By Lily Bearings
©2004-2008
IT SEEMED to be the coup of the decade when Schaeffler, a family-owned German firm that makes bearings, triumphed in the hostile takeover of Continental, a car-parts firm three times its size. Schaeffler had not only displayed great stealth and cunning in sealing the deal. It also relied almost entirely on borrowed money, pulling itself up by its own bootstraps, as it were, to create one of the world¡¯s biggest car-parts suppliers. Now, however, a conquest that stunned corporate Germany last year for its audacity looks almost certain to end in humiliation.
Few have ever doubted the underlying logic of Schaeffler¡¯s €12 billion ($17.9 billion) bid for Continental. It promised to combine two highly complementary businesses in an industry undergoing rapid consolidation. One firm, for instance, made fuel injectors; the other specialised in the software to control them. And with the world economy and commodity markets still booming, Continental¡¯s tyre business alone was thought to be so valuable that, if it were sold, the proceeds could pay down a significant portion of the debt Schaeffler had raised to buy it.
Schaeffler¡¯s big mistake, however, was to structure a bid so Panglossian that it could have failed in any number of ways, almost all of which have now come to pass. The company¡¯s first problem was that it was more successful than it wanted to be. Its too-clever-by-half takeover had been finely tuned to gain it just a little less than 50% of Continental. To do that Schaeffler used derivatives and bought shares on the sly to build up, in effect, a secret 36% stake in Continental before launching its takeover attempt.
But its first offer for the shares was so low that it was rejected by Continental¡¯s board. Although the offer was later raised just enough to win consent, Schaeffler promised not to control more than half of the resulting firm. Schaeffler¡¯s misfortune, however, was that its offer closed just after the collapse of Lehman Brothers sent markets into a spin, spurring almost all of Continental¡¯s shareholders to accept its bid. Instead of buying just half of Continental for about €6 billion, Schaeffler ended up buying almost all of it.
Its second problem was the way it structured its debt by relying on borrowing from banks, rather than selling bonds with long maturities. A privately owned company, Schaeffler does not say much about its finances or its borrowings. But people familiar with the firm reckon it could have pulled off the deal had it been able to limit itself to buying half of Continental. One insider says Schaeffler¡¯s cash generation would have easily sufficed to shoulder the debt burden it would have needed to finance a 50% stake. But now it is struggling to finance borrowings estimated to have swollen to as much as €11 billion, more than twice what the firm is thought to have planned on when it first launched the bid.
That Continental itself is swollen with debt only compounds Schaeffler¡¯s problems. Two years ago the tyremaker paid €11 billion for VDO, a specialist in car electronics. Its bankers are also knocking at the door. In January they forced Continental to trim its dividends and use the cash to service debt. And in February Moody¡¯s cut its rating on the firm¡¯s debt.
Because of their debt, both firms are vulnerable to slowing demand. One measure of Continental¡¯s troubles emerged on March 11th, when it said it was shutting plants in Germany and France and cutting back elsewhere. Its sales of truck and car tyres, having fallen 20% in the last three months of 2008, fell again by as much as 30% in the first two months of 2009.
Schaeffler has asked the German government for a bail-out, saying that without bridging finance it may collapse or be broken up, taking thousands of jobs and two national champions with it. Yet its pleading is not finding a sympathetic ear, partly because the harm from a collapse of this deal would probably be contained. Continental itself would feel few ill effects from the collapse of its now-biggest shareholder, because the two firms¡¯ financing and operations are not yet integrated.
And Schaeffler¡¯s profitable operating businesses would probably find another home soon¡ªperhaps even inside Continental if they were going cheaply enough. The primary victims of Schaeffler¡¯s collapse would be the family that controls it, the banks that financed it and the blind optimism that encouraged them to embark on a deal that could have prospered only in the best of all possible worlds.