Blockbuster Merger of Alstom and Siemens stuns CRRC

Siemens and Alstom deal ‘Best Industrial Logic’, form European Train Giant to Beat Chinese Competition. ‘Merger for financial and geo-footprint strength’, said Joe Kaeser, Chairman and CEO at Siemens SA, and Henri Poupart-Lafarge, Chairman and CEO at Alstom AG.

MUNICH/PARIS – German industrial group Siemens AG and French rival Alstom SA agreed to merge their rail operations, creating a European champion to better withstand the international advance of China’s state-owned CRRC Corp Ltd. This blockbuster merger stunned CRRC in a big way.

“I must say I‘m really glad to have won him over,” Kaeser said of Alstom CEO Henri Poupart-Lafarge, who will lead the new business, helping to counter criticism that France is giving up control of another national industrial icon. “It was a remarkable cooperation between two, obviously competitive, units,” he added on a conference call with analysts, referring to the negotiation process. Siemens will own 50 percent plus a few shares of the joint venture, to be called Siemens Alstom, while Alstom will supply Henri Poupart-Lafarge as chief executive, helping to counter criticism that France is giving up control of another national industrial icon.

Europe’s main benchmarks climbed to a new ten-week high on Wednesday as deals remained front and centre, while a weaker euro also supported indexes which had dipped this summer as the strong currency dented earnings expectations. Merger and acquisition news stole the spotlight with Alstom shares rising to their highest level in more than six years after the French industrial group struck a deal to merge rail operations with Germany’s Siemens.

The new company, to be called Siemens Alstom, is a response to intensifying competition from China Railway Rolling Stock Corporation, the state-backed train maker that has been winning contracts in the United States and emerging markets where mass transit is a fast-growing business. The company’s success is emblematic of China’s increasing economic power, which, combined with a more isolationist American foreign policy, is forcing European leaders to violate old taboos in order to improve the functioning of the European Union and its economy.

Sources had told that Siemens was close to an agreement with train and plane group Bombardier but that talks were tough due to Bombardier’s weak finances and desire to control any joint venture. Kaeser however declined to comment on any talks with Bombardier but pointed to Alstom’s strong balance sheet. “Newco is going to be a very financially strong company,” he said.

The non-executive chairman will come from Siemens.

Siemens and Alstom’s decision to merge their rail operations is about business and not politics, according to the companies’ CEOs, despite the deal being framed as a response to China’s advancing dominance.

“The rationale is undoubtedly (to do with) business, it’s a unique opportunity to create a global leader and a European champion … in a dynamic market,” Alstom CEO Henri Poupart-Lafarge said. He added the deal would create a “world leader” in the rail business.

“We’re combining our forces both in terms expertise … to create this new champion,” he said.

Meanwhile, Siemens CEO Joe Kaeser said the deal would make the two companies more competitive and that the merger was a “compelling” deal.

In the wider economic environment, Kaeser said the deal made sense because “mobility will be one of the major beneficiaries of population growth in the world … So we have a very positive underlying scheme to make this a success.”

He welcomed the state approval of the deal, saying “we welcome that the governments on both sides have been very supportive, as have the unions by the way. Last but not least if you look at the share price in the last few days, it seems that we have almost all the stars – the stakeholders – aligned.”

Their comments come after it was announced on Tuesday that the German industrial group Siemens and its French competitor Alstom, will merge their rail operations in a bid to compete with China’s state-owned CRRC.

“The message of this merger is that the European spirit is alive,” Joe Kaeser, the chief executive of Siemens, said at a news conference in Paris on Wednesday. “That’s a powerful message in times that are marked by populism and nationalism and social and political divides.”

The announcement comes just days after a far right party won seats in the German Parliament for the first time since World War II. On Tuesday, Emmanuel Macron, the French president, called for “the rebuilding of a sovereign, united and democratic Europe” that would include stronger border controls but also a European budget large enough to help countries in economic trouble.

Competition from China has already been a factor in other big European mergers. Last week, the German steel giant ThyssenKrupp said it would merge its European steel operations into a joint venture with Tata Steel. And last year, Nokia of Finland acquired Alcatel-Lucent, a French maker of telecommunications equipment, in part to address intense competition from China’s Huawei.

Other sectors, like shipbuilding or semiconductors, could also be ripe for mergers.

Mr. Macron has made competition from China a central focus of his European policy drive. This year, he proposed Europe-wide scrutiny of any new major stakes by Chinese companies in European industrial jewels, but was met with resistance by small countries like Greece and Hungary, which are eager for new investment.

The French president and other European leaders have grown increasingly alarmed that the E.U. is ceding control of advanced technology to China. In a recent speech in Athens, Mr. Macron called for strengthening the bloc into a “power that can face the U.S. and China.”

Those concerns deepened after a state-owned Chinese chemical company, ChemChina, bought the Swiss pesticides and seeds group Syngenta this summer for $43 billion. The Chinese state-backed shipping conglomerate Cosco recently took a majority stake in Greece’s Piraeus port to anchor China’s New Silk Road through Europe. Germany itself has been no stranger to takeover bids by Chinese state-backed firms.

Just weeks ago, Chancellor Angela Merkel of Germany tightened rules to limit takeovers of German strategic assets, a move aimed at Beijing.

Chinese competition was a driving factor in Mr. Macron’s backing to seal a deal between Alstom and Siemens, despite outcries from political opponents in France that he was handing over a French icon to the Germans.

“The big story here is the French willingness to let this happen,” said Mikko Huotari, director of the international relations program at the Mercator Institute for China Studies in Berlin. “Alstom is one of the crown jewels of French industry.”

The Siemens-Alstom deal is in part a bid that being bigger may be a better way to counter China Railway Rolling Stock, known as CRRC, which has grown into the world’s largest and most competitive maker of railway equipment. The European company could yet grow further: Ahead of Tuesday’s announcement, there had been speculation that Siemens could link up with Bombardier of Canada. On Wednesday, Mr. Kaeser of Siemens did not rule out that Bombardier could later become part of the combined company.

Still, with sales of over $33 billion last year and 180,000 employees worldwide, CRRC is bigger than the train businesses of Siemens, Alstom and Bombardier combined.

Last year, the Chinese company secured contracts to build 64 subway cars for the city of São Paulo, and sold more than 800 railway cars to Chicago for $1.3 billion, winning the deal by submitting a cheap bid with good technology.

“Of course CRRC is extremely strong, and has changed a little bit the picture of the market,” Henri Poupart-Lafarge, the chief executive of Alstom, told reporters Wednesday.

Mr. Poupart-Lafarge will be chief executive of the new company, which will have its headquarters in Paris. The Mobility Solutions unit of Siemens Alstom, which provides systems to control rail traffic and is more profitable than the unit that makes trains and streetcars, will be based in Berlin.

The new company will have annual revenue of €15.3 billion, an order backlog valued at €61.2 billion and more than 62,000 employees worldwide.

Alstom in particular is a symbol of national technological might for the French, with high-speed TGV trains racing across the countryside, and Eurostar trains connecting Paris to London in just over two hours through the Eurotunnel.

While populist parties such as the National Front are hostile to closer political ties in the European Union, they are less likely to oppose corporate mergers that protect European companies from foreign competition.

Pro-European political leaders like Mr. Macron have themselves not been averse to government intervention to protect jobs at home.

Despite pledges to be less protectionist than his predecessors, Mr. Macron has shown a willingness to involve the state in industrial policy by getting involved in big deals. Last month, he temporarily nationalized one of France’s biggest shipyards, STX France, to prevent it from being taken over by an Italian competitor.

As France’s economy minister, he pushed through a government plan last year to order €630 million worth of new TGV trains — most of which were not calibrated to run on faster tracks — from an Alstom factory in the eastern town of Belfort to prevent hundreds of jobs there from moving to another plant.

The Alstom deal with Siemens also reflects, however, a willingness to be flexible to protect broader French interests.

On Tuesday, the country’s finance minister, Bruno Le Maire, said the French government welcomed the deal with Siemens, characterizing it as one that protected French jobs at Alstom.

The merged companies will be known as Siemens Alstom and will be led by Alstom’s current Chief Executive Henri Poupart-Lafarge. Siemens will designate six directors to the 11-member board of directors and will own a 50 percent share of the new company.

After more details of the deal were released on Wednesday, shares of Siemens were up 2 percent while Alstom shares were up 6.2 percent.

Kaeser said there was a lot of work to complete the deal and he said regulatory matters needed to be dealt with. “There is a lot to do, then we go after the synergies,” he said, which are estimated to amount to around 470 million euros ($551.8 million) annually and expected four years after the deal has closed.

As a result, Kaeser said there was bound to be redundancies as a result of the companies merging.

“Of course after the combination of businesses there will also be redundancies, there are two companies, two CEOs, two finance directors, two HR departments and you only need one. So of course there will be synergies relating to the combination of the businesses.”

The framework deal, which still has to be approved by Alstom shareholders as well as regulators, is a Franco-German industrial breakthrough for French President Emmanuel Macron but is a move that has riled opposition politicians.

Their worries centre on France losing control of its TGV high-speed train – a symbol of national pride that has highlighted French engineering skill – and possible job losses.

Finance Minister Bruno Le Maire said on Tuesday that the French government welcomed the planned tie-up, which he said would protect French jobs.

The French state said it would not exercise an option to buy a 20 percent stake in Alstom from industrial group Bouygues SA.

The Siemens and Alstom transport businesses span the iconic French TGV and German ICE high-speed trains as well as signalling and rail technology. They have combined sales of 15.3 billion euros ($18 billion) and earnings before interest and tax of 1.2 billion euros.

“This Franco-German merger of equals sends a strong signal in many ways. We put the European idea to work and together with our friends at Alstom, we are creating a new European champion in the rail industry for the long term,” said Siemens CEO Joe Kaeser.

Alstom’s Poupart-Lafarge said: “Today is a key moment in Alstom’s history, confirming its position as the platform for the rail sector consolidation.”

Analysts at Deutsche Bank kept a “hold” rating on Alstom shares, saying extracting cost savings from the deal could be tricky.

“Politicians will also likely try to ensure some form of jobs protection in France (28 percent of Alstom’s workforce) and Germany (39 percent of Siemens’workforce), making cost synergies difficult to extract,” they wrote in a note. The deal leaves out in the cold Canadian transportation group Bombardier Inc, which also held talks with Siemens, sources have said, and which faces a separate battle this week to protect jobs in Quebec and Northern Ireland.

China’s CRRC, with annual revenue of about $35 billion, is bigger than Siemens Mobility, the rail and infrastructure division of the German conglomerate, Alstom and Bombardier Transportation combined. Previously focused on China, it has won projects in Britain and the Czech Republic in the past year, and is eyeing the United Kingdom’s High Speed 2 project, which will connect London with cities in the north of England.

Special Dividends

Siemens will receive newly issued shares in the combined company representing 50 percent of Alstom’s share capital and warrants allowing it eventually to acquire another 2 percent of Alstom shares.

However, the deal prevents Siemens from owning more than 50.5 percent of Alstom for four years after closing, and includes “certain governance and organizational and employment protections”, Siemens and Alstom said in their statement. The deal is unanimously supported by Alstom’s board, Siemens’ supervisory board and Alstom shareholder Bouygues, the companies said.

The French government acquired its option on the Bouygues stake in Alstom in 2014 as part of a deal that helped Alstom snub Siemens as a buyer for its energy business in favour of General Electric Co.

Macron was economy minister at the time.

The global headquarters, rolling stock business and stock-market listing of the new entity will be in Paris and the signalling and technology business in Berlin. The new company, with 62,300 employees, targets synergies of 470 million euros four years at the latest after closing of the deal, which is expected at the end of 2018. The companies said their operations were largely complementary, with Alstom present in growth markets in the Middle East and Africa, India, and Central and South America, while Siemens was strong in China, the United States and Russia.

Siemens CEO Kaeser said ahead of the signing of the memorandum of understanding he believed the scale of China’s CRRC left little room for regulators to oppose a deal. “It always depends, but the facts are that there is a dominant player,” he told Reuters in an interview in New York.

Siemens stands to gain control of Alstom’s main business, since all of Alstom’s divisions deal with the railways and transportation industries. Existing Alstom shareholders will be paid two special dividends: a control premium of 4 euros per share to be paid shortly after closing of the transaction and an extraordinary dividend of up to 4 euros per share to be paid out of the proceeds of Alstom’s put options for its General Electric joint venture, “subject to the cash position of Alstom” ($1 = 0.8484 euro).

While a combined entity Siemens AG and Alstom SA to create a new European champion, the deal has appeal for the German and French companies’ shareholders but governance, antitrust and cost-cutting, the merger will have control of only about 14 per cent of the €110-billion ($160-billion) rail-equipment market, the footprint will be bigger in parts of Europe.

So will Europe’s antitrust authorities block it? That depends. After the 2015 merger of two Chinese rolling-stock companies, the new entity CRRC Corp. dwarfs its international peers.

CRRC has won rail contracts as far afield as Chicago and Kenya, and China’s Belt and Road initiative will bring yet more international business its way.

The fear is that the Chinese company’s size plus access to cheap finance will let it crush rivals unless they bulk up, too. In absolute terms, CRRC spends seven times more on R&D than Alstom, Morgan Stanley notes.

But it isn’t unbeatable, at least not yet. International customers accounted for only 8 per cent of CRRC sales last year, when its railway-equipment sales declined. The Alstom and Siemens train businesses have performed quite well in the meantime, as rapid urbanization spurs demand for less-polluting mass transit.

So why risk a big cross-border merger? Unsurprisingly, Siemens isn’t wedded to its comparatively low margin rolling-stock business: The unit does lots of manufacturing in high-cost Germany, while rail companies regularly suffer delays and cost overruns on long projects. Chief executive Joe Kaeser has form in unlocking value via spinoffs and separate listings, so folding the business into Alstom is worth a shot.

The French company has a big and globally diverse order book, very little debt and is poised for a €2.5-billion cash injection related to the sale of its energy activities to General Electric Co.

A merger is appealing to Alstom, too. First, there’s the risk that Siemens could do a deal with Bombardier Inc. instead. Plus Siemens’s rail business is more profitable than Alstom’s because it sells more high-tech signalling and rail automation products. Siemens would contribute about 60 per cent of a combined group’s operating profit.

Alstom investors spy higher margins: The company has added almost €700-million of market value since Bloomberg reported the Siemens talks last week. A combined entity should spend proportionally less on R&D and will have a stronger hand in price negotiations with customers and suppliers – although regulators might not like that.

Yet, cutting production costs won’t be easy. Last year, Alstom had to row back on job cuts at a French plant amid government and trade union pressure. Besides, rail companies are building factories overseas to win international contracts, while customers tend to want bespoke trains to fit their country’s needs. This makes economies of scale difficult. Joining forces might also cause some customers to take their business elsewhere (so-called revenue dis-synergies).

Governance is a worry, too. While Siemens would probably own slightly more than half of the combined entity, according to Bloomberg News, Alstom’s CEO, Henri Poupart-Lafarge, will be in charge and the headquarters will be in France. The two companies haven’t always got on.

Still, a merger gives Emmanuel Macron and Angela Merkel a prized example of European business co-operation. So, if regulators can be persuaded, this Railbus will no doubt roll on regardless.

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