GKN Buys Volvo Aero for $1 Billion as Supply-Chain Worries Grow
07/05/2012| 07:03am US/Eastern
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--GKN says acquisition creates a market leader in aero engine components.
--Deal comes as aircraft makers face massive ramp-up in production to meet order backlog
--Alix Partners warns of supply-chain stress
--GKN's shares surge higher as investors warm to company's strategic shift at reasonable price
(Recasts, rewrites, adds analyst and executive comment, detail, background)
By Christina Zander and David Pearson
British engineering group GKN PLC (>> GKN plc) Thursday said it has bought the aircraft engine division of Swedish truck maker Volvo AB (VOLV-B.SK) for SEK6.9 billion ($1 billion), significantly increasing its exposure to the booming civil-aviation equipment market just as risks of supply-chain bottlenecks in the sector grow due to soaring global demand for passenger aircraft.
The aviation industry's supply chain faces years of stress as plane makers may have to crank up production by at least 45% between now and 2015 to deal with a growing order backlog, according to the latest industry study by business advisory firm Alix Partners.
Alix Partners reckons production volumes in the industry may even have to rise by 70% or more among companies that are building or providing parts for new, more complex aircraft.
"Everybody today is struggling--be they airframe builders or engine manufacturers--to make sure they get a good grip and especially a good anticipation of what the problems are going to be," said Eric Bernardini, one of the authors of the report.
Mr. Bernardini's warning comes as Airbus, a division of European Aeronautic Defence & Space Co NV (>> EADS), has already signaled it won't increase production of the A320 neo as quickly as originally planned, though, like arch-rival Boeing Co. (>> The Boeing Company), it is confident its suppliers can keep up with demand.
Airbus and Boeing, which dominate the market for large jetliners, are paying increasingly close attention to their suppliers after experiencing major delays in new jet programs in the 1990s and the last decade, keen to have fewer but more financially resilient contractors on their rosters.
Boeing has just forecast a big jump in the value of commercial-aircraft deliveries over the next 20 years, pegging their value through 2031 at $4.5 trillion, a $500 billion or 13% rise from projections a year ago driven by the higher prices, growing global demand for air travel, and the overall trend among airlines of buying larger aircraft.
Among GKN's key existing aerospace contracts are deals to supply the Airbus A380 and Airbus A350, the aircraft-makers newest jets, as well as Boeing's 787 Dreamliner, which went into service last October after a more than three-year delay, and the 747-8, the revamped version of the U.S. plane maker's jumbo jet. Aerospace made up 24% or 1.48 billion pounds ($2.31 billion) of the group's 2011 revenue of GBP6.11 billion.
Volvo Aero designs, engineers and makes components for major aero-engine manufacturers such as the General Electric (>> General Electric Company)-Safran SA (>> SAFRAN) joint venture CFM, Pratt & Whitney, and Rolls-Royce Holdings PLC (RR.LN). They all equip Airbus and Boeing aircraft.
"This is a highly attractive acquisition for GKN creating a market leader in aero engine components," Nigel Stein, GKN's chief executive, said in a statement.
"With excellent technology and strong life-of-program positions on most civil aero engines, Volvo Aero will significantly enhance GKN Aerospace's engine components business," Mr. Stein said.
Investors agreed. GKN shares rose 14% to GBP2.12 on the London stock exchange in morning trading.
GKN said it will finance the Volvo acquisition with GBP493 million in debt and the issue of GBP140 million of new stock representing approximately 5% of GKN's current market capitalisation.
Volvo Aero is a good strategic fit for the U.K. company, "allowing the company to broaden its... footprint in aerospace and obtain complementary technologies and products to its existing portfolio," said Tom Chruszcz, an analyst at Fitch Ratings. "It also improves the group's balance," Mr. Chruszcz said.
Buying the Volvo business will also reduce GKN's reliance on the auto sector, where many volume manufacturers are struggling with over capacity and Europe's economic downturn, as well as military sales as defense budget cuts loom in Europe and the U.S.
At around 6.3 times Volvo Aero's forecast earnings before interest, taxes, depreciation, and amortization, GKN also paid less than investors expected it to for the Volvo business, resulting in a smaller issue of stock to part finance the deal, said Investec analyst Andrew Gollan.
GKN said separately that revenue in the first five months of the year rose 9% on a comparable basis with the same period in 2011, with "good progress" expected for the full year.
Still, the aviation sector is facing some near-term uncertainty. High fuel prices continue to put all but the most efficient airlines under intense pressure, particularly in Europe given the region's growth-sapping financial crisis, which might ultimately hold back demand for new aircraft.
Alix Partners said the future of airline profitability is in doubt amid volatile fuel prices and a degraded economic environment. In aggregate, net profits at airlines have been squeezed to an all-time industry-average low of 0.5% of revenue due to fierce competition and rising operating costs among other factors.
Some 55 airlines across the world posted a combined net loss of over $1 billion in the first quarter, compared with a post-tax profit of $17 million in the same period last year, with demand for air travel slowing in May from a year earlier, the International Air Transport Association, or IATA, said earlier this week.
Write to Christina Zander at christina.zander@dowjones.com.
Peter Nurse in London contributed to this story.
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