Bouncing back

A COUPLE of decades ago two tyremakers, Pirelli of Italy and Continental of Germany, were locked in a takeover battle. A merger would have brought them close to the size of the world's big three tyre firms: Bridgestone, Goodyear and Michelin. It didn't happen. Continental fought off Pirelli and they went their separate ways. Both have had a bumpy ride.

Tyremaking is a dependable, if unglamorous, business. Even when recession bites—as it has twice since 1991—motorists still need replacement tyres, which account for 75% of revenues. But that steady cashflow tempted both Pirelli and Continental to veer off track.

Pirelli jumped into communications and property. Its boss, Marco Tronchetti Provera, became chairman simultaneously of Pirelli and Telecom Italia as well as deputy chairman of Olivetti, a computer firm. It was only last year, as Pirelli hived off its property and broadband businesses, having shed cables and Telecom Italia some years back, that it became a straightforward tyremaker again.

In 2011, for the first time in 20 years, Pirelli will supply Formula 1 racing teams with tyres to burn up at high speed. Mr Tronchetti describes this as “the best possible marketing tool”.

Continental has diversified, too, adding brakes and interior components to its Contitech partsmaking division (see chart). But in 2007 it overreached by paying €11 billion ($15 billion) for Siemens VDO, the car-electronics division of Siemens. A year later Schaeffler, a family-owned maker of ball-bearings, tried to take over Continental with a low bid, but because of the financial crisis attracted a flood of shares. Maria-Elisabeth Schaeffler and her clan, once reckoned to be among Germany's ten richest, ended up owning 75% of Continental, instead of the 50% they wanted, and owing their banks €12 billion.

Automotive experts reckon a full merger of Continental and Schaeffler makes little sense. Yet the two companies are bound by a web of debt. Much of their cashflow goes to paying it off rather than investing in the future. It is some consolation that the automotive industry is enjoying a boom, and that Schaeffler can defer payments on half of its debt until 2014.

Pirelli reckons its narrower focus on tyres, especially premium ones, will prove an advantage as it expands in emerging markets. Half of its business is already in the emerging world—“more than any other of the top five tyremakers”, says Francesco Gori, head of Pirelli's tyre division. Its salvation during the recent crisis was Brazil, where it is the leading brand. Pirelli's worldwide sales dropped by only 2.9% compared with the industry-wide average of 10%, Mr Gori says.

Pirelli was one of the first into China when majority foreign ownership of tyre factories was allowed in 2005. In November it signed joint-venture agreements with Russian Technologies and Sibur Holding of Russia to upgrade a tyre plant (for premium and winter tyres) and to reorganise a truck- and farm-tyre plant which employs 12,000 people. Other tyre companies regard this as “brave”, given the difficulty of doing business in Russia.

Pirelli will not yet touch India: the market for premium tyres is tiny, and the wheel sizes of commercial trucks and of the Tata Nano (a super-cheap car) are too small, says Mr Gori. Continental, in contrast, first came to India in 1974 and wants to expand. The firm also has a tyre plant in China, where it competes with 300 local producers as well as the big three. “Even Michelin and Bridgestone are small in China,” says Hans-Joachim Nikolin, a board member at Continental. The firm has pioneered low-cost manufacturing in regions such as central Europe.

Which company is best-positioned for the future? Pirelli has the best brand and is the favourite of many car enthusiasts. Apart from sidelines such as branded clothes, latex mattresses and a calendar featuring unclad women, it is focused on making tyres. Continental, which responded to the downturn by diversifying, finds the tyre business is carrying its other divisions. But the world may change.

High demand for natural rubber has driven up prices. Tyre-producers are seeking alternatives, including recycling old tyres and using more synthetic material. But even today natural rubber makes up around 14% of car tyres and 27% of lorry tyres. Pirelli and Michelin, which sell many lorry tyres, are most exposed, points out HSBC, a bank. Until hastily planted rubber trees mature, the advantage may lie with Continental rather than with its slimmed-down former suitor.