Schaeffler goes shopping: Can supplier land Continental?

Douglas Bolduc, Automotive News Europe

Many industry watchers and executives were surprised earlier this month when they read the first reports of Schaeffler Group's plan to takeover much-larger supplier Continental.

"I think many eyes got wide when they saw that," Autoliv CEO Jan Carlson told Automotive News Europe.

After reflection, the idea for the deal is not that shocking.

Deep car production cuts in the US combined with rising fuel prices and a prevailing uncertainty about the future of the auto sector have caused most auto industry stocks to fall.

Continental's share price was €109 about a year ago and less than €54 on July 11, which was the last day of trading before news of the takeover bid was made public.

Schaeffler was smart. It bid for an undervalued supplier that has invested heavily to strengthen its expertise in two area poised for massive growth: powertrains and electronics.

Analysts and industry executives expect further consolidation in those sectors as automakers race to develop more fuel-efficient cars that can meet tougher emissions standards.

Schaeffler, a German family-owned maker of ball bearings, has a pile of cash, experience with takeovers and weakness in the areas where Continental is strong.

Plus, the industry is in desperate need of economies of scale to fight the rising cost of raw materials.

Despite these points, Continental last week rejected Schaeffler's initial takeover offer of €11.2 billion, which is €200 million less than the price Continental paid to acquire Siemens VDO Automotive last December.

The question is: What's wrong with this deal?

One reason Continental says it rejects the approach is because Schaeffler stands to gain much but provide little.

An analyst speaking under condition of anonymity also said that the deal makes no sense from a business perspective.

He accused Schaeffler of having too much cash. If the company were publicly traded he doubts its board would have approved such a move.

Philip Wylie, the UK-based director automotive investment banking at Houlihan Lokey, said there are dangers when a supplier gets too big.

"Look at what happened with ArvinMeritor, Dana and many other US suppliers and you see that getting big didn't do them much good," Wylie said. "You need economies of scale and the right product mix.".

Many suppliers undervalued

Lars Holmqvist, CEO of the European supplier association, CLEPA, has no objections to the deal in principle.

He supports the creation of another Europe-based megasupplier -- a combined Continental and Schaeffler would likely pass Germany's Robert Bosch and Japan's Denso to become the world's largest partsmaker with combined sales of more than €35 billion.

What Holmqvist doesn't like is the factors that made Continental an attractive takeover target.

He said many suppliers are undervalued. Continental is not the only company that has seen its value fall.

Said Autoliv's Carlson: "We are all taking a major hit in the stock price."

Since May, safety specialist Autoliv's shares have slipped to about 250 kronor (about €26) from more than 350 kronor.

Holmqvist says suppliers' share prices are declining because analysts are fixated on bad news such as production cuts in the US and the market's uncertainty about the sustainability of the industry.

He thinks that they should consider positives such as growth in markets like Russia, India and China.

'Cascade of deals'

"I think people who are only seeing part of the picture are sending panic through the market," Holmqvist said. "Proof of that is when a well-managed global company with a strong portfolio of future products like Continental can be seen as a dead duck."

If the deal goes through, Holmqvist predicts more consolidation will follow as rival suppliers try to keep pace and the new megasupplier spins off businesses.

"There is always a cascade [of deals] when this happens," Holmqvist said.

If so, there will be uncertainty about those companies' futures as they cope with the changes.

That could lead to more fears about the sustainability of the industry, even lower share prices and even more deals.

A vicious circle? Perhaps. But such deals could result in a a supplier industry made up of bigger, stronger, more flexible and more future-proof players.

Those are good things.

When asked whether having fewer bigger suppliers would be good, Holmqvist said that the total number of partsmakers is not as important as staying ahead with innovation.

"The day you stop developing new technology," Holmqvist said, "is the day you start digging your own grave."

From Automotive News Europe (A Crain publication)

Press release from Schaeffler Group