LONDON/MILAN Canadian plane and train maker Bombardier and Japanese industrial giant Hitachi are the two frontrunners to buy Finmeccanica's rail subsidiaries, several sources close to the auction process said.
Italy's Finmeccanica has been trying to sell its cash-strapped train division AnsaldoBreda together with its profitable rail signals business Ansaldo STS for three years, to help reduce net debts of 4.8 billion euros ($6.4 billion).
The sources said Bombardier Inc and Hitachi Ltd are expected to bid for the Italian group's rail businesses ahead of an August 29 deadline. Three other groups are also expected to bid.
They are French defense electronics firm Thales, Spanish train builder Construcciones y Auxiliar de Ferrocarriles and train maker China CNR Corp Ltd, in tandem with its partner Insigma Technology Co Ltd.
Finmeccanica has struggled to sell its rail businesses together because the division that makes trains, AnsaldoBreda, has been losing money for years and has long been a drag on the Italian defense group's results.
Finmeccanica's listed signaling business, Ansaldo STS, is considered an attractive prospect for the bidders and has a market value of $1.45 billion.
The sources close to the auction process, who declined to be named because the talks are private, said Bombardier and Hitachi had the most overlap with train builder AnsaldoBreda.
Several sources said Bombardier Transportation was well-placed to win because it already works with AnsaldoBreda in the development, production and sale of the new Frecciarossa 1000, a train capable of transporting passengers at 360 km per hour.
Hitachi, the company behind Japan's first "bullet" trains, said in March it was moving its global rail business to Britain as part of a push to expand within Europe and beyond.
A spokesman for Finmeccanica, which is being advised on the sale by Mediobanca and UBS, said the process remained open and offers needed to reflect the value of the assets and guarantee investment and development prospects.
Representatives of Bombardier, Hitachi and Spain's CAF declined to comment. Spokesmen for Thales, China CNR Corporation and Insigma were not immediately available for comment.
Mauro Moretti, a veteran rail executive who took over as Finmeccanica's chief executive in May, is under pressure to make changes at the Italian group and intends to wrap up the rail business auction in October.
State-controlled Finmeccanica aims to raise about 2 billion euros from the sales to help cut its net debt, which is rated as junk, and focus on its core aerospace and defense businesses.
The challenge for Moretti is to make AnsaldoBreda as attractive as possible so the combined sale is a success.
The sources said some of the bidders, including Bombardier and Thales, are more likely to submit provisional offers by the August 29 deadline, rather than binding bids.
The companies want more clarity on what parts of AnsaldoBreda will be included in the deal and what guarantees Finmeccanica is ready to make so the asset is more appealing.
At least two of the bidders want the Italian defense group to recapitalize AnsaldoBreda prior to any deal, two sources said, and their bids will remain conditional until Finmeccanica spells out exactly what it is prepared to do.
AnsaldoBreda, which aims to break even at an operating level in 2015, has a negative value of 150 million euros, according to one analyst estimate. It posted a loss before interest and tax of 227 million euros in 2013. Annual pre-tax losses reached a peak of more than 700 million euros in 2011.
A capital increase would help bring AnsaldoBreda's value back to zero and beef up the balance sheet, as the division is likely to need more investment in the future, two sources said.
This would then allow the various suitors to table a competitive offer for Finmeccanica's Ansaldo STS. The sources said the signals division would command a premium of about 25 percent over its current market value.
If Finmeccanica agrees to a capital injection then it would retain a stake in the troubled train maker and could complete an ongoing restructuring plan, the sources said.
Analysts say AnsaldoBreda is starting to see the impact of the plan designed to make the company more efficient and more selective in tenders to ensure adequate levels of profitability.
It has seen a strong rise in orders, including a subway deal in Peru. The company employs about 3,000 people, partly based in the unemployment-plagued cities of Naples and Reggio Calabria.
But a Hong Kong-based banker said there was still a pressing need for a "long-term plan" to get AnsaldoBreda back on track. He said that while a recapitalization would reduce the purchase price, it would not resolve some of the underlying issues such as the train maker's pension liabilities.
A sale of Ansaldo would mark a revival of industry consolidation after an attempt to merge Siemens and Alstom's train-making units failed this year.
The last major deal in the sector was Siemens' 2.2 billion-euro acquisition of Invensys' signaling arm, which received the green light from antitrust authorities in 2013.
In the face of fierce competition from Asian rivals, European champions see limited scope to increase their size in the global rail market without joining larger conglomerates.
China CNR, one of the bidders for Ansaldo, is the world's largest train maker by sales ahead of China South Locomotive and Rolling Stock Corp Ltd and Bombardier Transportation.
Like Bombardier, CNR already has ties with AnsaldoBreda. The two companies signed a 10-year deal in 2012 for the provision of up to 600 of AnsaldoBreda's Sirio low-floor trams. But CNR's takeover ambitions could be challenged by the need for Chinese government approval, the Hong Kong-based banker said.
The sources close to the Finmeccanica sale said France's Thales was mainly looking to buy Ansaldo STS and had little appetite to turn AnsaldoBreda around because of the limited overlap between the two companies.
Spain's CAF, has a market capitalization of 1 billion euros and would struggle to finance a bid without teaming up with a partner, several Madrid-based bankers said.
In the first-half of the year, Finmeccanica's rail businesses posted core earnings (EBITA) of 26 million euros, beating forecasts mainly thanks to smaller losses at AnsaldoBreda. Revenues rose 6.7 percent to 1 billion euros.
(1 US dollar = 0.7469 euro)
(Additional Reporting by Andres Gonzalez Estebaran in Madrid; editing by David Clarke)