UK: GKN HITS ITS STRIDE. - At its last earnings peak in 1989, an estimated 86% of GKN's profits came from automotive and industrial interests. Today this figure is nearer 55%. Retiring as chief executive, chairman Sir David Lees has left his successor a

by Andrew Lorenz.
Last Updated: 31 Aug 2010

At its last earnings peak in 1989, an estimated 86% of GKN's profits came from automotive and industrial interests. Today this figure is nearer 55%. Retiring as chief executive, chairman Sir David Lees has left his successor a solid platform for future expansion.

Late in November CK Chow was joking about the challenge he faced in making his mark at GKN, where he was to succeed Sir David Lees as chief executive on New Year's Day. 'Unfortunately,' Chow told friends, 'finances are in such a good state that I cannot secure profits increases by making a big provision'.

Then came a bolt from the blue. On 19 December, a jury in Charlotte, North Carolina ruled that GKN's Meineke subsidiary, one of America's largest retailers of replacement exhausts, had breached its contract with a group of franchisees. The ruling could expose GKN to damages of $554 million (£326 million), although the group will vigorously contest the award, fighting a legal battle which may take years to resolve.

'It looks as if Sir David will have to take a big provision this year and as if CK might eventually get the chance to write some of it back,' noted one GKN follower.

Within a week, the Meineke bombshell had wiped £500 million - more than 12% - off GKN's stock-market value, cutting its worth from almost £4 billion to less than £3.5 billion. But while Lees was in no mood to ponder the fact, GKN's ability to absorb the North Carolina shock was a tribute to his leadership of the group. Nine years ago, when he took over as chairman and chief executive, GKN would have been devastated by such a blow. Today, with its stock-market rating and balance sheet transformed, it can withstand the Meineke setback and still embark on a new expansion phase. A New Year recovery in its share price highlighted its resilience.

At the time Lees (who has stayed on as chairman) took command, GKN's position was very different. It had just dropped the historic name Guest, Keen and Nettlefolds - whose antecedents dated back to the early days of the industrial revolution - and was striving to extract itself from the vestiges of its past as a steel maker which had moved downstream into screws, nuts and bolts.

GKN had a diverse motor components business, with a particularly strong position in the growing European market for constant velocity joints, driveline products that transmit power from the engine to the wheels in front-and four-wheel drive vehicles. It also had a range of disparate industrial services, notably the Chep pallet hire business run in partnership with the Australian company Brambles, but also including vending machines and scaffolding. Neither the automotive nor the services operations were highly rated by the City, which regarded GKN as being locked into cyclical businesses (motors) and low-margin operations (Chep, etc), and believed that the combination of manufacturing and services made the company a rather unattractive hybrid.

GKN was left looking like a tarnished blue-chip ripe for a break-up. BTR was regularly tipped as a hostile bidder. Even Parkfield, an upstart, highly ambitious mini-conglomerate, fancied its chances.

Parkfield's attempt never got off the ground, and the company eventually collapsed during the recession, but the fact that such a minnow could even contemplate a bid said something about GKN's vulnerability.

Lees's first big move did little to calm City nerves. He agreed to take a large minority stake, amounting to well over 20%, in Westland, the aerospace company that had been controversially rescued from near-disaster by America's United Technologies Corporation (UTC) which bought a near-30% holding.

Lees believed the deal bought GKN a necessary option for diversification into the high-growth, more highly-rated aerospace business. Westland's helicopter business also had marketing synergies with GKN's armoured vehicles division, maker of the Warrior and other wheeled and tracked vehicles.

'We were very conscious of the cyclical nature of GKN,' Lees says. 'We wanted to try and develop on three fronts and get more balance into the business.'

But some of GKN's own senior managers were dubious about the Westland deal, and the City was sceptical, particularly about the strategic benefits trumpeted by GKN for battlefield co-operation between helicopters and armoured vehicles. Their concerns were aggravated when the Berlin Wall collapsed and the Cold War abruptly ended, putting defence stocks in the doldrums. Then came the recession, which hit the motor and aerospace industries particularly hard.

Lees brought to bear all the financial management skills he had learned since joining accountants Binder Hamlyn as an articled clerk in 1957 and working his way up to become GKN's finance director.

He had never forgotten the shock of the early 1980 slump, which had taken GKN so much by surprise that the company had dived into the red and slashed its dividend. This time, GKN saw the storm approaching and battened down the hatches: 'We did cut quickly - and hard too,' says Lees. 'For me, that was the lesson of 1980-2.'

Meticulously, he worked his way through GKN's sprawling portfolio, selling a string of non-core businesses from the remaining fasteners operations (ironically to Parkfield) to vending. 'Things like vending and scaffolding were fundamentally weak businesses with no international potential,' Lees says. Everything was done to maximise cash generation. The company's research and development programmes, which had mushroomed in the late 1980s, were scrutinised, and resources concentrated on the most crucial areas such as driveline. Among the casualties was the composite leaf spring, a lightweight, energy-saving underbody vehicle component into which GKN had already ploughed about £50 million but which had secured almost no orders. Lees also set about dissecting the company's financial constitution, eliminating minority positions and interests as well as fine-tuning the balance sheet.

His micro-surgery saved the dividend, which GKN was able to maintain in 1991, when pre-tax profits fell to £69 million from £113 million the year before, and earnings per share dropped 61% to 14p, by dipping into reserves. In 1992, while other engineering companies were still struggling to cope with the slump, GKN pre-tax profits bounced back to £122 million. They slipped a little the following year, but soared to £200 million in 1994 as automotive volumes recovered and the group reaped the returns of its streamlining. The dividend was raised for the first time in four years. And the last steel interest, GKN's 40% stake in United Engineering Steels, was sold to its majority partner British Steel in 1995. By then, GKN had emerged from the recession transformed from possible takeover prey into probable predator.

The acquisition that did most to rebalance GKN was made two years ago.

Of this development, Lees says,'The most important single strategic move was the acquisition of Westland'. It was a move GKN might not have been able to make. In 1990, Lees had seriously considered selling the Westland stake, and would almost certainly have accepted an offer from British Aerospace. But although BAe looked closely, it never tabled a bid. Then it ran into financial crisis and was too occupied with saving itself to think about buying Westland.

Lees and his team reappraised the Westland situation and, as GKN recovered, decided to pursue the aerospace expansion strategy. When TI bid for Dowty in 1993, GKN pondered making a counter-offer before deciding that the price would be too high. By late 1994, with increasing signs that UTC wanted to sell out of Westland, and with BAe beginning to show renewed interest in adding helicopters to its portfolio, it was make-your-mind-up-time for Lees and Co.

GKN bid for Westland in January 1995 and, after a brief battle, won with a £500 million offer. Lees remains delighted with the purchase: 'For GKN, it has opened up new market opportunities to take the group forward. The helicopters business is fine, and we are very excited with what we have got. But it has also brought us into the aerospace business beyond helicopters. It gave us UK earnings (important in reducing GKN's tax charge, in particular its exposure to advance corporation tax) and made the portfolio much more balanced.'

For Lees himself, the Westland acquisition marked a return to the aerospace industry: his first industrial employer after Binder Hamlyn was the Handley Page aircraft company, where he worked for six years before joining GKN in 1970. For his company and its shareholders, his return to the business could not have been more auspicious. Within days of the deal's completion, Westland received a £190 million payment from the Arab Organisation for Industry (AOI), settlement of a compensation claim by the British company which dated from the late '70s over and was over an order from Egypt that was abruptly cancelled. So few people had ever expected that Westland would get real money from the AOI that, although GKN's take-over terms had given Westland investors the option of taking AOI settlement cash in part-payment for their shares, almost everyone had elected to take GKN paper. As a result, almost the entirety of the AOI payment flowed into GKN's coffers.

Lees had been extraordinarily lucky, but fortune favoured his audacity in targeting Westland. With a £4 billion order book from its Lynx, SuperLynx and EH101 helicopter range, the Yeovil-based firm has brought GKN a sound airframe business. And, as Lees's comments suggest, the hidden jewel in the crown was its technologies division, expert in various areas with relevance beyond aerospace. Its potential was highlighted last summer when it won an order from German railways for an advanced air-conditioning system. 'That was a breakthrough for us,' says Lees. 'Rail equipment is another market that was not really open to us before Westland.'

Westland provides Chow with several expansion possibilities. In helicopters, there is the potential to move closer to Agusta, Westland's Italian partner in the EH101 project, which is due for eventual privatisation. And a link-up with BAe, the Franco-German company Eurocopter or an American group cannot be ruled out. Through the technologies division, GKN could move further into the aerospace systems mainstream, and deeper into rail equipment, an area which shows signs of becoming a growth industry in the early 21st century, 200 years after Guest Keen won its first rail orders in the age of steam.

Chow also stands to benefit from the foundations laid by Lees's careful development of the Chep operation, both into the potentially vast American market and in Continental Europe. Lees is justifiably proud of the profoundly unsexy pallet hire business: 'The thing about Chep is that we have just gone on growing it. In geographical terms, the biggest single decision was having the guts to take it into the US. It looks an obvious move now, but I can remember doing the sums and working out what the write-offs would be if we got it wrong. We had three looks at the US in the 1980s, but we were dead right not to move until we did (at the turn of the decade) because the market came towards us in the end.'

The clincher for GKN and Brambles was when America's grocery giants, such as Procter & Gamble, realised how much money they were losing through defective pallets. One estimate put the cost to the trade at $500 million a year. In the increasingly cost-conscious 1990s, Chep's high-quality pallet pool offered the perfect cure for this headache.

But Chep has also diversified in product terms: 'The wooden pallet is only one of its products,' says Lees. 'There is reusable secondary packaging, steel containers, plastic autocrates', all for just-in-time delivery to European vehicle makers. 'All these services lend themselves in different ways to the pooling system,' says Lees. Chow will find that both Chep and the waste management business Cleanaway, GKN's other joint venture with Brambles, have significant potential for overseas growth.

So does the automotive business. Run by the unsung (outside GKN) but supremely professional Trevor Bonner, the automotive and agricultural vehicle components operations remain what Lees calls GKN's 'engine room', with sales forecast by Robert Speed of stockbroker Henderson Crosthwaite to exceed £2 billion in 1996 out of a total £3.4 billion, despite the truck market slump which restrained first-half sales growth. Having repulsed an early '90s attempt by its Japanese former licensee NTN to depose it from world technology leadership, GKN now dominates the global driveline market with a share of 70%, excluding in-house production by the vehicle makers. Few other British companies enjoy such pre-eminence in a volume product sector or possess so truly global a business.

The driveline operation is moving rapidly into the fast-growth markets of Asia and Latin America, where it should benefit enormously from the combination of Bonner's intimate connections with the customers and Chow's country knowledge. Hong Kong-born, American-educated, and the former head of BOC's worldwide gases business, Chow is a true borderless executive.

Chow and Bonner must sustain the development of the core driveline business, notably by responding to the vehicle makers' increasing emphasis on the supply of systems rather than individual components.

But their real strategic task is to determine which other automotive operations should be expanded internationally. An indication of the company's acquisitive intentions was the recent decision to create a new post of business development director for the auto operations. The job specification involves 'a comprehensive market review and the identification of acquisition opportunities, as well as new product and market entry strategies'.

One likely area for acquisition is powder metallurgy, the materials technology of making components from sintered metal. T&N is the British leader in the business, which has been fragmented but is beginning to consolidate. Bonner says GKN 'can't be expected to remain aloof' from the consolidation process. Late last year, it made an approach to buy T&N's powder business, valued at about £250 million, but was rebuffed.

GKN's Sankey division, based at Telford in Shropshire, is also set for considerable change. In recent years, the huge site has been upgraded from a metal-bashing jobbing shop into a producer of higher-value assemblies, such as chassis frames for Land Rover vehicles and suspension components for the Ford Escort. But it is still overwhelmingly dependent on the UK home market. 'Sankey has made significant strides forward and is growing organically, but it faces the issue of industry globalisation,' says Bonner.

'It is no longer possible just to be a regional player as Sankey's engineering business is at present.'

Lees, whose first job in GKN was as chief accountant of Sankey, will see the honing of the Telford business where he cut his teeth in GKN, as entirely consistent with his own quiet revolution. 'Focus is the key,' he says. 'You must not sprawl into conglomeracy. Although our three businesses are different, they are all quite big players in their sectors. And there are fiscal and economic synergies between them.' Adam Collins, motors analyst at Merrill Lynch in London, agrees. 'GKN has been transformed in recent years. At the last earnings peak in 1989, an estimated 86% of profits came from cyclical automotive and industrial interests. Today, this percentage is nearer 55%.'

With its cash reserves - a net £252 million at the last count - borrowing capacity and share rating, and even with the Meineke costs, GKN could muster more than £1 billion for expansion and still hold debt gearing at 40%. That financial muscle could help GKN to push through a merger of its armoured vehicles business with the tanks operation of Vickers, something Lees is keen to engineer but about which Sir Colin Chandler, his counterpart at Vickers, has been cool. The shortest route to such a union would be a GKN bid for Vickers, but analysts think this course of action unlikely unless the Vickers share price falls sharply and provides GKN with the headroom to offer existing investors a premium.

Beyond Vickers, Chow has plenty of opportunities to ponder. The former BOC man was a surprise choice as chief executive, but with experienced specialists in charge of the three main operating groups, Lees was keen to find a generalist to take over direction of the whole. Lees says that Chow is 'a natural builder of businesses', and GKN is now ready to for its next phase of reconstruction. The character of the leadership may change - Chow's ebullient style contrasts with the more solemn management culture of GKN - but the resolve to drive the company forward will remain as strong as ever. Thanks to Lees, the platform for this expansionism is rock solid.

The company's shareholders will also benefit from Lees's legacy. 'When the next auto recession comes, we will not be able to sail through it unaffected, but I'd be very disappointed if the dividend ever came under threat,' Lees says. 'You couldn't say that at the end of the 1980s.' That is only one, if perhaps the most fundamental, gauge of GKN's new resilience.

An unlikely radical, Lees has carried through nothing short of a corporate revitalisation.

Andrew Lorenz is business editor of the Sunday Times.


First half '96 (£m) First half '95 (£m)

Automotive and agritechnical 1,075 1,029

Aerospace and special vehicles 466 313

Industrial services 174 148


First half '96 (£m) First half '95 (£m)

Automotive and agritechnical 101 102

Aerospace and special vehicles 38 23

Industrial services 37 26.

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