Continental AG (OTCPK:CTTAF, OTCPK:CTTAY) will spin off its powertrain division - which is now called Vitesco Technologies - to its shareholders next year, pending the approval of the general meeting (which can be considered a mere formality). The spin-off first and foremost is a symptom of an unpleasant environment. Thus the move should be understood as a cautionary signal. Nonetheless, I believe that given the circumstances, it is in the best interest of Continental shareholders. I will explain my thesis in more detail below.
First, one should take a look at the business to be spun off. Vitesco Technologies will comprise of the former powertrain division in its entirety. Its portfolio includes a broad range of solutions not only for internal combustion engines but also for electric engines.
In 2018, those businesses accounted for €7.7 billion in revenue. That represents about 17.3 percent of Continental's total revenue for the period. However, with an EBIT of merely €119.8 million (compared with a total EBIT of slightly above €4 billion), it has been the least profitable division.
The spin-off is somewhat of a "plan b" for the division. Initially, the company had been entertaining a partial sale and a separate listing of Vitesco in order to raise additional capital. Yet, the market climate did not allow for it.
Therefore, I think that the failure to proceed as planned should be seen as a warning sign by investors. The global economic slowdown and particularly the dimming outlook for the automotive sector are far from being pleasant for an automotive supplier such as Continental. And, of course, a spin-off to shareholders has the additional downside of not raising any capital for the parent. During challenging times, every penny of additional funds matters.
Nonetheless, I believe that the Vitesco spin-off will benefit Continental shareholders. Sure, they will own the exact same businesses post-transaction as they did before. But they gain flexibility. Investors will be able to decide individually whether to hold on to the powertrain business or not. If an investor wishes to no longer have exposure to the capital intense development of electric engines or the risk associated with the possible demise of the combustion engine, he or she will be able to simply sell his or her Vitesco shares. The remaining Continental would also be less dependent on what kind of engines vehicles will primarily rely on in the future. Regardless of being powered by combustion, electricity or fuel cell, a car needs an interior, a stable chassis, and tires.
Having a fully independent powertrain company might become particularly beneficial if there will be increasing consolidation forward. It might be easier to actively or passively participate in consolidation for a stand-alone Vitesco than it would be for a part of a diversified group.
Despite the newly won flexibility, one should nonetheless remain aware of the fact that both Vitesco and the remaining Continental will share a similar exposure to macro risks. If fewer vehicles are sold, both companies will inevitably suffer.
As neither company will raise any funds from the spin-off, their respective financial resilience does not improve in the process. The overall risk exposure for investors thus remains basically unchanged (provided they continue to hold both shares).
All in all, the spin-off of Vitesco Technologies should be viewed in the broader context of the parent's, Continental AG, situation. It is thus to be understood as a sign of challenging times ahead. But these challenges are to be faced either way, so the spin-off is still positive news as it gives Continental shareholders more flexibility with regard to their investment.
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Additional disclosure: Disclaimer: All research contained in this article was done with the utmost care. However, I cannot guarantee accuracy. Every reader is advised to conduct his or her own due diligence and research.