ThyssenKrupp Plays Its Joker

(Bloomberg Gadfly) -- When talks with a potential deal partner drag on forever, it helps to have a joker up your sleeve. Not least because it might get those sitting across the table to move a bit faster.

ThyssenKrupp AG is considering a radical break-up as an alternative to a proposed steel joint venture with India's Tata Steel Europe Ltd, Bloomberg reported on Wednesday.

You can't blame ThyssenKrupp CEO Heinrich Hiesinger for losing patience. The Tata talks have been going on more than a year and his workers are worried about the tie-up and potential job cuts.

Plus there's a fashionable new model in Europe for how to separate structurally-challenged divisions from the more profitable and promising stuff: essentially you keep the bad bit and spin off the good bits in an initial public offering. German utility RWE AG pioneered this approach last year with the IPO of its renewable energy and grid activities -- see here -- creating value for its shareholders. ThyssenKrupp's so-called Plan B would see it keep steel and spin off the more exciting technology and capital goods units.

Even so, the Tata steel joint venture remains the more likely outcome, I'd wager, because it represents ThyssenKrupp's best chance of transforming the steel unit's profitability.

You can see why Plan B is tempting. The German company's biggest problem is that investors give it little credit for its profitable technology businesses. That's largely because it's overshadowed by a steel unit that doesn't make much money and is saddled with massive liabilities.

ThyssenKrupp's elevator unit accounts for about two-thirds of group operating profit. If valued at a similar multiple of profit to Finnish rival Kone Oyj, it would be worth almost as much as ThyssenKrupp's total market capitalization today, according to my rough calculation.

But while spinning off the elevator and automotive components businesses seems sensible at first glance, it would probably be complicated by those liabilities. ThyssenKrupp has 5.8 billion euros of net debt and about 8 billion euros in pension obligations. Shareholder equity is a meager 2.3 billion euros. Although steel prices have improved thanks to curbs on Chinese steel exports, ThyssenKrupp's steel business generates comparatively little profit.

In theory, the dividends from a standalone capital goods and technology business could help fund those steel-related liabilities, plus ThyssenKrupp could raise capital while keeping a chunky stake in a more valuable capital goods business. Still, the parent company's supervisory board, regulators and credit rating agencies might have something to say about ThyssenKrupp casting off cash-generating assets.

By contrast, a Tata joint venture would let ThyssenKrupp shift debt and pension liabilities off the books at the same time as improving the steel unit's profitability. Analysts see about 500 million euros of savings from combining raw materials and research activities. In time, those better earnings might allow the combined entity to cut debt and seek a separate listing.

The steel JV isn't perfect. It won't help ThyssenKrupp raise capital, nor does it guarantee consolidation of Europe's steel sector: Tata has given a five-year job guarantee to workers at a British plant. 

So Hiesinger is right to show his Plan B joker. But, on balance, Plan A still looks like the winning hand.

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

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

1. That valuation would be a stretch though, because Kone's operating margin is better than ThyssenKrupp's elevator unit.

To contact the author of this story: Chris Bryant in Berlin at cbryant32@bloomberg.net.

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net.