Conti should turn tables on Schaeffler

July 23, 2009


Porsche isn’t the only family-controlled German company that has got itself into a complete pickle bidding for a far larger rival.

    Indeed, if you want a test case of how ambition can land a company in serious financial difficulties, look no further than Schaeffler, a privately-owned ball bearings maker which has
seriously overextended itself following a bid for listed car parts maker Continental last year.

    Despite snapping up 90 percent of Conti’s stock, Schaeffler could easily lose control of its intended prey and may end up being swallowed by it.

    Following the bid battle, Schaeffler holds a 49.9 percent direct stake in Conti. A further 39.36 percent is held by Schaeffler’s banks — Sal Oppenheim and Metzler — in a sort of warehousing deal to reflect the fact that Schaeffler does not actually have the money to buy the whole of Conti. Schaeffler has signed an agreement that it will not increase its stake above the current level prior to August 2012.

    This leaves Schaeffler in an awkward spot. It cannot consolidate Conti and the two companies continue to be run as separate units in an uncomfortable stand-off. Conti is not paying a dividend, meaning that Schaeffler can only finance the stake out of its own earnings. Meanwhile, Conti’s share price has fallen sharply from the 75 euros Schaeffler paid a year ago
to around 25 euros now.

    Both companies are highly leveraged. Schaeffler has debts of about 11 billion following the Conti takeover, while Conti has net debts of a similar amount — just over 11 billion — mostly the result of its purchase of VDO from Siemens. Its debts are equivalent to 71 percent of its enterprise value.

    It is Conti’s high debts which, paradoxically, may allow the target to turn on its pursuer. It must repay 3.5 billion euros ($5 billion) by the middle of next year and intends to raise equity to meet part of this liability. The only alternative would be to sell assets at low prices, which would hurt Schaeffler. There is talk of an equity issue to raise 1.5 billion euros.

    Unless Schaeffler was able to come up with the 750 million euros it would need to follow its money, its direct stake would be diluted. It is hard to see why its banks would invest either — especially if they are relying on Schaeffler to take them out of their holdings at some point.

    Even though Schaeffler’s representatives dominate Conti’s supervisory board, it would be difficult for them to torpedo a fundraising unless they had an alternative funding plan. Moreover, a cash crisis at Conti would hurt them very severely.

    Conti seems to be talking about issuing shares at a discount of around 15 percent to the current level. This looks very tight. But were it to do this, and Schaeffler did not invest, its direct stake would fall to 35 percent. And assuming its banks did likewise, the total stake would fall to 63 percent.

    Conti’s chief executive Karl-Thomas Neumann, wants to seize the initiative and merge the two businesses. Following the capital raising, Conti’s equity value would be a touch under 6 billion euros. Neumann clearly thinks that would make it considerably bigger than Schaeffler. His proposal would be to push together the two businesses under Conti’s control.

    Unsurprisingly, the Schaefflers do not welcome the idea of being scrunched down in this way. True it would give them access to a listing, synergies from the merger and the possibility of repaying some of their heavy debts. But it might also deprive them of control.

    They are wriggling on the hook. They seem to believe, with the advice of JP Morgan, that their private company has an equity value of some 10 billion euros. On this basis they have rejected Conti’s advances.

    Meanwhile, Schaeffler is trying to get to grips with its own debts, hiring restructuring experts Houlihan Lokey to help out. It has bought itself some time with a 1 billion euro bridge loan.

    The outcome is likely to be decided by the bankers. And here it looks as if Conti has the edge. It is taking steps to cut its debt, while pushing for a resolution of the stand-off between
itself and Schaeffler. Meanwhile, Schaeffler looks to be playing for time while trying to stave off a deal by relying on what may be an unrealistic valuation for its own business.

    Conti has recently attacked Schaeffler publicly, accusing it of destroying value and behaving irresponsibly. If the bankers decide they want a deal, it may well be on Conti’s terms.


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