Feb. 10 (Bloomberg) -- Schaeffler Group, the bearings maker strained by 11 billion euros ($14 billion) in debt from buying Continental AG, may consider a debt-for-equity swap if it fails to get German government aid or other fresh capital, people close to the talks said.

Lenders led by Royal Bank of Scotland Group Plc may be forced to swap debt for shares owned by Maria-Elisabeth Schaeffler and her son Georg after the company failed to attract new money to cut borrowings, said three people, who declined to be identified because the talks are private.

The banks may be reluctant to take control of Schaeffler because they will struggle to find buyers for its assets amid a slump in the auto market. Talks are continuing and Schaeffler wants to convince the banks that better options are available as it lobbies the government and seeks investors, the people said.

“Everything’s up for grabs, but asset sales will be hard to pull off in the current environment,” said Michael Tyndall, a London-based analyst with Nomura Securities. “The banks control Schaeffler’s destiny.”

RBS, along with UBS AG, Commerzbank AG, Dresdner Kleinwort, Landesbank Baden-Wuerttemberg and UniCredit SpA’s HVB Group unit, financed Schaeffler’s purchase last year of 90.2 percent of Continental, Europe’s second-largest car-parts maker. Continental rose 16 cents, or 1 percent, to 15.63 euros in Frankfurt trading, 79 percent below the price Schaeffler paid before the recession soured the automotive market.

Tire Division Interest

Continental’s tire business may have the best shot of being sold off to raise cash. The unit, Europe’s second-largest tiremaker, may find a buyer willing to pay 6 billion euros to 7 billion euros in the second half of this year at the earliest, one of the people said.

Last year’s acquisition of Continental by Schaeffler, the second-largest ball-bearing maker after SKF AB, was the biggest deal in Germany since 2000, according to data compiled by Bloomberg. The total value of transactions in Germany fell 51 percent in 2008 to $191.5 billion.

Hanover, Germany-based Continental is in the process of carving out the tire division into a separate business as Chief Executive Officer Karl-Thomas Neumann reviews a combination of the company’s remaining car-parts operations with Schaeffler’s.

Markus Breidenstein, a spokesman for the bearings maker, declined to comment on bank discussions. A spokeswoman at RBS in London said she couldn’t immediately comment.

Offer Too Successful

Schaeffler’s troubles have piled up since its July 15 hostile bid for Continental, a company three times its size. Schaeffler, based in the Bavarian hamlet of Herzogenaurach, expected that derivatives contracts and what was then a low-ball bid would secure a stake of 30 percent to 50 percent. Instead, 82.4 percent of Continental’s capital was tendered, adding to a 7.8 percent holding, as investors sold amid collapsing markets.

The Schaefflers have said they appealed for “temporary” government aid for their 53-year-old company after failing to find investors. The owners pledged to “do everything to prevent a senseless breakup” and are prepared to sell part of the company, a move that was previously ruled out.

International Petroleum Investment Co., a sovereign wealth fund from the United Arab Emirates, is considering taking a stake in Schaeffler or Continental, the Financial Times Deutschland reported, citing an unidentified person in the financial community. The fund plans to contact Schaeffler and its banks about the potential purchase of a stake of at least 20 percent, the paper said.

Detlef Sieverdingbeck, a Schaeffler spokesman, declined to comment on the report about IPIC’s interest.

Government Aid

Schaeffler was rebuffed in previous attempts for German aid. After talks on Jan. 28, the government called on the company to submit a “viable” business plan in agreement with its banks. Chancellor Angela Merkel ruled out government support for Schaeffler, which needs 3 billion euros to 5 billion euros, Bild reported Feb. 2.

Schaeffler, which makes transmission parts and ball bearings for cars, planes and fishing reels, intended to create the world’s top auto-parts maker, combining Continental’s electronics and software expertise with Schaeffler’s mechanical know-how. The two companies have a combined 22 billion euros of debt as the global recession plunges the auto industry into its worst crisis in more than a decade. U.S. car sales plunged 37 percent in January in the worst month since 1981.

Earnings Erosion

Schaeffler has an estimated 899 million euros in interest expenses in the first year of the deal, enough to suck up 84 percent of operating profit, based on first-quarter 2008 figures given in the Continental offer document. Since then, weak demand for cars has likely eroded earnings, and Schaeffler’s expenses have risen after the company raised the bid in August.

The company is in talks with unions about deferring a 2.1 percent pay increase from May to December, Sieverdingbeck said today. Schaeffler is offering a profit-sharing plan to employees that would start next year in exchange for the delayed pay rise.

Schaeffler is also shutting production four to five days a month through July because of weak auto markets.

The company directly holds 49.9 percent of Continental’s capital after transferring 40.3 percent to private German banks B. Metzler seel. Sohn & Co. and Sal. Oppenheim Jr. & Cie KGaA for possible sale later.

The arrangement is the result of an August agreement between the two companies that governs the relationship. It restricts Schaeffler from boosting the direct stake to a majority or adding to Continental’s debt, and calls on Schaeffler to support management’s strategy.

To contact the reporters on this story: Chris Reiter in Berlin at creiter2@bloomberg.net; Ambereen Choudhury in London at achoudhury@bloomberg.net

Last Updated: February 10, 2009 12:16 EST