Divide and rule
Can the break-up of GKN secure its future?
There’s nothing like an unsolicited takeover bid to focus the mind. What does a business really want to be, and how does it want to achieve it? These are the questions, one imagines, rushing through the minds of the GKN board earlier this week, after receiving a £7bn bid from smaller rival Melrose.
The board’s answer was to tell Melrose to take a hike. GKN, the FTSE 100 engineering group that traces its roots to an ironworks in Merthyr Tydfil in 1759, wants to go it alone. It hasn’t had a very good time of late, what with profit warnings, lawsuits and a power vacuum caused by having to ditch its CEO designate before he’d even started.
But the board believes it can still make a go of things, and it has a radical plan: it’s going to do what people have been saying for ages it should do, and split up. Its automotive business, supplying parts to the car industry, will go one way, and its aviation business the other.
The thinking is that, by being yoked together, GKN’S businesses have long been undervalued. Setting them free will allow investors to choose whether they want exposure to a world-class car parts maker or a world-class aviation supplier.
Melrose has other ideas. It thinks it can run GKN’S assets better than its current management and make bigger returns to shareholders to boot. It also has plans to “liberate” GKN’S businesses – but by handing back power to the divisional managers, who will be able to run things how they see fit and jack up the company’s lacklustre margins in the process. For the time being, at least, Melrose would keep GKN together.
The FTSE 250 group, founded in 2003, has been likened to private equity in the sense it targets firms ripe for a turnaround and – as in the case of meter business Elster in 2015 – sells them for a handsome profit. As a measure of its success, its four top directors each earned share-based bonuses of £36m last year. Though smaller than GKN, it shouldn’t have trouble financing the deal.
Melrose’s long-expected swoop on GKN is a textbook case of an opportunistic bid. Prior to leaping yesterday on news of the bid, its share price had been depressed. Management appeared rudderless. Takeover talk swirled, held in check mainly by concerns about GKN’S £1.8bn pension deficit.
The Unite union labelled Melrose’s approach “predatory” and “destructive”. Sir Vince Cable wanted the Government to intervene. Little chance of that. Theresa May might have briefly exercised herself about the threat of foreign firms raiding UK plc on the cheap, but this is one British company buying another. The combined group would have a market cap of £11bn, with little overlap to concern regulators.
Melrose may bear comparison to private equity, but it is a listed business with all the oversight that involves and it has a track record of investing to improve, while shunning the high levels of leverage a fund might employ. If the unions are worried about costs being cut, they may want to scrutinise GKN’S own “Project Boost”, a restructuring programme announced yesterday as part of its defence that will look to trim the fat, for example by slashing incentive schemes that have become inflated across the business.
GKN was supposed to unveil this, and the decision to split the two main parts of its business, later this month, when new CEO Anne Stevens was to be crowned officially. Bringing forward all three announcements does not lessen the impression of a company on the back foot.
True, there are challenges ahead for the upstart Melrose. The deal is almost three times bigger than anything it has attempted before. The pension deficit hasn’t gone away, which could complicate matters later if Melrose wants to dispose of some of GKN’S parts. If successful, it will catapult itself into the big leagues of tier-one automotive suppliers, where it may discover that one reason GKN’S margins are so tight is because the giant car makers drive such hard bargains.
Expect Melrose to come back with a better offer. GKN shareholders will be sorely tempted to take it.
‘Melrose has been likened to private equity as it targets firms ripe for a turnaround’