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The Bell Tolls For Germany Inc.


How did DaimlerChrysler (DCX) Chief Executive Officer J?rgen Schrempp survive as long as he did even as the auto maker's profits slumped, its share price plummeted, and investors clamored for his overthrow? The answer may well boil down to two words: Germany Inc. For half a century this matrix of cross-shareholdings, labor cooperation, and personal relationships underpinned the economy, insulating managers from irate shareholders and the harsh demands of global capital.

In Daimler's case, it worked like this: Deutsche Bank (DB) owned 10.4% of the carmaker. Former Deutsche Bank Chairman Hilmar Kopper served as chairman of the Daimler supervisory board. Half the seats on the board were occupied by representatives of Daimler's German workers, who had a promise from Schrempp not to force layoffs. Let the fund managers scream all they liked. Kopper's vote plus those of the worker reps was enough to keep Schrempp in power.

But the Daimler CEO's abrupt resignation is the clearest sign yet that what remains of Germany Inc. is crumbling. The alliance of bankers, companies, and workers was forged in the dark days following World War II, when Germany needed social stability to heal the wounds of fascism and rebuild the economy. But these days no German bank can afford to keep its money tied up in a car company, especially one as troubled as Daimler. Germany's banks, in fact, have lost their dominant role in global finance -- and are under severe pressure from foreign shareholders to boost returns to the lofty levels of U.S. and British rivals. In those circumstances, a decades-old investment in a carmaker looks less like a strategic pact and more like an investment that must be unwound.

Deutsche Bank's desire to reduce its Daimler stake almost certainly played a role in Schrempp's departure. As Daimler shares soared as much as 11% on July 28 on news of the unpopular CEO's exit, Deutsche sold shares equal to a 3.5% stake and collected $1.7 billion. Deutsche Bank's sale "is the confirmation of a long-term trend," says Hans-Dietrich Winkhaus, former CEO of D?sseldorf household products maker Henkel and a member of the supervisory boards of BMW and Lufthansa (DLAKY). "Germany Inc. is deconsolidating."

The drama at Daimler is likely to accelerate that process. Companies such as insurer Allianz (AZ), reinsurer Munich Re, and utility RWE (RWEOY) have gradually sold off their shares in German industry to free up capital. As the cross-shareholdings have unwound and the rules governing Germany Inc. have loosened, outside investors have smelled opportunity. Numerous hedge funds -- local and foreign -- have started to accumulate positions in Germany. This rush of global capital includes $54 billion in private equity. More than half of it remains to be invested -- meaning there are plenty more buyouts to come.

As a result, German managers now receive almost daily reminders of the power of international capital. Earlier this year, the Children's Investment Fund Management, a London hedge fund, forced out Werner Seifert, CEO of Deutsche B?rse, operator of the Frankfurt Stock Exchange. The fund's 8% stake was enough to force major changes. Jana Partners LLC, a San Francisco hedge fund, has taken a similar approach with industrial parts maker SGL Carbon (SGG) in Wiesbaden. Since buying 5% of SGL shares last year, Jana has persuaded management to sell the loss-making Corrosion Protection Div. and more aggressively boost sales at the Technologies Div., which makes high-performance components. "They pretty much have done everything we've asked them to do," says Barry S. Rosenstein, Jana managing member.

Private-equity investors are just as aggressive as the hedge funds. Texas Pacific Group bought an 18% stake in B?delsdorf telco Mobilcom and eventually forced out Mobilcom CEO Thorsten Grenz. Companies controlled by private equity now employ some 638,000 people and have sales of $137 billion, according to the German Private Equity & Venture Capital Assn.

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Sometimes the new players build up the companies they have acquired. But other times they have restructured pretty brutally, shedding thousands of local jobs. Unions such as IG Metall, which represents auto workers, have protested, but so far they haven't been able to stop the changes. For one thing, German companies have steadily moved operations to Eastern Europe, forcing unions to make painful compromises to hold on to their remaining jobs. A sex-and-money scandal at Volks-wagen has also put a harsh spotlight on the unions' dealings with companies. Prosecutors are investigating whether VW executives and a high-ranking labor leader took trips together, paying for prostitutes with company funds. The perception that unions have become narrow special-interest groups has placed them among Germany's least trusted institutions, according to a survey by McKinsey & Co.

In September, a new government is likely to bring more change. Christian Democratic Union leader Angela Merkel has a commanding lead in the polls and has said she will curtail the power of labor if she is elected Chancellor. There is speculation she might even roll back the system that awards labor 50% of supervisory board seats, the bedrock of union power.

Inadvertently, Merkel may also have already accelerated the demise of Germany Inc. by threatening to reverse a 2001 tax break on the sale of company stakes. One theory circulating is that Deutsche decided to seek a buyer for its Daimler stake while it could still do so tax-free. For Daimler, that raised a nightmare scenario of hostile shareholders buying the shares, perhaps even hedge funds that would demand a breakup. According to the theory, Daimler decided to force out Schrempp, boosting the shares and allowing Deutsche Bank to cash out on the open market. Deutsche Bank would not comment; Schrempp says his departure is voluntary.

If Merkel wins, resistance is bound to increase from unions and left-wing politicians, some of whom have labeled the private-equity groups "locusts." Public resentment toward foreign buyout firms has fueled support for a new "Left Party" that could get the most votes in East Germany. If the party draws too many voters from the mainstream, Merkel's Christian Democrats might have to form a coalition with the center-left Social Democrats. Whatever happens, unions will try to slow the advance of foreign capital. "There should be more openness about what hedge funds do," says Jörg Reinbrecht, an official of the United Services Union representing bank workers.

But the dissolution of Germany Inc. is probably inevitable. Given the money available, there is already speculation that someone, perhaps private-equity firms working in concert, will go after a blue-chip company. Ernst Fassbender, co-head of investment banking at Lazard & Co. (LAZ) in Frankfurt, is not sure hostile bids will materialize, but he's sure the pressure from hedge funds and others will prompt many German CEOs to shed poor-performing businesses. "People understand they have no chance to escape this and they might as well be the first mover," he says. More movement may be just what Germany needs.

By Jack Ewing in Frankfurt, with Justin Hibbard in San Mateo, Calif.


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