German automotive group Daimler and British engine maker Rolls-Royce are considering a joint bid for engine maker Tognum in a deal sources said could be worth about 3 billion euros ($4.2 billion).
Shares in Tognum, a manufacturer of industrial-size diesel engines formerly owned by Daimler, gained more than a fifth on the news to trade at 22.57 euros at 1307 GMT after being up 29 percent at one stage.
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"Daimler AG confirms that together with Rolls-Royce, it is in discussions about the possibility of acquiring the majority of Tognum AG in equal shares," Daimler said in a statement that Rolls-Royce later confirmed.
"Currently, constructive discussions with the supervisory board and management board of Tognum are being held," they said.
Both added no final decision had been made.
Tognum said in a statement that it would evaluate any proposal that may be received.
Sources close to the talks said that Daimler was willing to consider a price of about 24 euros per share -- almost 30 percent above Friday's closing price -- whereas Tognum was pushing for more.
"Management and employees hold roughly 10 percent and to convince them, a 30 percent surplus on the share price wouldn't be enough," one person close to Tognum said.
A source close to the deal said the German engine maker would greatly benefit from the network and know-how provided by the far larger Rolls-Royce.
"Tognum has done a great job but they've got some strategic tasks to address. They only make diesels -- natural gas engines are a white spot in their portfolio -- so as part of the deal Rolls-Royce would contribute its Bergen unit to Tognum," that person said.
Rolls Royce acquired Bergen in 1999. The unit makes engines for power generation and marine propulsion, including natural gas engines.
In 2009, Tognum generated only 37.8 million euros in revenue through its gas engine and fuel cell businesses combined. The latter is being discontinued due to weak prospects for profitability in the mid-term.
The deal would also help Daimler secure ties to a key customer.
"Daimler makes quite a significant number of engines for them, so this is an important revenue stream representing hundreds of millions of euros," the source close to the deal said.
Daimler's truck diesel engines are bought by Tognum and find their way into cranes, harvesters, snow cats and mining equipment.
Tognum buys Daimler truck engines spanning an output of 100 kw to 480 kw, modifies them for use in more harsh conditions and certifies them for off-highway applications as required by carbon emission regulators.
LOTS OF CASH
Daimler agreed to sell Tognum to Swedish private equity group EQT in December 2005 for 1.6 billion in equity and debt, only to buy back over 20 percent in April 2008, the year after its former unit went public.
Credit Suisse analyst Ross Cowley said Rolls-Royce had been trying to gain critical mass in energy production and build presence in the marine business.
"Given the kind of capability Tognum has and the fact that Rolls has a lot of cash on the balance sheet it looks like a deal that would make sense," Cowley said.
Daimler's operations had a cash surplus of 11.9 billion euros at the end of last year.
Earlier, German magazine Manager Magazin cited sources as saying Daimler and Rolls-Royce have been negotiating over the past week on a joint bid. According to the report, Tognum Chief Executive Volker Heuer was open to supporting a possible bid.
(Additional reporting by Frank Siebelt, Hendrick Sackmann and Rhys Jones, writing by Christiaan Hetzner; Editing by David Cowell and Sophie Walker)