Analysis: Deutsche Bahn may be planning some pruning of the corporate tree

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While it is difficult to calculate a fair value of Deutsche Bahn – its numerous moving parts and how its empire will look like at the end of next year and beyond – it is possible to try and determine why the German group is making a serious attempt to change its corporate tree.

When the state-owned passenger, logistics and rail freight company reported its first-half results, chief executive Rudiger Grube noted that Deutsche Bahn was able to end the “longest and most consequential wage dispute in the history of DB Group, literally at the last minute”.

As a result, he added, “there must not be, and hopefully will not be, any more strike waves with work stoppages of over 350 hours in passenger transport and more than 400 hours in rail freight transport”.

Its operational problems showed in its financial results in the first half of 2015 – revenues rose 1.3%, but profits almost halved to €391m from €642m. Notably, net debt rose by €1.4bn to €17.6bn in just six months, which implied a rising net leverage to 3.7 times. Management said that Deutsche Bahn had no choice but to become a more dynamic and leaner entity, and any transformation would clearly have to involve corporate action in some key divisions, such as DB Schenker.

When it announced its restructuring earlier this summer, a partial privatisation of DB Schenker Logistics was mooted as being an important part of the plan, which comes at a time when certain rivals may benefit from increased competition in the European marketplace. Competitive forces and unfavourable market conditions in freight and logistics force changes upon Deutsche Bahn, although the process is painfully slow.

Separation

The group doesn’t plan to sell its transportation and logistics activities, which operates under the DB Schenker umbrella and comprises two units, Logistics and Rail – their combined revenue amounts to about 50% of the group’s total. Logistics is responsible for about €15bn of revenue, split into three business segments: air & ocean freight (€6.6bn); European land transport (€6.4bn); and contract logistics (€2bn). Meanwhile, Rail – whose new boss, Jurgen Wilder, started last week – turns over about €5bn.

Assuming Deutsche Bahn reaches €40bn of revenues at group level in 2015, DB Schenker’s operating units could be valued at between 0.5x and 0.7x revenue, including net debt, based on their revenue trajectory, operating profits, margins and levels of capital invested in each unit. That would mean a valuation range of between €7.5bn and €10.5bn for Logistics, and between €2.5bn and €3.5bn for Rail. These numbers reflect the enterprise value, rather than the equity value, of both divisions.

Details on the financials are sketchy, but assuming a separation and that the two divisions would end up carrying 30% of group net debt, and that the resulting €5.5bn of net debt would be assigned to the two units based on their actual operating cash flows – which can be derived making certain assumptions but are undisclosed – then the equity value of Logistics and Rail could end up being up to €6.5bn and €2bn, respectively.

However, even under this bull-case scenario, their resulting net leverage would be unsustainable, which partly explains why DB Mobility Logistics – essentially a conglomerate owned by Deutsche Bahn and which is in charge of integrated transport networks and has historically comprised Logistics and Rail – has not been listed on the stock exchange in recent years, despite ambitious IPO plans and favourable market conditions.

When the interim results were released, The Loadstar reported that DB Mobility would be folded into the group holding company of Deutsche Bahn in order to reduce duplicate structures, while DB Schenker Rail would join Bahn Long Distance. As the group acknowledged at the time, the business units that “demonstrate the highest need for action to achieve their respective financial targets” were Bahn Long Distance, Bahn Regional, Schenker Logistics and Schenker Rail – all of which, excluding Logistics, are subject to various projects aimed at improving punctuality, among other things.

DB Netze Track

On top of that, anti-competitive conduct is an issue that is not simplified by its overly diversified corporate structure, so another question is what Deutsche Bahn would look like if it had to divest its ownership of the tracks, which the European Commission has repeatedly promised other countries it will force the company to do.

DB Netze Track – which comprises DB Netz, DUSS, DB Fahrwegdienste and DB RegioNetz Infrastruktur – had the biggest, negative impact on corporate EBIT in the first half, and was responsible for operating losses of over €40m. Heavy capital requirement makes the unit less appealing that it may seem at first sight, and could render it even less so to would-be suitors, in spite of immediate capital share gains.

Deutsche Bahn says “infrastructure business units accounted for a total of around 73% of gross capital expenditures” in the first half, totalling €3.3bn in the period, compared with around 65% the year before, with DB Netze Track alone responsible for around 67% of that, compared with 58% in the first half of 2014.

The unit is heavy in terms of operating costs, too. With 43,000 employees, it ranks third behind DB Shenker Logistics (65,000) and DB Arriva (45,300). All these elements contributed to a drop in return in capital employed to 5.1% from 6.5% in 1H14, which suggests that more costs will have to be cut sooner rather than later, and thus further raises the spectre of possible strikes in the future.