Dana Offer Puts GKN's Would-Be Predator on the Spot

(Bloomberg Gadfly) -- The opportunistic takeover specialist trying to buy GKN Plc finally has some competition. Melrose Industries Plc will almost certainly need to raise its bid for the U.K. engineering company if rival interest from Dana Inc. of the U.S. comes to something.

On Friday, GKN said it was in talks to merge its automotive unit to Dana in an equity deal, implying a sale in return for shares in its New York-listed peer and one-time joint-venture partner. With another of GKN's main divisions already on the block, a deal with Dana would leave the British company as an attractive pure-play aerospace business.

There is logic to this. GKN shares have been under pressure, not only because of the company's weak profitability, but also because investor appetite for a combined auto and aerospace business is limited. Hence both GKN's own demerger plan, and Melrose's hostile bid.

The lack of a publicly traded car parts industry in the U.K. means GKN shareholders would be best served by giving the auto arm a U.S. listing -- or finding a buyer or partner with synergies to bring to the party. A paper deal with Dana could achieve both.

The aerospace business has the greatest margin-improvement potential, so by hanging on to it, GKN would give its shareholders all the upside from any turnaround.

So the theory goes. Dana will need to come up with a convincing story for what it can do with the enlarged business if the British shareholders are going to warm to the idea of receiving shares in the combination.

After more than doubling over the previous two years, the U.S. buyer's stock has fallen 17 percent so far in 2018. Should GKN's shareholders worry about taking what could appear to overvalued paper? Not necessarily, because Dana shares are trading close to their two-year average relative to their peers -- a 9 percent discount on an enterprise value basis and a 19 percent discount on price-earnings, according to Bloomberg data.

Still, a deal would transform Dana in size and scope. Its business is tilted towards systems for trucks, while GKN's focuses more on passenger vehicles.  The U.S. company has an enterprise value of $5.1 billion, while GKN's auto unit could be worth between 3 billion pounds ($4.1 billion) and 5 billion pounds, depending on which analysts you read. 

If GKN can swap its auto business for a stake in the enlarged Dana that is clearly worth more than its break-up value, this would be a big boost to the defense. Melrose plans to address GKN's performance issues before later finding buyers for its constituent parts. But a sale to Dana at the end of it could be the outcome too. Why not realize that value now?

A Dana deal would make comparing Melrose's offer and the value of GKN's strategy much easier. With GKN shares already trading 6 percent above the value of Melrose's offer, the predator must decide how much it wants to win this battle.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

©2018 Bloomberg L.P.

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