A growing understanding in the car industry of the value of combustion engine technology able to meet new anti-pollution requirements is likely to fuel a wave of consolidation in the next two years, industry executives and bankers say.
Mergers and acquisitions have been stuck in a rut since Volkswagen Group was caught cheating pollution tests in 2015, triggering a global tightening of emissions regulations that depressed the value of gasoline and diesel technologies.
But the market is beginning to separate companies capable of meeting new emissions standards from those struggling to do so, which could close the gap in price expectations between buyers and sellers over the next 12-24 months, industry experts say.
The auto industry has all but stopped developing next-generation combustion engines as limited resources are directed towards building electric and self-driving cars.
However, electric vehicles are still a niche product, accounting for only 1.26 million - or 1.5 percent - of the 86 million cars sold worldwide last year, and analysts forecast it will be the middle of the next decade before a tipping point comes when electric cars overtake combustion-engine variants.
That means there will still be demand for emissions-compliant combustion engines and so automakers and suppliers able to offer that are likely to see valuations recover, said Reinhard Kuehn, co-head of European Automotive at Deutsche Bank.
"At the same time, suppliers that struggle with this will remain a hard sell," Kuehn said.
Meanwhile, as production capacity of gasoline and diesel engines is cut back, the impetus for mergers among suppliers should increase, bankers believe. VW, one of the largest producers of engines, has said it will develop its final generation of combustion engines by 2026, while Ford last month said it would close two engine factories in Europe.
"The profit pool of companies with combustion engine-related technology -- once the envy of the industry -- is shrinking with the rise of electric vehicles and the digitization of the industry," Goldman Sachs managing director Axel Hoefer said.
"You would expect someone to come in and consolidate to benefit from economies of scale."
VW is now warning its suppliers to prepare industry-wide solutions for winding down combustion-engine manufacturing as it ramps up mass production of electric vehicles.
The company is retooling 16 factories to build electric vehicles and plans to start producing 33 different electric cars under the Skoda, Audi, VW and Seat brands by mid-2023, transforming the industry's supply chain.
"It makes no sense to have factories running at only 40 percent capacity," Stefan Sommer, VW's procurement head, told Reuters. "The auto industry is obliged to develop structures to consolidate combustion engine assets, to decide where to bundle certain activities."
"If we end up with uncontrolled insolvencies, it will be a problem for the industry," he said.