Schaeffler Group KG (Germany; privately-held parent of LuK, INA and FAG Bearings) has begun a reorganization process that will eventually change its corporate structure to raise capital by allowing outside investors. It will also force an unprecedented level of transparency. The new corporate structure is designed to allow Schaeffler to cleanly merge with Continental, most likely by 2011.

Essentially, Schaeffler will change from a limited partnership (KG) to a limited liability corporation (GmbH).

This all becomes necessary because the Schaeffler family went too deeply into debt (USD $17 billion) for its 2008 takeover of publicly-held Continental AG. When Continental's share price plunged 80% in the recession, Schaeffler began scrambling to cover the debt service. But Schaeffler's business units were also hard-hit and the family was unable to accomplish the feat, despite appealing for government aid. Along the way, Schaeffler reached an important agreement with the IG Metall union for concessions in exchange for no layoffs.

Last August, the Schaeffler family settled on a refinancing arrangement with its banks which essentially saved their company from the jaws of its lenders. But in return, they had to make a historic sacrifice, conceding to change its corporate structure to become public, properly merge with Continental, and lift the veil of secrecy which has surrounded the company for so many years.

Since last summer, the global economy has rebounded, benefiting both Continental and Schaeffler. Although the risk and pressure on Schaeffler has been reduced, it is still too deeply in debt.

The first step in that process has been to reestablish the manufacturing operations under Schaeffler Technologies GmbH & Co. KG.

A few weeks ago, Continental refinanced some of its debt with a $1.6 billion sale of new shares (5251R9N7), which also pushed Schaeffler's equity position down to from 90+% to just 75%. Continental is burdened with too much of its own debt, having overpaid in its acquisition of VDO.

It is unclear who may lead the combined Schaeffler-Continental organization when it unfolds next year. In the early running, Schaeffler CEO Juergen Geissinger is not considered the prime candidate. Instead, Continental's newly-installed CEO, Elmar Degenhart, is being tagged for the job. Continental also has a high-visibility business star in its charismatic Supervisory Board Chairman, Wolfgang Reitzle.

Another long-term effect of Schaeffler's secrecy-shrouded "creeping takeover" of Continental is that Germany's Federal Ministry of Finance will plug the disclosure loophole which Schaeffler exploited. Schaeffler used cash-settled equity swaps, backed by a consortium of banks, to acquire Continental shares. Terms of the equity swaps theoretically allowed Schaeffler to terminate them. And because they could have been terminated, they did not trigger disclosure requirements. The use of non-traditional financial instruments further allowed Schaeffler to skirt disclosure requirements.

In an effort to close those transparency loopholes, the Federal Ministry of Finance will most likely change the Securities Trading Act to require notification when any widely-defined financial instrument, claims, or loans, are used to acquire shares in any company. The intent is to trigger market notification requirements when any acquisition is underway, regardless of how cleverly it may be structured. Unfortunately, the Ministry of Finance lacks much enforcement firepower, so it's possible lucrative deals might still be done in secrecy, with minor penalties absorbed later.