View from City Road: BAe's streamlined shape will allow it to soar

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The Independent Online
No, there never was any synergy in 1988 when British Aerospace bought Rover for pounds 150m, and yes, it was a steal.

Owning Rover has made no net contribution to group profits, as losses have offset profits, and it has had no impact on BAe's net debt.

But the sale crystallises a profit of perhaps pounds 350m to pounds 400m, which will be available for future dividend payments to BAe shareholders. The windfall can also be used to absorb any costs - analysts reckon pounds 150m to pounds 200m - of restructuring BAe's turbo-prop aircraft side at Prestwick, currently losing more than pounds 120m a year.

Honda seemed set to keep BAe locked into a business it did not want to be in. BAe shares soared yesterday but a 5 per cent jump in BMW shares to a new record in Frankfurt demonstrated that Rover's synergy for the Germans, by contrast, is strong. Access to Japanese production systems, a move into four-wheel drive and smaller cars and greater use of an extensive distribution network suggest that BMW has not overpaid.

The deal with BMW, astonishing to Honda and everyone else by its speed, has several positive elements for BAe. A debt-free consideration of pounds 800m looks like a peak cycle price at an early stage of the European and US car recovery.

But the deal also takes BAe closer to the culmination of an enormous and painstaking switch into a focused defence group with a robust balance sheet. During 1993 its announced disposals - corporate jets, construction and computer services - were expected to raise pounds 500m.

Last year it took steps to modernise its legal structure to ensure that it could protect its dividend-paying capacity from nasty exceptional losses on the sale of important assets.

Not long afterwards it negotiated a change to debt covenants with lenders, altering the restriction from net worth to interest cover. If it had not done this, the Rover sale could not have gone ahead. Net assets at Rover were pounds 1.4bn at the end of 1993. And before the covenant change, BAe could not have contemplated a disposal that, even at BMW's price, would mean a pounds 450m reduction in BAe's consolidated net assets.

Rover's sale will also release BAe from the huge financing obligations that go hand-in-hand with car production - working capital, capital investment in new models and supporting distributorships.

On average Rover has been carrying borrowings of pounds 200m and has pounds 700m of off-balance sheet debt to keep its distributors running smoothly. In this sense BAe will enjoy a hefty pounds 1.7bn improvement in its finances, as perceived by lenders, and will eliminate on- balance sheet debt.

Given this huge financing overhang, BAe never stood to make a satisfactory return from Rover, after financing costs and relative to its true value, except at the peak of the cycle. So earnings will be boosted from 1994 onwards.

Taking a bath in turbo-props, probably through putting together a joint venture with its French- owned rival, will also produce a strong profit improvement in 1995. With some forecasts now exceeding pounds 200m pre-tax for 1994, or a prospective p/e of 12, BAe shares, up 55p at 499p, seem set to resume their remarkable recovery.