British engineering group is clear frontrunner to buy Volvo's aero engine business but sources say deal is not imminent
Britain's manufacturing industry could receive a shot in the arm if the British engineering group GKN succeeds in a planned swoop on Sweden's largest aerospace company that could value it at up to £800m.
Although sources close to the talks say a deal is not imminent, GKN is now the clear frontrunner to buy Volvo's aero engine business after other bidders, including Germany's MTU Aero Engines, dropped out. The buyout firms Carlyle Group and Nordic Capital are also understood to have pulled back.
The acquisition of Volvo Aero, which makes entire engines as well as parts for aircraft including Saab's Gripen fighter jet and had sales of £616m last year, would be a major expansion of GKN's aerospace business. It is the second largest, by revenue, of GKN's four divisions.
There is speculation that GKN is trying to raise cash for the Volvo deal by selling its wheels business, which makes parts for construction and other heavy vehicles and is regarded as a non-core business.
GKN makes lightweight parts for Airbus and Boeing jets on the Isle of Wight and in Bristol, and has a joint venture with Rolls-Royce to produce lightweight turbine blades for aircraft engines. In January it lost out on a lucrative contract to do work on the wings of the Airbus A320 jet, after a Korean rival made a cheaper offer.
Two weeks ago GKN's chief executive, Nigel Stein, said the company was looking for suitable acquisitions, especially in aerospace and land systems, but he would remain disciplined on how much he would pay.
He described 2011 as a "year of transition" for the aerospace division, where a pick-up in the civil aviation market offset lower military orders. The sales mix, historically closer to 50/50, was 58% civil and 42% military last year and GKN expects this to move towards 70% civil and 30% military.
Volvo wants to sell its aero engine division, which supplies parts to civil and military aircraft, to focus on heavy trucks and construction equipment. Volvo Aero traces its history back to a company formed in 1930 by a locomotive manufacturer to supply 40 aircraft engines to the Swedish air force that at the time only existed on the drawing board.
Analysts are cautious about the mooted deal. Andy Chambers and Alexandra West at Redburn said recently that it would be a "significant undertaking, and therefore carries an element of execution risk".
Sandy Morris at Jefferies said Volvo Aero, based in Gothenburg, would be a good fit with GKN Aerospace, but warned that the acquisition might stretch GKN financially and a rights issue might be required.
"The lure of Volvo Aero is clear," he said. "We see a clear trend towards consolidation in the engine components market and believe Volvo Aero and GKN Aerospace have a lot in common. Both, for example, are working on the development of composite materials for use in engines, with GKN focused on composite fan cases and composite fan blades and Volvo Aero working on a composite fan frame. Both are also already significant suppliers to GE, Pratt & Whitney and Rolls-Royce, but the combined entities would have a stronger overall portfolio."
Funding the deal could be tricky. To raise £250m through, for example, a placing of shares at 200p would mean that about 125m shares were issued, around 8% of GKN's share capital.
"We recognise that GKN would be testing the water somewhat in doing an equity placing and increasing debt against a still uncertain backdrop for the eurozone," said Morris. "On the other hand, we believe GKN simply would not contemplate such a step unless the acquisition case was compelling."
GKN declined to comment.