Business Standard

Analysis: Workers can shield German conglomerates from GE-style breakups


By Edward Taylor and Alexander Hübner
FRANKFURT/MUNICH (Reuters) - The breakup of General Electric announced this week has put pressure on German conglomerates to consider similar moves, but executives must take account of the labour unions on their boards who have the power to veto radical plans.
GE said it would spin off its healthcare business and divest its stake in oil services company Baker Hughes following months of shareholder pressure to overhaul its conglomerate structure.
This increases pressure on German firms to speed up their own strategy overhauls, but they will have a harder time pulling off far-reaching reforms proposed by shareholders unless they can win over powerful labour leaders.
This makes partial listings more likely than complete breakups for Volkswagen's truck business, Daimler and BMW's joint mobility division - which includes car-sharing and electric vehicle charging - and some of Continental's businesses such as powertrains and sensors, bankers and executives said.
Radical moves can be blocked by German labour representatives, who command half the seats on the supervisory boards of large corporations, giving them the power to quash strategic moves that could leave a company vulnerable to a hostile takeover or result in job losses.
The success of Thyssenkrupp's planned steel joint venture with Tata Steel in Europe, for example, hinges on labour approval, even as activist investors push for deeper reforms at the submarines-to-elevators group.
Siemens listed its healthcare business and agreed to combine its rail operations with French rival Alstom, but only because labour reps agreed that a merged Franco-German rail company can better compete with Chinese rolling stock manufacturer CRRC in the long run.
Specialised businesses are often more highly valued than conglomerates because in times of growth, high-potential assets do not have to share the balance sheet with lower-return businesses.
"The advantages from having a diversified conglomerate, for funding purposes for example, are not as pronounced as the valuation discount on conglomerates through complex structures," said Alexander Mayer, a Goldman Sachs partner in investment banking in Germany.
"Companies are more vulnerable to takeovers or become targets of activist investors if they are burdened with a conglomerate discount," Mayer said.
Firms which have reshaped their portfolios through spin-offs and divestments have outperformed their competitors, Goldman Sachs said, a trend which helped asset divestments in Europe reach their highest level since 2007.
But German labour leaders warn that splitting up the country's conglomerates could leave some high-tech divisions small enough to be snapped up by a Chinese rival or become embroiled in a hostile takeover by a financial investor, as happened to British engineering group GKN.
Juergen Kerner, a management board member of Germany's biggest trade union IG Metall, said: "Breakups are a dangerous way forward."
The benefits of slimming down have been eroded with the emergence of newly assertive Chinese rivals and technology companies which are not as enthusiastic about such strategies as some activist shareholders, Kerner said.
"Google, Amazon, Microsoft are all diversifying," Kerner said, explaining that these software companies are now dabbling in areas like autonomous vehicles, drones and food delivery.
Chinese, Korean and Japanese conglomerates too remain diversified, which gives them the scale to more easily rebuff takeovers and handle a downturn.
Exposure to several businesses with different growth, margin and cash flow generation rates is still an advantage when the economy tanks in one particular sector, Kerner said.
Specialised companies have fewer ways to cut costs, putting them under pressure to squeeze their suppliers, which could damage the engineering expertise they depend on.
The more specialised companies become, the harder it will be to preserve this supply chain, Kerner said. Germany still has a thriving sector of small and medium-sized companies which serve global conglomerates, he said. Debt rating agencies agree.
In May, Moody's, in note about auto suppliers, warned that separating stable, cash-generating businesses from high-growth, cash-consuming operations could damage their credit ratings because of "smaller scale and reduced diversification".
Bankers say reforms at German conglomerates can only succeed if labour leaders are convinced of the industrial logic.
It is not enough simply to say that shareholder value can be created via a breakup, Christian Kames, JP Morgan's head of investment banking in Germany, told Reuters.
"The discussion needs to begin with whether it is the right step from a strategic point of view," Kames told Reuters.
A complicating factor is China's new assertiveness in buying up high-tech businesses at a time when Germany lacks regulatory tools to fend off unwanted takeovers.
Washington has the Committee on Foreign Investment in the United States to review whether a foreign person can gain control over a U.S. business, but Germany does not have similar protectionist tools.
Chinese buyers bought robot maker Kuka and Geely chairman Li Shufu took a 9 percent stake in Daimler. Li used derivatives to mask his purchase until the last minute, prompting CDU lawmaker Hans Michelbach to demand that the German regulator take action.
Germany is now reviewing how to tighten disclosure rules to prevent another "sneak attack".
"We would welcome everything which reduces uncertainty in the area of approval processes for international transactions," Goldman Sachs' Mayer told Reuters. "You need to be able to estimate what works and what does not," Mayer said.
(Editing by Giles Elgood)

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First Published: Jun 28 2018 | 7:46 PM IST

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