Conti in position to turn the tables on Schaeffler

ERJ staff report (AN)

London (Reuters) -- Porsche Automobil Holding SE isn't the only family-controlled German company that has got itself into a complete big trouble bidding for a far larger rival.

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

Despite buying 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 all of Conti. Schaeffler has signed an agreement that it will not increase its stake above the current 49.9 percent level prior to August 2012.

Awkward position

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 about 25 euros (about $35.50) now.

Both companies are highly leveraged. Schaeffler has debts of about 11 billion euros following the Conti takeover, while Conti has net debts of a similar amount -- a little more than 11 billion -- mostly the result of its 2007 purchase of Siemens VDO from Siemens AG. Its debts are equivalent to 71 percent of its enterprise value.

It is Conti's high debts which, paradoxically, may allow the prey to turn on its predator. Conti must repay 3.5 billion euros 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 fund-raising 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 about 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.

Time to combine?

Conti CEO 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, Schaeffler does not welcome the idea of being scrunched down in this way. True it would give the company access to a listing, synergies from the merger and the possibility of repaying some of its huge debt. But it might also deprive them of control.

Schaeffler is wriggling on the hook. The company's co-owners, Georg and Maria-Elisabeth Schaeffler, seem to believe, with the advice of JP Morgan, that their private company has an equity value of about 10 billion euros. On this basis they have rejected Conti's advances.

Meanwhile, Schaeffler Group 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.

From Automotive News (A Crain publication)