The Locusts Privaty Equity Firms Strip Mine German Firms

Be it television stations, large machine builders or auto-parts suppliers, international investors are buying up large swaths of the German business landscape. The new lords of business want one thing: profits, profits, profits. But criticism of the "locust" method of doing business is growing in Germany.


German broadcaster ProSiebenSat.1 has become a plaything of private equity firms.
DPA

German broadcaster ProSiebenSat.1 has become a plaything of private equity firms.

If your baby doesn't cry when you wash its hair, there's a good chance the reason can be found not far from Germany's Rhine River. Same thing if, after washing your windows, there's not a streak to be seen. Cognis, a giant chemical company headquartered near Düsseldorf, makes it happen. And not surprisingly, demand for their products is high. Indeed, in 2000 the company made a tidy profit of €109 million ($143 million) after taxes.

Half a decade later, demand for Cognis products is still high, with sales through the roof. Profits, though, are a thing of the past. In fact, in 2005, the company was deeper in the red than it had ever been. The total loss for the year was €136 million ($178 million). The company continues to limp along but is now on the auction block, likely heading for bankruptcy. Dozens of workers have been laid off.

So what happened? The answer has more to do with a recent development in the global economy than it does with Cognis management itself. In 2001, Cognis fell victim to a private equity firm, those companies trolling the world economy for lightening quick returns on their investments. Using money thrown at them from all sides -- Permira, the company that took over Cognis, counts the California pension fund Calpers, the Singapore government and Harvard University among its investors -- private equity funds buy up companies, suck them dry, and spit them out again. Twenty percent returns are considered normal. And there are more and more of them: In 2006, the private equity sector -- with its giants like KKR, Apax, Blackstone, and Texas Pacific in addition to Permira -- will have gobbled up firms worth a total of €600 billion ($787 billion). That's twice as much as in 2005.

Companies all over the world have fallen victim, including Bawag Bank in Austria and the Australian airline Qantas last week. But Germany is quickly developing as one of the most profitable pastures for the private equity herds, and the list of takeovers is already long: Frozen food giant Iglo, eyeglasses experts Rodenstock, the model train company Märklin, the company which runs the autobahn rest stops, and almost 5,700 others. Private equity funds have now invested in German companies employing a total of almost 800,000 people, a figure which has doubled in just three years.

Graphic: Hunters and Gatherers -- The Private Equity Business
DER SPIEGEL

Graphic: Hunters and Gatherers -- The Private Equity Business

There are a number of reasons for the focus on Germany. In recent years, the tight web of ownership woven by the country's largest banks and companies has loosened substantially. Recent years of economic stagnation in Europe's largest economy have also forced German companies to restructure and focus on efficiency. Now, many of them are in great shape, but lack capital. Several are among the market leaders in their sectors -- and they can be had for cheap.

Take German TV, for example. Just last week, two private equity leaders, Permira and Kohlberg Kravis Roberts (KKR), announced they had taken over a majority of Germany's largest private television company, ProSiebenSat.1 Media AG. The plan is to merge the company with SBS Broadcasting, which the two funds bought last year for €2.1 billion ($2.8 billion), and grow it into Europe's leading television company.

A noble goal, perhaps. But all too often, the result looks more like what happened to Cognis. Permira, together with Goldman Sachs, bought the chemical giant for €2.5 billion ($3.3 billion) in 2001. Most of the money for the purchase was financed through new debt, with the buyers only investing €450 million ($590 million) of their own money. Now, five years later, Cognis is deeply in debt and burdened by astronomical interest payments on the loans it took to come up with the purchase price. Permira and Goldman Sachs, meanwhile, have gotten out almost twice what they put in: €850 million ($1.12 billion) has so far been squeezed out of Cognis.

Experts say that this sort of grasping for easy money is what can make private equity firms dangerous. The emphasis is on quick money, short term results, and the highest possible returns for their investors, regardless of what it means for their prey. "Buy it, strip it and flip it," is the industry credo. There are indications, says Dieter Heuskel, head of Boston Consulting in Germany, "of a fundamental shift in ownership structures." He is concerned, he says, "about a massive shift in value and profit from the future to the present." In other words: money now, the future be damned.

Private equity companies have been around for a long time; KKR celebrated its 30th birthday this year. But only recently, especially since the burst of the high-tech stock-market bubble, have investors started turning to them in droves. Funds based on share prices simply weren't churning out adequate profits anymore and private equity funds started growing in popularity. As of 2005, investors had handed over a worldwide total of €261 billion ($342 billion) to private equity funds -- with expectations of high returns.

The added capital has meant the private equity funds have begun to set their sights higher. No longer satisfied with small and mid-sized firms, they have begun to eye larger companies. The company Fortress, for example, has been buying housing in Germany as fast as it can. In the last three years, the company has bought 160,000 apartments in Germany for €6.7 billion ($8.8 billion). The state of North Rhine-Westphalia is considering selling its public housing to Fortress as well. Some are concerned that even German mainstays like Siemens, DaimlerChrysler or Lufthansa could be ripe for the picking.

A longer version of this story appeared in this week's issue of DER SPIEGEL.
Greg Bridges

A longer version of this story appeared in this week's issue of DER SPIEGEL.

Anxiety in Germany that something wicked is afoot hit its highpoint ahead of last autumn's general election campaign when then Social Democrat head Franz Müntefering in an April 2005 interview famously referred to private equity companies as "locusts." But many are still unwilling to hop on his populist bandwagon. Profit has been the motor behind Western economies for years. And often, the companies taken over by private equity firms are in serious need of a shake-up and of capital. "Private equity firms fill an important role in the restructuring of industries in need of consolidation," says Ann-Kristin Achleitner, a professor in Munich.

Smaller, family-run firms can also benefit. The German model train company Märklin, for example, was in bad shape after the family which owned it couldn't agree on a management strategy and seemed to prefer endless bickering to profit. Along came Kingsbridge Capital from the UK this May -- a move welcomed by Märklin's own employees -- and now the company is as healthy as ever, with new products and booming Internet sales.

More often, though, the result looks more like what happened to Cognis. Or the German cable television network. Laid by Deutsche Telecom back when it enjoyed a monopoly, the network was bought by private equity firms Apax and Providence together with Goldman Sachs for €1.73 billion ($2.27 billion) in 2003. Most of the purchase price was financed by the cable network itself and within two and a half years, the new owners had sucked €1.6 billion ($2.1 billion) out of the company, which began making hefty losses. When Providence bought out Apax and Goldman Sachs recently, the two sellers each made an additional €300 million ($394 million).

It is still unclear whether this is what the future looks like. Indeed, even as more and more money flows into private equity funds -- by the end of the year, they could command over $300 billion (€229 billion) -- the number of companies ripe for takeovers is slowly dropping. With less prey out there, each new investment becomes more expensive, and more risky. Many are saying the market is overheating, just like Internet share prices in the 1990s.

And private equity firms are also beginning to worry about their negative image. Last week, for example, German credit insurers made public that the number of private equity-funded companies experiencing financial difficulties has "significantly increased" this year. Fund managers have even begun trying to improve their public perception, having realized that negative headlines could easily create an insurmountable hurdle to takeovers of major companies. Their message? As David Pascall, head of Terra Firma in Germany, said at a podium discussion in Munich recently, "We aren't locusts."

cgh/spiegel

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