The sale this spring of the former state-owned East German railcar manufacturer Deutsche Waggonbau AG (DWA) to Bombardier of Canada for DM635 million was the closing chapter of a remarkable success story. It is also an eloquent vindication of the role private equity can, in certain circumstances, play in transforming a company that apparently has no viable future into a major player on the international stage.
In a blaze of publicity, Advent international in June 1995 acquired DWA from the Treuhand, the agency charged with the privatisation process in post-unification Germany. Much of the comment regarding the original deal was tinged with skepticism: although no financial details of the transaction were ever released, market observers found it difficult to believe that DWA could be made a commercial proposition.
Considerable justification for this view was provided by the 39 other bidders that had cast their eyes over OWA prior lo Advent. Attracted by the group’s substantial assets and break-up value, none was prepared to acquire DWA as a going, concern, the only basis on which the Treuhand was prepared to agree to a sale. Yet the fortieth bidder, a hard-headed Western European private equity house, was prepared to buy both the company and the ‘l’reuhand’s vision of its commercial future, despite an operating performance so unpromising that the deal proved, quite literally, to be unbankable.
And the risk paid off: DWA now ranks not only as the sole instance to date of a large Treuhand company to have made the transition to commercial profitability, but as one of the most successful private equity investments ever seen in Germany.
Here’s Another Fine Mess …
DWA company dates back to the beginning Germany’s rail industry and had a proud history of engineering excellence. In the 1930s, it built the Flying Dutchman locomotive, which travelled faster than many of today’s high-speed trains. World War 11, DWA maintained its reputation for quality even though it was operating under the constraints of a socialist economy.
So what made the company such a difficult proposition?
In 1990, when the West German government took ownership of DWA, its major customer then was the Russian State Railway, which shortly afterwards ran out of money to purchase new trains. So, those orders stopped coming.
After 40 years of socialism, the company was not adapted to operate in a market economy, lacking even rudimentary marketing or sales division. The West German rail operator Deutsche Bahn, however, welcomed access to DWA’s output of double-decker passenger cars, and this additional outlet kept DWA alive
But the company was an not an economic proposition. In 1990, it had a workforce of 30,000. Between 1990 and 1993, exposure to international competition forced prices for its railcars down by 30%. The Treuhand, meanwhile, had brought in new management and began to implement a restructuring and costcutting programme. This was only partially completed when, in 1993, the Treuhand decided to privatise DWA.
By this stage, DWA’s pride in its origins had in some ways come to work against the company’s best interests: managers at each of its five sites – all of which manufactured entire railcars, rather than components-were competing against the other DWA plants.
When DWA was put up for sale in 1993, it was clearly not cost-efficient enough to compete in Western markets. It had a turnover of DMI billion and was losing a triplefigure Deutschmark sum- believed to be between DM100 million and DM150 million-annually.
A Sale with Strings Attached
Many of the 39 potential bidders for DWA that preceded Advent were raiders attracted by the company’s asset “piggy-bank”, with no intention of preserving DWA as a stand-alone company. There were also several attempts by major railcar manufacturers to take over DWA through a number of alternative structures-again, in order to shut it down and thus remove the unwanted East German competition from the market.
The Treuhand, however, wanted to see DWA in the hands of owners who would complete the restructuring of the company and keep it as an independent, ultimately profitable operating unit. During its restructuring programme, the Treuhand had realised that one of the DWA sites would have to close, but the agency did not want to sell to a buyer that would undertake any further closures.
After a thorough examination of DWA, Advent International decided the company could indeed have a viable future, given the closure of one plant and further intensive restructuring, downsizing and cost-cutting.
As with all Treuhand sales, Advent International, as a buyer, would have to guarantee a certain level of employment, together with an agreed amount of capital expenditure.
It took nearly a year for Advent International, Treuhand, the unions, the Federal States and the German Finance Ministry to hammer out a pain that war acceptable to all parties. During this time, the Treuhand continued downsizing the company. “It was not just a question of money, but of how the company would be run. At the end of the day, the deal was effectively a joint venture with the German government”, explained John Walker, Advent’s chief executive.
Prior to the deal, the blueprint was also agreed with DWA’s management, supervisory board and workers.
Although the basic points of the restructuring were agreed to in the sale contract, once DWA was acquired, the Treuhand had no direct say, other than what was stipulated in the various guarantees, over DWA’s operations. Such an arrangement, said John Walker “would have put us in a straitjacket”.
The deal was finally struck in June 1995, funded by the private equity house alone without new debt facilities. By then, DWA’s workforce had already been reduced to 7,000 from 30,000 and Advent had guaranteed that number would not fall below 2,400 jobs. The new owners has also drawn up a plan, dubbed “DWA 2,000”, to take tile company public at around the turn of the century. Under the terms of’ the deal, the Treuhand, or its successor, the BVS, would receive 50% of the sale proceeds (excluding management’s holding).
The “DWA 2,000” Programme
Although Advent is unable to disclose the financial package it put together for DWA, Christoph Niezert, a director in the group’s German office, said that the equity and cash provided to DWA ultimately transformed it “into one of the best capitalised companies in the former East Germany” .
Then began the long haul to improve DWA’s operating performance on all fronts. One of the first priorities was to rationalise the whole production and assembly process.
“A lot of benefit was derived from convincing the management of the individual plants to work as a team”, John Walker said. Instead of continuing to run an entire railcar manufacturing line at each of DWA’s remaining plants, the individual sites were assigned specific components, enabling each to focus on its particular skills. Though this represented a radical change of culture for DWA, the management and workforce were by now acutely aware of the need to justify the survival of their individual plants and worked to make the integration of their activities a success.
In turn’ the reorganisation of production and assembly enabled DWA to develop a better integrated product range and this, together with substantial investment in the latest manufacturing equipment, produced considerable improvements in efficiency.
The introduction of new production methods and equipment both compelled and assisted DWA’s workforce lo become more flexible and efficient. “This was crucial, as achieving the same added value per employee as DWA’s US competitors was A keystone of the DWA 2,000 plan”, explained Christoph Niezert.
While the operational restructuring plan was being implemented, DWA was also working to develop its marketing side and win new contracts in Germany as well as in the new markets that were opening up throughout Eastern Europe and the former Soviet Union, As DWA moved into the black, the company was able to raise a DM500 million line-of-credit and guarantee package to cover advance payments,
Meanwhile, gradual downsizing continued in some areas of the business, while complementary strengths were added in others through two acquisitions, one in Switzerland and one in the Czech Republic.
By 1997, DWA had transformed itself into a competitive, independent business with a healthy order book, a workforce of 4,800-double the number required by the Treuhand guarantee -and forecast profits believed to be in tile region of DM50 million. At this stage, ahead of the DWA 2,000 blueprint, Advent began discussing the projected flotation with a number of German banks.
Industry Trends Move the Goalposts
A flotation, however, was not to be, even though the banks DWA consulted agreed that the company, in its transformed condition, represented a suitable flotation candidate. Advent’s successful restructuring of DWA had been carried out against a background of integration and consolidation in the global rolling stock industry. Continuing worldwide consolidation meant that an IPO would have been unlikely to be the end of the story for DWA. “We saw that a takeover would have been on the cards within a relatively short time,” John Walker said, “and judged that it would be hefter for the company to find its ultimate home and get the whole process over in one go”.
Therefore, rather than pursuing a flotation, Advent and DWA began to seek a buyer. The world railcar marker is dominated by a handful of players. As DWA wished to continue to compete with other German companies in the sector, the field was effectively narrowed down to three potential acquirers and, in the spring of 1998, DWA was sold to Bombardier of Canada for DM635 million.
For Bombardier, DWA represented the opportunity to acquire a very substantial European presence, with a strong order book in German and considerable potential for further growth in Eastern European markets. For DWA’ having Bombardier as a parent provided an excellent opportunity to expand into North America and other international markets.
DWA’s managers and workforce, who had a holding of close to 10% in the group, are now wealthier men than’ in 1990 they could ever have imagined. Precisely how successful the deal was for Advent is hard to quantify, as agreements with the Treuhand and its successor, the BVS, preclude disclosure of financial details. However, after the original cash price paid to the Treuhand, substantial capital investment into DWA and the transfer of half the sale proceeds to the BVS under the teens of the original sale agreement, Advent reports a very substantial gain and an attractive IRR on the deal. And, despite the Treuhand’s original confidence in DWA’s future as an independent group, the 50% of proceeds the BVS received from the Bombardier sale are likely to have far exceeded the government agency’s original expectations.
From Dinosaur to Dynamo
The decisiveness with which Bombardier moved to acquire DWA once the opportunity arose is a testament to the role played by Advent in transforming a former state-run industrial dinosaur into an efficient, competitive and profitable player on the international stage. l-he merger of Bombardier and DWA has created a truly powerful world force in the rail vehicle market, ranking fourth behind Adtranz, GEC Alsthom and Siemens.
The outcome could have been very different had a private equity buyer not emerged for the group back in 1993.
Post-unification, many West German companies moved in and neutralised potential competition from East German companies by acquiring and downsizing them. As a result, with the exception of the chemical and rail industries, few of East Germany’s heavy industries have any major players left. Had DWA been acquired by Siemens, for instance, the chances are that it would now be a small offshoot of the Siemens group rather than a major successful company in its own right.
In general, few financial investors were willing to accept the onerous guarantee conditions normally imposed by the Treuhand, and private-equity-backed privatisations were rare in consequence. In the case of DWA, taking on a loss-making company part-way through a major restructuring programme, subject to guarantees regarding staffing and capital expenditure levels, in an unbankable deal, Advent was assuming a level of risk far greater than in most other private equity transactions; without long experience of building businesses throughout Europe, the risk would have been reckless. Ultimately, the combined tenacity and ambition of Advent International and DWA paid off, and the initial gamble has been amply rewarded.