GKN has pledged to demerge its aerospace and automotive businesses by mid-2019, setting a timeline on a split of the FTSE 100 engineer in an effort to fend off a hostile £7bn approach from Melrose Industries.
Unveiling a 16 per cent drop in underlying annual pre-tax profits, GKN said it aimed to create two investment-grade listed companies with the demerger.
Agreement in principle had been reached with trustees of GKN’s pension fund to inject some £150m into the retirement schemes to ensure they could continue to meet their obligations to pensioners after the split, the group indicated.
GKN is fighting for its independence against a hostile cash-and-shares bid from Melrose, the industrial turnround specialist, which is also proposing to break the company up and sell the businesses on after it attempts to reverse what has been a patchy performance in the last two years.
In response, the aerospace and automotive supplier has promised to deliver some £340m in recurring cash benefits to shareholders by 2020 from a three-year restructuring plan unveiled by its recently appointed chief executive Anne Stevens.
Melrose pounced on GKN last month in a rare hostile bid after the 259-year-old engineer discovered mountains of overvalued inventory in its US aerospace business. It was forced to part ways with its chief executive designate, who had been in charge of the division.
The succession debacle, along with two years of disappointing performance in aerospace, left GKN vulnerable to mounting investor discontent with the group’s structure and its management.
The decision to demerge the aerospace and automotive businesses in a relatively short timetable will unwind more than a decade of strategic diversification, but is likely to please investors who have long pushed for a division to improve transparency.
Ms Stevens said the demerger and the group’s plan unveiled two weeks ago to boost cash and margins through a series of operational and investment initiatives meant “the building blocks are now in place to show the clear sum of the parts value” of GKN.
She added that a demerger would rectify confusion over the company’s true value, masked by its dual focus on aerospace and automotive sectors. “It is all about delivering value and the conglomerate discount is value leakage for shareholders,” she said.
However, it could also put pressure on those interested in bidding for one of GKN’s divisions to come forward.
Both units have drawn interest from potential bidders. GKN supplies components to the world’s biggest jet makers, Airbus and Boeing, and its automotive division supplies parts and systems for more than 50 per cent of the world’s cars and light trucks.
GKN said a demerger represented its “base case separation structure for a number of reasons, including that the timetable is within GKN’s control, it allows GKN to allocate liabilities appropriately and it is tax efficient”.
The company also laid out in detail for the first time the potential of its aerospace division, including the partnerships it has with engine manufacturers. Revenues from risk-sharing partnerships on engines including Pratt & Whitney’s new geared turbofan and Rolls-Royce’s Trent XWB were expected to total some $13.5bn up to 2055, the group said.
The aerospace division was the main cause of GKN’s lower profit because it was hit last year by charges of £112m as a result of overstated inventory in the North American business. The automotive business, meanwhile, has been investing heavily in systems for electric vehicles.
Sandy Morris, aerospace analyst at Jefferies, said the decision to demerge was the result of the market’s inability to absorb the challenges of two different sectors.
“The market could arguably understand the setbacks in aerospace were it covered by sellside aerospace analysts. Likewise for automotive,” he said.
“But there was too much not going right. There is no academic reason a company should not be able to accommodate aerospace and automotive together [but] it has patently not worked for GKN.”
Christopher Miller, Melrose chairman, described GKN’s demerger plans as being “full of long-term promises and more short-term actual misses”.
He added: “At the heart of this is a plea for the incumbent team to embark on an unproven and risky plan which we believe is wrong for all GKN stakeholders and UK plc as a whole.”
GKN, meanwhile, said it had increased sales 11 per cent to £10.4bn in 2017 on a management basis, which includes joint ventures.
Operating profit on a similar management basis — excluding non-trading items such as currency and the impact of derivatives valuation — fell 14 per cent to £662m while pre-tax profits fell from £678m to £572m.
On a reported basis, which includes one-off charges and currency movements, pre-tax profits rose from £292m to £658m.
The aerospace division saw 6 per cent growth in sales to £3.6bn, while trading profits nearly halved to £175m from £339m.
Driveline delivered a 15 per cent rise in sales to £5.3bn, with trading profits up 14 per cent to £377m.
The group said results were in line with guidance, when the £112m aerospace charge was added back in. Free cash flow was flat at £207m. Net debt rose from £704m to £889m. It expected some margin improvement in both aerospace and automotive this year, on the way to group margins of 11 per cent by 2020.
Sash Tusa, aerospace analyst for Agency Partners, said the outlook was “mixed and a bit ‘jam tomorrow’”. The underlying profit for both aerospace and powder metallurgy divisions had been “significantly weaker than our forecasts”. The aerospace business in particular faced significant challenges in reversing losses in North America amid continued pricing pressures and declining legacy programmes.
Shares in GKN were little changed at 429.2p in afternoon London trading, while Melrose was also flat at 225.1p.
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