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Melrose/GKN: demerger reflects weakness of auto sector

UK stock market investors have many faults. Sentimentality is not one of them. They are unlikely to celebrate the partial return of sometime stalwart GKN out of nostalgia next year.

They may however be a little disappointed by the demerger plan of owner Melrose. Sometimes described as a “public private equity group” Melrose has specialised in streamlining industrial businesses and selling them to trade buyers at a big profit. Handing shares in GKN’s large and unglamorous automotive business to shareholders is a departure from that script.

Melrose’s red-blooded capitalism made its 2018 acquisition of GKN an acrimonious affair. But a steep £8bn purchase price and the backing of event-driven hedge funds delivered eventual victory.

Melrose may be spinning off GKN automotive because the state of the world vehicle industry is too uncertain to support a profitable sale. Valuations for parts makers remain near decade lows. Car sales took a hit in the pandemic and may again in an anticipated recession. Supply chains have been badly disrupted. Combustion engine vehicles, for which GKN still makes many key parts, particularly drivetrains, are on the way out.

The state of Melrose’s other main markets in aerospace are not much better. The difference is that Melrose believes its turnround of the automotive business is complete. An aerospace deal would be next on the agenda.

Melrose is including a powder metallurgy business with the automotive company. Combined revenues at the two might hit £5bn this year, thinks Numis. An enterprise value of six times expected 2023 ebitda — the top of the range for listed peers — would value the group at just over £4bn. 

The final rating will depend on how well the new group can position itself for the EV revolution. Melrose is confident of 10 per cent operating margins if revenues return to their 2019 level.

It hopes the rump aerospace business would then re-rate. At 12 times forward ebitda this might be worth as much as the automotive business. Total upside could notionally be as much as one-fifth for shareholders, Lex calculates. But Melrose shares were flat in early trading on Thursday.

Investors should not entirely dismiss the possibility of a cash buyout of GKN automotive. The pound has slumped to around $1.15. M&A bankers expect a steady trickle of US takeovers of underpriced UK assets in months to come.

The Lex team is interested in hearing more from readers. Please tell us what you think of the planned GKN demerger in the comments section below.

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