Lucas was a European leader in flight and engine controls - and industrial products. His motivation was 30e understandable: motor components stocks were not well regarded by the stock market. But Gill's efforts to diversify into higher rated areas were undermined in one case by faulty execution, and in another, by fundamental misconception. In aerospace, Lucas spent almost £200 million in less than three years in the late 1980s buying a swathe of American companies. Not one of those acquisitions has been an outright success.
Lucas's efforts to build a third leg, an industrial division consisting - incongruously - of small electronics companies and fluid power distribution, wasted management time and shareholders' money. Lucas then U-turned and decided that it would use the industrial businesses - now regrouped under the title Applied Technology - to support the two core divisions of automotive and aerospace. Gill and his close associate, John Parnaby, had also developed two software businesses - Lucas Management Systems (LMS) and Lucas Engineering & Systems (LE&S). When Simpson arrived, LMS was losing money heavily and the disposal of both had to be made a top priority.
Gill's main achievement was to avert a takeover of the company. His formidable reputation, allied to the substantial holding in Lucas by the company's pension funds (about 16% for much of the time, in breach of industry guidelines on pension fund self-ownership) deterred predators such as the manufacturing conglomerate BTR. Gill's main weapon against predators was the dividend, which Lucas maintained through the early 1990s despite the fact that it was uncovered by earnings and had to be paid from reserves. Much as he would have liked to cut it as soon as he arrived, Simpson judged that, with Lucas starting to emerge from the worst of its travails, such a move would probably antagonise investors. So, unlike other new chief executives who have taken the one-off opportunity of their arrival to 'rebase' the dividend - Simpson had to live with Gill's payout legacy.
But Simpson did not falter when it came to cleaning the slate in other areas. With a huge provision of more than £200 million, which reduced the results for the year to July 1994 to a loss of almost £130 million, he laid the foundations for reshaping the group, including the disposal of many businesses now worth much less than their 1980s purchase price and book value.
The provision would have been lower but for the unforeseen costs of extricating Lucas from two embarrassing escapades in America. Both involved fines by the Pentagon for breaches of contract, and both breaches were committed by companies - AUL and Lucas Western - bought during the 1980s aerospace acquisition splurge. By far the larger was a civil action by the Pentagon against the Utah-based gearbox division of Lucas Western which caused all Lucas companies to be barred from new US military contracts until its settlement. Debarment affected only about £40 million of annual sales, but cast a shadow over Simpson's efforts to escape Lucas's past.
At least Simpson now has Lucas pointing in the right direction. In March, the company reported that pre-tax profits had more than doubled to £44.5 million in the first half of its financial year. That still represents a minuscule return on sales - which rose 13% to £1.35 billion - but margins are widening. By reinforcing the share price, the results cleared the way for a £120 million conversion of warrants in June that cut gearing to around 16% and should be enough to propel the group back into the FTSE-100 from which it was dropped four years ago.
Simpson has no illusions. 'We are on track,' he said after unveiling the half-year results. 'But that's only six months' results.' For analysts, the most encouraging feature of the figures was a 20% surge in sales by the motor components side, well above the industry growth rate. And within that, the Simpson effect was most visible in brakes, which represents one-third of the total automotive division.
Lucas, as the company has never tired of trumpeting, is a world leader in car, truck and bus brakes - it claims 28% of the car disc-and drum-brake market alone. Its Colette disc brakes are, says the company, the most widely used in the world. Yet, by the early 1990s, this had become profitless volume. Indeed, as Simpson revealed in March, brakes were loss-making during 1993, an astonishing fact given that sales that year were more than £500 million. Now, after intense efforts to improve efficiency, brakes are on the rise. At the company's Bouzonville plant in France, it used to take 180 hours to make a braking system. Manufacture time is now down to three hours. Similar productivity improvements are under way at the sister factories in Koblenz and Pontypool. Such efficiency gains helped fuel a 26% surge in brake sales in the first half of this year. Nick Cunningham, motors analyst at BZW, reckons this was five times the rate of market growth.
The brakes turnround is an exemplar for the new Lucas that Simpson is trying to build. 'I wanted to emphasise some things that people had not done before,' he says. 'One was a performance culture - delivering what we say we are going to do. Then there is customer focus: maybe we have been slightly arrogant in the way we dealt with customers. And the third essential is teamwork. We had developed an organisation which didn't get the synergistic benefits of people working together. If we get these three, then Lucas will change dramatically.' Simpson knows that this culture change is an essential pre-condition for Lucas's profitable survival in what are now two rapidly changing industries. Immediately in automotive, but conceivably in aerospace, globalisation by the platform assemblers - ie, the vehicle and aircraft makers - is causing a shake-out in the ranks of their leading suppliers. Ford's move to an integrated worldwide organisation, including global sourcing, will cut its supplier numbers by up to 66%. 'In Ford's case, we will have to be able to supply them in Detroit, Mexico, Brazil, China, Essex and Germany. Unless suppliers have the capability to deliver globally, they are going to fall short,' he says.
On Simpson's analysis, that evolution will demand three things from Lucas that are imperative if the company is not to lose out. 'We must grow, because tier-one suppliers are going to be the big guys. We must also spread geographically, because we are too focused on the UK and Europe. And we have to increase our R&D.' In size terms, Lucas stands well down the world pyramid of automotive and aerospace suppliers. An internal study which ranks suppliers by size places Lucas well behind the top manufacturers - only one-third the size of industry leaders such as Bosch in automotive, and Allied Signal in aerospace. Simpson's short-term target is to boost group annual sales to £5 billion before the end of the century.
Geographical expansion is vital if Simpson is to reach that target. With 66% of sales in the UK and Continental Europe, Lucas is overly dependent on its home market, under-represented in America - and barely visible in Asia.
Simpson has begun to plug those gaps, with car and heavy-duty-braking joint ventures in China and, most impressively, the near-£67 million acquisition in America of Lake Center Industries. Not only does Lake Center increase Lucas's US presence, but it also helps to fulfil Simpson's other prime objective in automotive, the development of a big business in the high-growth but still fragmented segment of body-systems.
If Simpson can achieve his body-systems aim while sustaining the brakes turnround and the strong growth of diesel fuel injection, Lucas will be on track. Fuel injection continues to shine, with new products such as the electronically controlled unit injector EUI winning a 32e £1 billion contract from Volkswagen which will kick in from 1997, and a smaller, but still significant £250 million order from Rover for the Storm engine range. Lucas is already working on what appears likely to be the next-generation method of delivering fuel to a diesel engine.
However, customers' increasing demands for main suppliers to produce complete systems rather than individual components mean that Simpson will need alliances to plug some product gaps. In brakes, Lucas needs to link with a friction materials supplier - not only to supply an assembler with a total package, but also to control its sources of supply in the important after-market operations. The natural partner, for both original equipment and after-market purposes, would be Lucas's compatriot T&N, owner of Ferodo. Simpson is known to be close to Colin Hope, T&N's expansionist chairman. America's Kelsey Hayes, keen to expand into Europe, is another possibility.
Simpson also needs to bolster Lucas's weak position in anti-lock braking systems (ABS), a growth market that the company almost missed by taking some wrong turns in the '80s. Earlier this year, Lucas linked with Japan's Sumitomo to develop ABS for the American market, but 'we need to do something similar for Europe', he says.
Perhaps the greatest unknown is the vast area of electronics, which comprise about 15% of a car by value today but are expected to rise to more than 30% by the end of the century. 'We have to find a way of becoming world-class in electronics,' says Simpson. 'Things are going to change: stuffing printed circuit boards will be fine for the next five years, but then, as electronics become distributed, we will need to partner people with silicon capability.' But while Simpson is picking horses for courses in different areas of his automotive business, he also faces two altogether larger choices. One is whether to keep aerospace, once it has been pared down to its core businesses of engine and flight controls. James Capel's Burrows believes that, in the medium term, aerospace will go: 'We continue to expect the eventual total divestment of the aerospace division,' he wrote earlier this year. 'But such a move is probably at least two years away, although exact timing will in part be decided by the availability of opportunities for automotive acquisitions.' The argument goes that Lucas will have to focus its finite resources on building up automotive. But Simpson, his BAe experience having given him a different perspective, sees things differently. He wants to keep the main aerospace operations for two reasons. 'Aerospace does represent a very important counter-cyclical capability for Lucas,' he says. 'It didn't happen in the last recession, because the cycles tended to go down together. But looking forward, they may be counter-cyclical because it will be another two years before things really take off in aerospace, by which time automotive will come off the top.' Simpson's BAe background has also given him an even better reason for wanting to retain aerospace: 'The potential for cost reduction in aerospace is massive: so even if prices come down, the potential to drive costs down even faster is huge. Going forward, most of our aerospace systems can be designed with half the weight, twice the performance at half the cost.' Aerospace margins are roughly twice average automotive industry margins; were Simpson to sell aerospace, he would have to buy double the amount of automotive sales to achieve the equivalent level of profitability.
Moreover, says Simpson: 'The investment requirements in aerospace tend to be lower than in automotive, so there is not a huge financial risk issue there although the payback tends to be a bit longer. People forget that aerospace is already a very significant cash-generator because of the long-term flow of parts on programmes. I think there is a lot of work to be done on the aerospace division to get it operationally excellent. That will take 12-18 months. Having done that, we should have a business that's very tight financially, profitable and focused. We can then build on it or cash our chips.' Aerospace's future may depend on Simpson's answer to the ultimate question: whether Lucas should stay independent, or take industry consolidation a stage further by merging with another company. If the Lucas recovery falters and the share price slumps, such a course of action may be foisted on Simpson anyway. Presupposing Simpson steers Lucas through to complete recovery, he will then have to consider the trickier question of long-term strategy. Friends say that he occasionally jokes about his name being made mud if, having negotiated Rover's disposal to BMW, he were then to sell Lucas into foreign hands. But the joke has a serious undertone. The low-profile, Dundee-born accountant is a pragmatist, not a missionary, but after almost 20 years in British Leyland and its descendants, battling against the decline of the British vehicle industry, he would clearly take pride in cementing the resurgence of its components sector.
Were Lucas to merge with another British group, then TI and T&N are the obvious alternatives. GKN appears to have other priorities and BTR may be turning away from the idea of bidding for Lucas. However, an all-British alliance could well be thwarted by interest from overseas, where both Germany's Bosch and America's Allied-Signal are potential buyers of the group. Simpson has turned Lucas round in short order. But he faces some tough strategic choices on his road ahead.
Andrew Lorenz is deputy business editor of the Sunday Times.
LUCAS: Financial Facts
Sales/Operating profit by Sector*(£m)
Automotive 1,815.7 88.1
Aerospace 537.1 13.2
Applied technology 237.7 2.9
Less interest, provisions, etc (233.9)
Total 2,590.5 (129.7)
Sales/Operating profit by region*(£m)
UK 953.6 30.4
Other European 879.5 54.8
North American 436.0 (5.2)
Other overseas 218.8 20.6
Share of ass. undertakings 102.6 3.6
Less interest, provisions, etc (233.9)
Total 2,590.5 (129.7)
Shareholders' funds (£m) 621.8
Number of employees 46,196
* for year to 31 July 1994.