The lifeline that Berlin promised Germany’s businesses earlier this year was so large it made other corporate rescues in Europe look tame. In its determination to protect companies and jobs Berlin is stirring new debate, at home and abroad, about its growing role as an industrial decision maker and even shareholder. Can the country use its financial muscle to relaunch its own sputtering economic model?
Akkumulatorenfabrik Moll is a vital employer in the pretty little Bavarian town of Bad Staffelstein, about an hour’s drive north of Nuremburg.
Peter Moll founded the car battery maker just after the Second World War. His daughter, Gertrud Moll-Möhrstedt, is still managing partner at the firm, which employs almost all of its 270 staff in Bad Staffelstein. Moll, in other words, is a classic German Mittelstand company: a family owned, medium-sized firm in a sector that has driven industry and exports in Europe’s largest economy for the best part of a century.
But all this is now in grave danger.
After the coronavirus spread from China to Europe and companies such as Daimler and VW shut down their plants, Moll – like thousands of other suppliers – had no choice but to stop production. At the end of March it filed for insolvency. Sadly, the company went bankrupt just as it was midway through a €15 million investment to diversify away from the big German car makers and modernize its production line, including for batteries for hybrid vehicles.
Its only chance now is to find new investors, one obvious candidate being China, where the car market has rebounded much faster.
Perhaps Moll, like so many other car firms in Germany, was a little too late. After decades when its cars were icons of quality and technical precision, Germany’s automotive industry is now in catch-up mode with electric vehicle producers in the US and even China. Yet from one perspective, the German government should be helping firms precisely like Moll, which are suddenly stressed by the crisis, yet are otherwise profitable and already actively restructuring.
The Economic Stabilization Fund or Wirtschaftsstabilisierungsfonds (WSF) is the centrepiece of a fiscal response in Germany that blew away all others as lockdowns swept through Europe this spring. Finance minister Olaf Scholz called it his “bazooka”. This fiscal response was about twice the size of those in France and the UK, according to the IMF.
Around €600 billion was earmarked for the WSF, comprising state-backed loans, subordinated debt and equity – all for German firms like Moll, with shaky finances due to the coronavirus. Although it didn’t save Moll, just the promise of these funds has boosted confidence that Germany will cope with the crisis much better than other western countries, especially as its medical response allowed it to reopen sooner.
Moll is a classic Mittelstand company, now in grave danger
For the longer-term health of German businesses, especially in the case of a second lockdown, the WSF could be crucial. The WSF has already bailed out Lufthansa in May with €6 billion in silent participations and equity: giving it a 20% state stake, together with €3 billion of loans. Now, thanks to EU approval for the WSF’s general framework in early July, the fund can also roll out other corporate and Mittelstand rescues. Its help can include guarantees for commercial bank loans up to €400 billion and direct recapitalizations up to €100 billion. The WSF is also the refinancing vehicle for state development bank KfW’s own separate coronavirus lending programme, with the remaining €100 billion of the WSF allocated for this purpose.
The WSF already has its imitators. Within Germany, federal states including big car producing regions, like Bavaria, have set up mini versions of the WSF aimed at firms that don’t have nationwide operations.
Notably, Italy’s corporate rescue package is a close replica of the WSF and is of a similar size. It was born largely from the worry that Germany was using its greater fiscal flexibility to give its Mittelstand exporters an unfair advantage.
The federal government is intervening more than before in the private sector- Lars Feld, Council of Economic Experts
However, to a much greater extent than elsewhere in continental Europe, this willingness to bail out struggling companies is new and highly contentious in Germany.
In France, by contrast, the government already owns large stakes in many of the country’s biggest listed corporations, worth about €55 billion, under l’Agence des participations de l’État (APE). (The APE, which previously owned 14% of Air France KLM, gave the airline €4 billion in subordinated shareholder loans in May – although it did not increase its stake.)
“The federal government is intervening more than before in the private sector,” warns Lars Feld, chairman of Germany’s government-appointed but independent Council of Economic Experts. The WSF is part of that. Although he deems the Lufthansa rescue unavoidable, he draws attention to things like the government’s €300 million equity investment this June, via KfW, in German vaccine developer Curevac. While there had been worries that the US government was eying Curevac, Feld questions why this firm was chosen over similar ones in Germany, such as BioNTech, which raised $250 million the same month from Singapore sovereign wealth fund Temasek and others.
Opposition to Lufthansa’s rescue revealed the animosity among German entrepreneurs to state recapitalizations
This is fuelling a growing debate in Germany. On the political right there is concern that the government is meddling with private businesses, or “nationalizing the Mittelstand,” as one Frankfurt-based banker puts it. The left worry whether the public is getting enough in return. Both sides are wary that the federal government has still failed to exit and get its money back on Commerzbank, more than a decade after bailing out private-sector banks during the 2008 global financial crisis.
“All the measures we are taking include incentives for the exit,” federal finance secretary Jörg Kukies told Euromoney’s Global Borrowers and Bond Investors Forum in June. Kukies, who chairs the WSF’s oversight committee, used the Lufthansa bailout as an example. “We can only exercise our shareholder rights in very substantial matters, such as dilution, mergers or very large and significant events. We completely forego any attempt to co-manage the company.”
But conditions for WSF and KfW coronavirus funding, including caps on management pay and a ban on dividend payments, seem to be somewhat politically driven, thinks Volker Treier, head of foreign trade at the German chambers of commerce association, the DIHK. He says this goes “beyond the natural boundaries of state interference” and to such an extent that they may not be used at all.
According to Kukies, it was Germany’s fiscal conservatism that allowed such a bold response to Covid 19, so the crisis validates the old approach. Still, the coronavirus came at a time when the government, a coalition between the centre-right CDU and centre-left SPD, was under growing pressure to unleash its financial firepower. The economy was close to recession, dragging down Europe. Support for the Greens, who are more in favour of ramping up public investment, surged in the 2019 European elections. Finance minister Scholz, who is from the SPD, may have needed an excuse as big as Covid to break, even temporarily, with the government’s schwarze Null or balanced budget philosophy.
Germany’s finance secretary Jörg Kukies (l) talking with finance minister Olaf Scholz (r)
Germany’s business and financial community was already starting to panic on the eve of Covid. The country’s cherished car industry was in such a rut that even the French economy, less reliant on manufacturing, was growing faster. The US-China trade conflict didn’t help. More fundamentally, though, the car industry had failed to tackle the challenges posed by electric car makers such as Tesla and its equivalents in Asia. The auto parts suppliers Eisenmann and Weber Automotive, which employ thousands of people, had already filed for bankruptcy last year.
Now, other big car parts suppliers are in trouble, with the Covid-19 crisis wiping out already thin profit margins. Take Benteler, which is also family owned. According to Reuters, after the crisis compounded other problems, Benteler has had to ask its banks – Commerzbank, DZBank, LBBW, NordLB and Erste Bank – to restructure about €2 billion of debt.
Failures will be even more widespread among smaller firms. Moll, for example, is one of just one of tens of thousands of suppliers to VW globally. BMW, Daimler and VW are all likely to cut marginal suppliers as a result of Covid, reckons Gero Wendenburg, co-head of German investment banking at Pareto Securities, one of 12 firms advising the WSF on unlisted companies. As a result, hundreds of German car parts producers may need recapitalizing. According to a survey by Munich’s ifo Institute, about a quarter of firms in the sector now believe the coronavirus threatens their existence.
All this might add to the urgency of state recapitalizations, yet it’s a moot question whether the grim situation in the automotive sector is because of too much or too little state nurturing – whether Berlin, for example, was overly protective of the car makers’ old business model in its 2008 cash-for-clunkers scheme.
We can’t reinvent the economy from scratch; you build on what’s already there- Fabio De Masi, Bundestag
This time, the government has rejected the industry’s calls for a new programme. Instead Berlin is doubling its subsidy for electric vehicle purchases to €6,000. It’s investing €2.5 billion in charging infrastructure and electric-mobility research and development, and offering a total of €1 billion for investments in innovation by car firms. That’s in addition to new state investments in artificial intelligence, quantum computers and 5G infrastructure. Car companies are also among the KfW coronavirus loans programme’s biggest users.
Across Germany’s political and business classes the coronavirus has slammed home the realization that the country can no longer rely on combustion engine exports to fast-growing economies outside Europe. The era of ever-increasing global trade is over. In any case, countries like China, which once looked to Germany for expertise, have caught up and even overtaken it on the technical front. And now there’s Covid-19 crippling global demand and disrupting international supply chains.
Can the WSF help propel the Mittelstand into a new era? As a vehicle set up to prevent a wave of business failures, the fund is not supposed to give a leg up to particular firms. Nevertheless, partly to satisfy the EU’s state aid rules, applicants will need to prove they have a future, which could be easier for companies serving the domestic e-mobility market, for example, not least given the government’s other investments in that area.
Jens Suedekum, a government adviser and professor at the Dusseldorf Institute for Competition Economics, says overly pessimistic German demographic projections in the early 2000s contributed to an approach of leaving the private sector to decide whether infrastructure investments were affordable and worthwhile, notably in telecoms and transport.
This is far from over. We might see more companies come back to KfW- Roland Boehm, Commerzbank
That view has steadily dissipated over the past decade, he says, with the coronavirus crisis raising even more calls for the state to steer private companies towards public goals, notably around the environment.
“Industrial policy is more out in the open, partly because of deeper economy challenges, especially in the automotive industry,” he says.
But even if some Germans like Suedekum admire Schumpeterian theories about creative destruction, in practice, there remains a consensus on both the right and left that the best way forward is to give older companies more time to change, rather than let them collapse so that new more forward-looking ones can emerge. Germany won’t simply give up on its old car companies, as they employ too many people – more than 800,000 in a recent count by industry body the VDA – and that’s just people directly employed by these firms.
“We can’t reinvent the economy from scratch; you build on what’s already there,” says Fabio De Masi, a senior member of the Bundestag’s finance committee representing Die Linke, on the far left. “If you let a company crumble, you can’t get it back. They have intangible assets and if people lose their jobs, they lose skills.”
Beyond the auto sector, the biggest squeeze on German firms’ liquidity could still be to come, as prospects for a V-shaped recovery become more remote. The KfW coronavirus programme was launched in March and it surpassed €50 billion in early August, just over half of it going to medium-sized firms.
“This is far from over,” says Roland Boehm, head of corporates international at Commerzbank, commenting on the coronavirus squeeze on corporate Germany. “We might see more companies come back to KfW.”
By late July – about a month after Brussels approved the general framework – only 20 firms had applied for equity from the WSF and none had applied for the guarantees, according to a source at KfW. But companies have until the end of June next year to ask for WSF recapitalizations, six months longer than for the KfW loans.
PwC, which is helping the government do an initial sift through applications, eventually expects about 200 applicants, according to a source who has seen the auditor’s findings. Bankers agree many more requests for recapitalizations will come later this year, or even in early 2021, as the reality dawns on companies that they will never be able to pay back the debt they’ve incurred, especially if lockdowns linger in Europe and globally.
Ekaterina Ksoll, Rothschild
“The tricky part is the longer-term effect of Covid on some business models – can you run the business in the same way post-Covid, with the same capital structure?” says Ekaterina Ksoll, managing director in debt advisory at Rothschild, which is advising the WSF on listed applicants.
Every German banker will tell you that, outside the auto industry at least, corporates here are in better shape than elsewhere in Europe. Unless there are second lockdowns, non-performing loans in Germany will almost double over the next two years, according to Oliver Wyman, but that still only brings them to 4% of total loans, versus 8% in France and 13% in Italy.
Even so, losses and higher debt incurred during the coronavirus in Germany must be covered somehow. Future profits will be thinner and owners will be wary about risking new equity at this time. If the solution is just less investment, that bodes ill. At a national level, Germany may therefore want its weaker companies to access the WSF less to prevent a tidal wave of bankruptcies than to prevent longer-term economic stagnation and corporate zombification, with a knock-on effect across Europe.
Investing in transformation comes with risks, particularly now, as the experience of a firm like Moll shows. Firms in the car industry, in particular, will need to make bold moves in unfamiliar technology not yet widely used by consumers and do so at a time of deep economic upheaval.
The tricky part is the longer-term effect of Covid on some business models – can you run the business in the same way post-Covid, with the same capital structure?- Ekaterina Ksoll, Rothschild
“The problem is uncertainty,” says De Masi. “Companies don’t know what the economy will look like. They are very reluctant to undertake the necessary investments. That’s where the state should come in.”
The WSF, in other words, could put companies on the front foot by paying for the up-front costs of redundancies, as well as by giving them money to re-orientate their business model and invest in new technology and sales channels. After all, says Pareto’s Wendenburg, it’s understandable for companies to focus on catering for what will still be mainstream demand for vehicles with combustion engines, for the next decade or so. Yet the gradual shift to making electric vehicles is an opportunity for these companies and for investors be they state or private sector.
“If you kill this industry, Germany will be in massive trouble,” says Wendenburg. “You need to allow the sector to transform.”
Ultimately, the banks could be the ones to push firms to the WSF if they refuse to extend more credit because of worries of over-indebtedness. Those situations may be relatively rare, due to Germany’s general corporate health and given the readiness of KfW and many private banks to put liquidity at risk.
Meanwhile, the German stock market has rebounded faster than elsewhere in Europe. There is probably more scope for domestic and international private capital raisings than in Italy, too. All this should allow firms to avoid resorting to the state. Germany, nevertheless, suffers from many of the same problem of illiquid capital markets as the rest of continental Europe, compared with the US and the UK.
For many firms there remain questions about how long public ownership will continue and how it could restrict companies’ strategic options, particularly on the international stage. Indeed, worries about whether state aid would complicate efforts to find new longer-term commitments from private shareholders was part of the reason why the WSF (or its Bavarian equivalent) couldn’t save Moll from bankruptcy, says an insider.
As with the bank bailouts that followed the 2008 crisis, the federal debt management office, Finanzagentur, will be the legal entity contracting WSF recapitalizations. The past controversy about burning public money on rescuing private-sector banks has made it even more important for the government to show that, this time, it is not for free. Yet this political sensitivity and the consequent obligation to forego bonuses and dividends makes it even less appealing for the companies involved.
Sven Giegold, MEP
The opposition of Lufthansa’s largest shareholder to its rescue speaks to some of the animosity among German entrepreneurs to state recapitalizations, especially by the government in Berlin. Heinz Hermann Thiele, the billionaire majority owner of Munich-based brake maker Knorr-Bremse, waited until the last minute to give his approval to the Lufthansa deal due to worries about political influence. The federal government was getting a 20% shareholding and two board seats for just €300 million in a heavily discounted share issuance – although it was also giving the airline another €5.7 billion in silent participations.
Frustratingly, the side of the political spectrum that wants the strongest conditions for state financial support is also the side keenest to use government money to relaunch the economy. Sven Giegold, a German Green Party member of the European Parliament’s finance committee, says it’s a travesty that the government could spend €9 billion and only gain a 20% share in Lufthansa, when its market capitalization was only around €4 billion – although the government is getting a fixed and rising remuneration on its silent participations, which convert to an additional 5% stake if the company doesn’t pay.
Giegold argues that ideology prevalent in the CDU played too big a part in the Lufthansa bailout. “They believe the state is too stupid to use its voting rights wisely, but there’s no proof of that.”
There are very stupid private investors and very stupid politicians- Sven Giegold, German Green Party MEP
Both private and public investors, including the state of Lower Saxony, oversaw VW’s decades of success and its disastrous diesel emissions cheating scandal after 2015, according to Giegold. Purely private ownership didn’t stop payments card Wirecard from filing for bankruptcy this year, after a multi-billion euro accounting fraud. “There are very stupid private investors and very stupid politicians,” says Giegold.
De Masi also criticizes Germany’s job furlough programme, Kurzarbeit, for continuing to allow its corporate users to pay dividends, which is not the case in the equivalent scheme in France.
Germany’s big car makers are among those that have made use of Kurzarbeit and continued to pay dividends. This leads De Masi to believe that, if Germany wants to encourage its car industry to invest more in new electric technology, tax breaks will not be enough, as it’s too hard to ensure they’re genuinely used for investments in research. He advocates an innovation-focused state equity fund for such purposes.
Feld at the Council of Economic Experts insists that public-sector owners are slow to spot failure. “The government has strong disadvantages in being an entrepreneur,” he says.
With the advent of the WSF, the more widespread state ownership of businesses is no longer such a wild idea – even in Germany.
Although Berlin has tried to make clear that the fund is for rescues and only for the short term, investment bankers in Frankfurt wonder whether the WSF might come in handy as a kind of domestic sovereign wealth fund, complementing a more assertive KfW.
This could be along the lines of the €10 billion fundraising this year for new shareholdings in large French firms taken by BPI, the French equivalent of KfW, in a scheme launched on the eve of the coronavirus.
BPI, which already has a €15 billion portfolio of stakes in large French companies including PSA, announced a first close of the new fund for €4.2 billion in May, with money from various French insurers as well as the Abu Dhabi sovereign wealth fund Mubadala. DIHK’s Treier advocates a similar fund for Mittelstand companies, which might get around the political drawbacks of German state coronavirus recapitalizations, perhaps by tapping sovereign wealth funds in the Gulf and Singapore.
For the BPI fund – Lac d’argent – the real impetus is the desire to nurture homegrown corporations out of fear that they might otherwise get swallowed up by US private equity companies or, even worse, by state-linked Chinese firms.
In fact Germany has already implemented new legislation to block corporate takeovers from outside the EU since the coronavirus. This largely has China in mind and consolidation opportunities, including those in the auto parts sector, could herald a return of Chinese interest in the German Mittelstand, after a fall in such deals over the past two years.
Even Moll is 15% owned by its Chinese partner, Chaowei.
“Given how the WSF is set up, with the government able to participate in discounted capital raisings, I would not rule out investments with a strategic or German political element,” says the investment banker. “Maybe there will be situations when the WSF is also used to create national champions, like in other countries.”
Pride and lack of comfort with outside investors makes the Mittelstand less likely to turn to state support. However, private alternatives may be even less appealing
Moritz von Soden is managing partner of Bornemann Gewindetechnik, a Mittelstand machinery producer for trains, offshore energy and medical equipment, based in Lower Saxony. It has seen sales fall by 20% since the start of the coronavirus crisis. But von Soden scoffs at the idea of taking up Germany’s new offer of state equity support through the WSF.
Von Soden’s attitude shows the kind of widespread suspicion among Mittelstand owners of using the WSF. By design the scheme is supposed to be a last resort – and its conditionality around management pay and dividends helps ensure it will remain so.
Sebastian Freitag of Freitag & Co is one of 12 firms advising the WSF on unlisted companies. He says that German family owners will do everything they can to avoid the WSF, because of these conditions. “The Mittelstand don’t want anyone there and they certainly don’t want anyone in a visible co-determinant fashion,” he says.
Thomas Ludwig of Ludwig & Co Corporate Finance, another WSF adviser, agrees that outside equity support, especially from the state, will still be difficult for family owners to swallow. “You’re talking about companies that have been family-owned for a century. They’ll be very reluctant to take on the reporting requirements that these facilities involve,” he says.
Von Soden, who is also on the economy ministry’s advisory panel, argues that banks are “not taking any risk anymore.” Family ownership and management of firms like his means capital raisings can be done rapidly – including by offering lenders the owners’ houses as a security. Owner-run governance is “the strength of the German Mittelstand,” compared with the more short-term orientated Anglo-Saxon model of public companies, he argues.
Even so, the WSF could have its appeal for some German entrepreneurs, says Ken Fritz, head of financial advisory for Lazard in Frankfurt, which is one of six firms advising the WSF on listed companies. International private equity, or perhaps Chinese strategic investors, might be more comfortable investing in Germany than in France or Italy. But they will be even less willing than the government to give the existing management a free hand. It might boil down to whether the firm was merely an inheritance.
“If the owners want to sell out, they might have some general concerns about protecting employees, but the main concern driver is valuation,” says Fritz. “If you want to keep the company and stay involved, on the other hand – but you’ve just got too much debt and need equity – private equity will most likely involve ceding a majority or at least far-reaching corporate governance rights. Some may prefer the government as a temporary silent partner instead.”
Meanwhile, reflecting a long-standing aversion to the federal authorities, some companies may initially look to state-level WSFs rather than the big one in Berlin.
“It depends on the reach and history of the firm, but for corporates who only have operations in Bavaria, the first point of contact may be the Bavarian state fund, because of their contacts at a local level,” says Jan Kupfer, head of corporate and investment banking at HVB in Munich.
According to other sources, these funds, like Bavaria’s BayernFonds, might have a further advantage for the recipients in that they may be naturally less concerned about long-term viability and issues around the green and digital economy rather than the immediate implications for jobs in the area.