Conti’s Rearguard Action Takes Shape

As an increasing number of voices speak out in favour of the proposed Conti/Schaeffler merger, Continental AG executives have called in a number of high profile investment banks to advise it on how best to defend its position. The most recent addition to this team is Deutsche Bank, which joins Goldman Sachs and JPMorgan as advisors.

The strategy behind the defensive manoeuvre appears to have two key objectives: to wrest complete control out of the clutches of the rapidly advancing Schaeffler; and to raise the suitor’s bid. Germany’s Handelsblatt reported that Conti chief executive, Manfred Wennemer told board members 89.74 euros per share (roughly 30% higher than the Schaeffler’s current 70.12 euros per share bid) is a ‘fair market price,’ for the tyre and automotive supplier. Other sources quote board members as saying 90 to 100 euros a share would be better. Could this be the target level the defence team will be seeking to achieve? And if so, how can Conti defend its position?

The answer could be found in the creeping strategy Schaeffler has employed to get to its current level of shareholding. The vast majority (28%) of the third of the company that Schaeffler now owns – directly and indirectly – is actually held by a group of German banks. It did this so it would not have to declare publically until the last minute that it was planning a takeover bid; and that by that point it would already be in an unbeatable position. According to breakingviews.com, this will change when Schaeffler decides to unwind its derivatives positions. As the banks are unlikely to want to hold Conti shares for the long term, in this scenario, Schaeffler would buy the shares it targeted through the banks from them.

However, if Continental can get an offer from someone else for the shares directly controlled by the banks, German law will oblige the banks to sell to the highest bidder.

Are there any white knights in the land?

Online news sources have reported that Continental has already received approaches from players interested in acting in this role. The difficult economic situation means a potential knight is unlikely to come from the clan of vehicle manufacturers.

French parts supplier, Valeo, has hinted that it may be interested at in parts of the company. Chairman and Chief Executive Thierry Morin told a conference call with analysts that the company’s recent reduction in debt to 621 million euros, from 799 million at the start of the year, gave it “extra flexibility for external growth.”

Morin told Reuters the group was following the Continental situation ‘with interest.’ Earlier, the French firm had been scouting out a possibility that Continental would sell parts of the VDO activities it bought from Siemens. “I do not think that Schaeffler can keep Continental in its entirity. They will move from a situation with excess cash to a level of debt that will without doubt be significant.” However, with a market capitalisation of 1.64 billion euros, Valeo is far smaller than Continental. Morin’s comments all appear to be based on a post-Schaeffler takeover scenario, perhaps ruling them out of strategic friendly bidding.

Then there is German automotive supplier Robert Bosch, which is also larger, but monopolies restrictions mean the chances of a company like Bosch buying in are similarly improbable. Therefore breakinviews.com suggests “a friendly billionaire might be a better bet.”

In this case Continental may have to look east to the land of oil-barons and oligarchs. Rusians Oleg Deripaska (a metal magnate that already has investments in auto parts) has been named as a possibility, as has steel tycoon Alexei Mordashov. Forbes points out that Germany also has 54 billionaires of its own in addition to the Schaeffler family. However, from Tyres & Accessories’ point of view the most interesting piece of unverifiable speculation circulating is the suggestion that the entrance of Indian steel billionaire, Lakshmi Mittal, into the situation would change it from a nightmare to a dream for Continental.

Schaeffler might need to borrow 22 billion euros

If Continental could tempt a white knight to lend its chivalry (wallet) to the situation, the Schaeffler Group may end up paying considerably more than they initially bid for the company. If they don’t the company may still need to borrow as much as 22 billion euros. Bloomberg quotes Christophe Boulanger, a debt analyst at Calyon in London, as saying that Schaeffler will either have to refinance 12 billion euros in loans that Continental obtained last year, or pay a penalty to lenders and assume the debt. Schaeffler will also have to find the cash to buy Continental’s equity, now valued at 11.7 billion euros.

Buying more than 50 per cent of Continental AG would enable lending banks such as Citigroup Inc. and Goldman Sachs Group Inc. to demand repayment of the 12 billion euros in loans they made last year. The banks may require a fee of about 1.5 percent of the loan, or 180 million euros, to waive the rights, according to Boulanger.