The Ox and the Frog – German Conglomerates in the Current Crisis

by François Masquelier, Head of Corporate Finance and Treasury, RTL Group, and Honorary Chairman,  EACT 

This article addresses the specific financial situation encountered by a few of the German family-owned groups. This situation may also apply to other multinational companies elsewhere in Europe. The economic crisis will force these companies to completely revise their organisation and their financial and shareholder structure. Is this worldwide recession sounding the death knell for the large family-owned groups? It may be, because some, like the frog in the La Fontaine fable, wanted to grow larger than an ox.

"...The small fool swelled up to the point of bursting (...) The world is full of poeple who are not any wiser. Every land owner wants to build like the great lords, every prince has ambassadors, every marquis wnats to have pages."

Jean de la Fontaine- The Ox and the Frog.

The theme of merciless capitalism featured in the famous American soap opera of the 1980s, Dallas, could also easily apply to German family-owned capitalist enterprises, as well as to certain other companies of this kind elsewhere in Europe. Many family-owned groups had eyes that were larger than their stomachs and tried to acquire major targets all for themselves. Of course, not very long ago, the case of RBS in the financial sector was a prime example (prior to the attempt to purchase ABN AMRO). Other examples proved that when everything is going well (particularly the economy) large ‘pills’ can be swallowed. However, the cases of Schaeffler and Porsche seem to be exemplary in more than one way. They show that sometimes it is important to remain prudent and that these solo acquisitions can turn out to be complicated. There is good reason to believe that many will say that they will not be making any more such acquisitions.

Organisational and shareholder structures can no longer afford to be monolithic and set in stone.

Alas, in order to avoid making the mistake of pursuing colossal acquisitions in the future, they must first survive the current crisis. Unfortunately, it is a safe bet that some of them will not. Others have understood that they needed to lighten their load. This was the case, for example, with IN-BEV. The Belgian-Brazilian brewery recently separated from Sing Tao quickly, effectively and, in the end, under optimal circumstances given the unfavourable economic situation. It has to digest the purchase of Anheuser-Busch and therefore had to make some choices.

In Germany, many groups are family-owned (over 90%) and they are major employers (over 70%). It is therefore safe to say that Germany, more than any other European country, has an economic history founded on powerful family dynasties. These have been involved in their share of sagas, classic love-hate relationships between rich families; they form an alliance, a dispute arises, and in the end it is resolved, or worse, one acquires the other and attempts a squeeze out. In short, family relations are and always will be tumultuous. The crisis will do nothing to improve this; on the contrary, it will only make them more difficult. We have even seen suicides, such as that of Adolf Merckle, shareholder in Heidelberg Cement and Radiopharm, among other holdings. Speculation, specifically in Volkswagen, was the fatal blow. The more recent case of Schaeffler illustrates what many are encountering. They became bogged down in refinancing the purchase of the tyre giant Continental.

Access to credit, which has become more difficult and much more expensive, can completely change the game. We should also mention the case of Haniel, which recently purchased the Metro group. Germany has plenty of other giants, such as Henkel, Lidl, Aldi, Bertelsmann, Bosch, Springer, Arcandor and BMW. Some large groups may turn out to be giants with feet of clay, and their growth could be halted in the current financial slowdown and recession. [[[PAGE]]]

Difficulties of family-owned groups

The big problem encountered by these family-owned groups, particularly in Germany, is the issue of succession. It is never easy. The longer a company exists, the more the generations multiply – through marriage, children and various alliances – and the more succession becomes a major issue. It is also often the case that one person disagrees with everyone else with a certain vision that no one else shares. Adolf Merckle and Maria-Elisabeth Schaeffler both came up against their families and employees.

We have seen a few private companies attack companies listed on the DAX (three in 2008). Since the end of the Second World War, Germany has always supported these large family-owned industrial groups, as they are major sources of labour. Yet the egos of patriarchs, succession wars, skills and talents that are not always hereditary, and a lack of long-term vision can sometimes be penalising or even fatal. Their business approach is unfortunately too often monolithic and behaviours irrational because the family strategy differs and egos can be excessively large.

They prefer and seek to fully control their shares, while preserving the entrepreneurial spirit that made them successful. With only very few or no other co-shareholders, they automatically limit their access to credit. They have very little recourse to structures such as A. Frère (GBL, CNP), in Belgium, or to sources of holdings and ventures.

The key question is determining whether today, in a changed, tougher economic climate, it is possible to preserve this state of mind that makes them strong, to maintain full control (100% or nearly 100%) over shares, and at the same time avoid refinancing problems. This is no easy task.

Partnerships are too often exaggerated and overestimated with respect to reality. There are very few examples of successful operational and commercial integration, whether the company is family-owned or not. Giant acquisitions always involve enormous risks. Sometimes it is necessary to cut off an arm to survive. The ego must be toned down. It is also important to avoid reaching critical mass and becoming too large. Size can turn out to be a handicap. Didn’t Arcelor-Mittal become too large? Don’t partnerships have their limits?

The clash of family shareholders with investment fund shareholders (equity funds or pension funds) can also be dreadful. The culture shock is often violent. Confrontations sometimes become blood baths, which is never good for the company. The culture is sometimes thrown off balance and the company loses stability. In our opinion, the great paradox of multinational family-owned companies is the entrepreneurial spirit that seems to be in direct contradiction to the idea of 100% control, which is often sought by family-owned groups in particular. This spirit would perhaps be best expressed and even thrive in a situation of majority rather than total control.[[[PAGE]]]

What should change

If we had to identify what needs to change in the coming months, we would give the following advice:

1. Open share capital to third parties, either directly or by holding an IPO.
2. Haul in the sails a bit and sell assets, whether or not they are redundant.
3. Modify holding companies and corporate centres to increase efficiency.
4. Create new alliances and structures to prevent and limit family disputes regarding vision – shareholder conflicts. (When times are tough, you see who your enemies are.)
5. Demonstrate greater prudence before making new acquisitions and digest the acquired company before any new purchases are made.
6. Maintain majority stakes rather than 100% control.
7. Establish more streamlined approaches to acquisitions and business in general.
8. Forget the Icarus myth – the sky has limits.
9. Growth cannot come solely from external acquisitions.
10. Governance of these groups should be revised in depth in light of this crisis.

Families and managers

The governance model must sometimes be revised in family-owned groups, as their very structure comes from and can be explained by family roots. Sometimes they have to begin by engaging the services of a skilled CEO. Being a member of the family is not always a sufficient criterion, and the most clear-sighted have often preferred external talent to a family member. The issue of alliances between heirs and managers is often worth addressing. France also has many examples of large family-owned groups (e.g. L’Oréal, Michelin, Carrefour, Galeries Lafayette and Leclerc). These companies need to find the most efficient method of operation and ensure that effective, unbiased decisions are being made.

Managerial strategy, as compared to family strategy, often lends a more rational quality to decision-making (although there are always a few exceptions). On the other hand, the family may have a longer-term vision than managers, who might have a more immediate, short-term vision. There will always be examples of growth through successful acquisitions (e.g. Publicis with Bcom3, Carrefour with Promodès). Examples abound of families whose infamous third generation brought about their downfall. In Italy, Fiat abandoned the family’s managerial hold. Forces of opposition and skill, whatever their source, are essential in every way. Unfortunately, there are no ideal examples in this area, but more or less successful models from which to learn.

Conclusion

It is reasonable to believe that the European economy, and the German economy in particular, will evolve and gradually change. It may be safe to say that the era of large family-controlled companies, whether they are publicly traded (with little float) or not, has come to an end. The current economic crisis should finish off some, punish others, and hurt nearly all. Certain models could have worked or could still work, but only under normal or good economic conditions. This is no longer possible in a (serious) recession such as the one we are experiencing. Sometimes one is hoisted by his own petard. In some cases, the reversal of the economy will turn out to be fatal.

The structures of these industrial giants will need to be more flexible and better adapted to the current economic environment and to the inevitable changes that every company will have to make. Organisational and shareholder structures can no longer afford to be monolithic and set in stone. They must be able to evolve and sway in the volatile economic environment we are experiencing. We will see further examples of excess and regrettable cases or stories in which we would have liked to believe. In economic and financial history, unfortunately the small Davids do not always knock down the big Goliaths.