LucasVarity sells diesel engines business for $1.3bn

LucasVarity yesterday announced the sale of its VarityPerkins diesel engine subsidiary to Caterpillar, the US engine maker for $1.3bn. Peter Thal Larsen finds that the deal will give the automotive and aerospace engineer a sizeable war chest with which to beef up its remaining businesses.

Although the offer from Caterpillar had been unsolicited, the $1.32bn (pounds 803m) price tag made it impossible for LucasVarity to refuse. "The price beat our own internal valuation of the division, so it was right to sell it," said chief operating officer Tony Gilroy.

Nevertheless, the sale contradicts the strategy mapped out for the business when Lucas and Varity announced their merger just eighteen months ago. At the time, chief executive Victor Rice claimed that VarityPerkins would benefit from sourcing Lucas's fuel injection systems. He said joint research & development initiatives between the two divisions would "result in cost savings and enable the two businesses to compete more effectively on a global scale."

At the time, Mr Rice also predicted that VarityPerkins's sales would almost double to pounds 1.3bn by the year 2000.

Last night, Mr Gilroy admitted that those targets were no longer attainable. "VarityPerkins' sales and margins are not as strong as expected," he said. However, he claimed that this was mainly due to the strength of sterling, which had hit VarityPerkins more heavily than the rest of the group.

LucasVarity's third quarter results, which were also released yesterday, support that view. In the three months to September, the group's Diesel Engines division produced operating profits of pounds 13m on sales of pounds 157m - lower than in the second quarter, and roughly in line with the pro-forma figures for the third quarter of 1996.

LucasVarity also said that more stringent environmental controls of diesel engines had prompted it to sell the business.

VarityPerkins largely produces diesel engines for off-highway vehicles like earth-moving equipment, which have historically enjoyed less stringent emissions requirements. But environmental legislation is prompting the technology used in off-highway diesel engines to converge with the engines used in trucks and cars. "We concluded it would have been very challenging to develop a major on-highway business organically," said Mr Rice, adding that building a position through acquisitions was not economically viable.

Investors welcomed the sale, pushing up LucasVarity shares 1.5p to 192.5p in a falling market. "VarityPerkins was always the likeliest disposal candidate. It wasn't really a surprise," said Tim Bennett, engineering analyst at investment bank Morgan Stanley Dean Witter. He added that at a multiple of 19 times forecast earnings and 1.2 times expected sales, LucasVarity had secured a good price for the business.

Industry observers now expect LucasVarity to use the proceeds of the sale to strengthen its aerospace and automotive businesses. After tax and transaction costs, the group expects the disposal to bring in "in excess of pounds 400m." That would reduce its net debt, which stood at pounds 496m on 31 October, to under pounds 100m. But Mr Gilroy confirmed that the group would be comfortable with current levels of interest cover, suggesting that LucasVarity could afford a big deal.

Since the merger, it has added to its aerospace businesses while also making three bolt-on acquisitions for its braking division. Speculation that the group was lining up an acquisition was heightened when it confirmed that it would not be accelerating the share buyback program which has seen it buy in 3 per cent of its equity this year. "The last thing this company wants to do is stick with cash," one expert explained. "The logical conclusion would be that they've got something lined up."