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The conglomerate is almost extinct in many countries but in Germany it still thrives. Not only do widely diversified companies such as Siemens, Bayer and Henkel plod on, they also continue to fight off demands from investors for tighter business focus. ThyssenKrupp even plans to make itself yet more complex.
Why are the conglomerates so reluctant to simplify themselves? The conventional wisdom is that they are run by bone-headed empire builders and egoists. And some might well be. But Germany's pension problem might also have a hand in their survival.
Balance sheet nightmares
The German pension regime is uniquely difficult for corporate managers. The obligations to ex-employees are high and German law makes it hard to close plans or make them less generous. That's bad enough in young, high-growth companies, but in mature industrial companies it's a total nightmare. Because few German companies endowed external pension funds in the past, and fewer mature businesses have the wherewithal to do so now, they are forced to keep the liabilities on their balance sheets.
This is a hefty burden for mature businesses to bear. Pension liabilities are nine-tenths as large as shareholders' equity for Siemens (which does keep most of them off balance sheet). For ThyssenKrupp the ratio is 97%, for RWE it's 105%. True, these ratios are higher in many mature US companies – at General Motors, for instance, pension liabilities are six times equity. But US companies have the advantages of external funding and a greater ability to restructure their plans.
What's more, the problem is almost certainly going to get worse. The German government genuinely wants to help companies become more flexible but it must deal with an ageing and shrinking population. Pension contributions are probably going to be rising for everyone – governments, individuals and companies. And the political background is not helpful. Looser rules for corporate pensions are a sure vote-loser.
How does this reality affect corporate strategy, in particular the reluctance to focus? It perhaps does so in three ways.
First, pension difficulties encourage managers to cling to existing complex structures. It is hard for them to sell off declining businesses that are stuffed full of pension liabilities, as ThyssenKrupp found when it failed to float off its steel operation on the stock market in 2001. And managers are reluctant to sell off growth businesses because these help to support the pension liabilities of the weaker bits of the group.
Second, the need to provide for pensions directly out of net profits means that there is a reluctance to put all one's eggs in one basket. That means that managers are keen to make things even more complex, by diversifying both geographically and operationally.
Lastly, their pension problems turn German managers into growth junkies. That's because the cashflow burden of a young and expanding workforce is minimal and the high returns to shareholders make the pension book reserve act like cheap debt, financing high-return industrial investments. SAP's German pension obligations are less than 2% of equity.
The snag here is that the businesses with the biggest problems are generally mature ones in highly competitive industries, with historically huge workforces. They can't wish away their core businesses; so the only way to get growth is to conglomerate.
So what are the lessons investors should draw from these insights? One is that there may be no magic turnround for mature businesses with huge pension liabilities. Big parts of these conglomerates might simply be worthless to shareholders, whoever is in charge.
That doesn't mean that such companies as ThyssenKrupp or even Deutsche Telekom shouldn't focus their operations. But the businesses they should spin off or sell are the attractive ones, not the dogs. Removing growth businesses from the equation might pitch the rump of the group into pension problems sooner, but at least some shareholders would be able to profit from the good parts. Otherwise, one set of German savers – the shareholders – loses out to another, German workers.
German managers might feel they are in the invidious position of having to rob shareholder Peter to pay worker Paul. Or vice versa. Unfortunately, that's the choice. The sooner they face up to this hard reality – and start breaking themselves up – the better.
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