Continental:  Continental is trying to strengthen its highly leveraged balance sheet. The Goliath of the German car parts industry might turn to the markets. A rights issue would hardly put a dent in the €11 billion debt pile. But it would significantly dilute Schaeffler, the much smaller rival which controls most of Continental’s shares.

Continental and Schaeffler – each sitting on a €11 billion debt pile– are both fighting for survival. Continental has to repay €3.5 billion by August 2010. As things stand, it won’t have the money. Unquoted Schaeffler, which used debt to finance its attack on Continental, is thought be struggling with something like €1 billion in annual interest payments.

The two can’t seem to decide if they should face the storm together or alone. An outright merger might sound tempting, as it would create the world’s second largest auto-parts supplier. But there isn’t that much overlap. A combined company would struggle to squeeze out a scanty €400 million in synergies – not enough to let the two turn the financial corner.

Continental, which never warmed to Schaeffler’s rule-stretching raid last year, is thought to be leaning towards raising its own equity. Under German law, the company can issue up to 86 million shares without even turning to Schaeffler for approval. If it manages to raise €1.5 billion it would be well on its way to getting over the first major debt hurdle – in August 2010.

What’s more, an equity issue would dilute the Schaeffler holding, since the company doesn’t have enough cash to participate. At a 30 percent discount to the current share price, a rights issue would dilute the family’s holding from 89.9 percent to just 60 percent. Its active shareholding would remain at 49.9 percent, but Schaeffler would have even less clout to force a merger.

When by far the largest holder can’t participate in a rights issue, the underwriters have to find substitutes. But a more diversified group of shareholders could strengthen Continental.

Still, the two companies will have to live with each other for some time. Their managers have enough to do surviving with too much debt in a very weak car market. This is not the moment for fighting over control.

Context News
Continental, the German automotive supplier, plans to raise fresh equity through a rights issue, Reuters reported on July 21. Karl-Thomas Neumann will present his proposals to increase capital to the company's supervisory board on July 30.

Shaeffler, the family owned car parts manufacturer, acquired 89.9 percent of Continental in January 2009. Shaeffler holds 49.9 percent of Continental's stock. The remaining 40 percent is held by Shaeffler's creditors.

Breaking Views