Continental: From Tires to High-Tech Titan?

The slumping company bets big on auto-safety systems

Motorists across Europe know Continental. The German company's tires come on models of every shape and size, from Volkswagen Golfs to Peugeot 206 compacts. But CEO Stephan Kessel is not happy running the second-biggest tiremaker in Europe, after Michelin. Tires are a tough, low-margin business, and Kessel is prepared to spend money to diversify--big money. That's why he plunked down $570 million on Apr. 2 to buy control of DaimlerChrysler's Temic auto-electronics business. The goal: to give Continental a leg up in the rapidly growing market for electronic stability programs (ESPs), which help prevent auto rollovers.

That's the lucrative kind of business Kessel wants in on. Profit margins on high-tech auto parts are normally more than twice those in the mature and fiercely competitive tire business. Continental's profits in 2000 fell 13%, to $187 million, on sales of $8.2 billion, because of higher commodity prices. The outlook for 2001 isn't good, either, with U.S. car and truck markets and Europe's truck business all in a slump. The stock is in the doldrums, falling 21% over the past year and underperforming other tire companies. Analyst Jürgen Pieper at Metzler Bank in Frankfurt is advising clients to bail out. "There's no reason to invest in this company other than ESP. That's the bright spot," Pieper says.

The goal is to make ESP such a smash hit that investors will flock back. It looks like a good gamble. Continental made its first move into electronic safety systems in 1998 when it acquired German brake company Teves for $1.9 billion. Teves and Stuttgart-based electronics specialist Robert Bosch are the two main producers of ESP, an advanced technology that grew out of antilock braking systems, which prevent skids. The technology, pioneered by Bosch, is now looking attractive to carmakers stung by a series of highly publicized rollover disasters.

Just look at Ford Motor Co.'s troubles. Ford was plunged into a public-relations nightmare last year when it turned out that more than 150 people had been killed in Ford sport-utility vehicles that flipped after faulty tires blew. In 1997, Mercedes-Benz suffered a blow to its prestige when the new A-Class compact rolled over during a road test. Mercedes halted production of the cars to install an ESP made by Bosch.

ESP can't prevent a rollover once it's under way. But it guards against the loss of control that usually precedes a rollover. Electronic sensors detect when the car is not going in the direction that the driver is steering. The system then intervenes by braking one or more wheels to realign the car to go where the driver wants it to.

That kind of technology comes at a price. ESP costs carmakers about $400 a system. But they're flinching less these days--particularly as they can resell it at upwards of $600 as an option. So while Mercedes uses ESP as standard equipment on all its cars, Ford will list it as an option on its Explorer SUVs starting in November. By 2005, it will offer ESP on all its light trucks and SUVs. With the safety concerns raised by Ford's troubles, Kessel says he has seen a surge in interest from manufacturers. He expects ESP sales to jump to 3.4 million units in 2003 from 1.4 million last year: "We've had strong requests to speed up some of our programs," he says. ESP accounted for a small fraction of Continental's 2000 earnings, but Kessel says he expects high-tech components, including ESP, to become his main revenue-drivers within a few years.

COMPANY COMING. For now, Continental and Bosch are ideally placed. Between them, they share the $700 million roughly 50-50. Auto makers say that although the two companies use different technologies, their ESP systems are equal in quality. But TRW and a lot of big suppliers are getting into the act, and that's going to drive prices down. "It's only the two of us now, but we're expecting competition any day," says Kessel. Continental is trying to stay ahead by lowering manufacturing costs.

Even more important, Kessel is working on the Next Big Thing: ESP-Plus. That's where the acquisition of DaimlerChrysler's Temic comes in. Temic will make electronics for ESP-Plus, which goes a step further by steadying the car once the sensors detect one or more wheels coming off the ground. "We're very interested in that technology and expect to deploy it in future SUVs," says a Ford executive. If Kessel can preserve Continental's lead in high-tech safety systems, the tired old tiremaker may just drive safely into the future.

By Christine Tierney in Frankfurt

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