German ball-bearings maker Schaeffler is hoping that a recovery in the share price of Continental AG will help save billions of euros in write downs on its holding in the company, chief executive Juergen Geissinger has said.

Speaking to the media on the sidelines of an event earlier in the week, Geissinger said that he expects that ''when we see how the market and the cooperation with Continental develop, and when the logic has been understood and we have showed results, then the share price will improve accordingly." 

Earlier in 2008, Schaeffler had agreed to keep its holding in Continental at lesser than 50 per cent for four years, in a bit to end a battle over controlling the company, and push through its €75 per share offer for Continental. However, shareholders tendered over 82 per cent of shares in Continental, increasing Schaeffler's holding to around 90 per cent.  (See: Continental agrees to conditional sale to Schaeffler) 

Now, Schaeffler has promised to hand out the excess 40 per cent holding to bankers, who would then sell them further.

A number of parties are said to be in talks to buy stakes varying from 10 to 20 per cent each from the banks. Geissinger said his company was looking at long term investors for the stakes. 

The problem now is that the market price of Continental shares not carrying Schaeffler's offer acceptance rights were trading at €38.60 mid week, valuing the company at €6.2 billion, much below the price of tendered shares.

Reports have suggested that Schaeffler's €11.35 billion hostile bid for Continental AG, which is the world's largest supplier of car parts, helped it gain control of 36 per cent of the company by exploiting a legal loophole. They said that at the time of announcing the bid, Schaeffler held 2.97 per cent of Continental's shares and another 4.95 per cent in physically settled call options. However, Schaeffler had also entered into cash-settled equity swaps for approximately 28 per cent of Continental's shares. 

Under the German Securities Trading Act, any company that acquires three per cent of the voting rights of a German issuer needs to disclose its position. They say that the same rules are applicable when a company or an investor holds other financial instruments that give it the right to acquire at least five per cent of voting rights. However, unlike shares or options, cash-settled equity swaps do not need to be reported.

Schaeffler agreed with Merrill Lynch to buy cash-settled equity swaps, which was more or less a bet on whether Continental shares would go up. As part of the agreement, Merrill Lynch agreed to pay Schaeffler an amount equal to any rise in Continental's stock price plus dividends that Schaeffler would have received if it had physically owned the stock. In return, Schaeffler said it would pay an amount equal to any fall in the value of the stock, plus interest Merrill would have received if it had loaned Schaeffler the money to buy the shares.

That agreement in place, Schaeffler launched a mandatory bid for the rest of the shares at the minimum level required by German law of €70.12, the average share price over the preceding three months. It subsequently raised its offer to €75 per share of Continental, and received an unexpectedly high take-up, with investors tendering 82.41 per cent of Continental stock. 

Combined with 7.78 per cent stake that Schaeffler already owned, it drove up  Schaeffler's holding to 90.2 per cent. Schaeffler had pledged to cap its holding in Continental at 49.99 per cent for at least four years to avoid triggering a requirement to renegotiate €10 billion debt that Continental has on its books.

Now, 40 per cent of the stock will be held by a group of banks which have promised not to sell it at below €75 for four years, without Schaeffler's consent.

Germany's newly adopted Risk Limitation Bill seeks to partially close this loophole, by mandating disclosure of shareholdings and options exceeding threshold levels. However, it will not cover cash-settled call options, the rules for which are under review by regulators.
 
Reports now suggest that Schaeffler is looking at plans to shut plants for an extended Christmas break, and possibly reduce working hours as the global economic situation hits auto sales.
 
Carmakers such as Bayerische Motoren Werke AG (BMW), Daimler AG's Mercedes-Benz, and Ford Motor Co.'s units, as well as General Motors Corp already have idling plants, with extended seasonal shutdowns in the pipeline to cut their German output by 200,000 vehicles. That has in turn caused their suppliers to scale back production. Continental was reported to be mulling plans to lay off around 5,000 temporary staff, and extend its holiday break to around four weeks.
 
European Union (EU) antitrust regulators would most probably come out with a ruling on the acquisition by 19 December, after which Schaeffler would have eight business days to pay off the holders of the stock tendered in the offer.