Expansion Into East Germany

On November 9, 1989, the Berlin Wall fell. A German privatization agency, Treuhand Anstalt, (literally translated, "Trust Agency"), was set up to arrange for the sale of thousands of East German companies. This created a unique opportunity for many West German firms. They felt that they could extend the use of their technological and marketing expertise, while the East German companies could contribute their knowledge about eastern markets. Some East German companies were snapped up by western firms with "near gold-rush ferocity" (in the words of the Financial Times of London). A large Swedish-Swiss electrical engineering group, for example, was one of the acquirers of East German firms.

On July 1, 1990, Kugelfischer acquired, for DM 69 million, East Germany's largest ball bearings manufacturer, Deutsche Kugellagerfabriken Leipzig (DKFL), from the Treuhand. Kugelfischer stated in its annual report:

The acquisition of DKFL was a decision of great importance. It was made because we see an attractive medium-term potential in East Germany and Eastern European [markets] and also because we felt that we had the responsibility to contribute to the maintenance and development of industrial facilities in the new German states.

The company also said that it expected it would have to make various adjustments in DKFL's operation in order to raise quality and productivity to world market levels. "The necessary adjustments," it said in its 1990 annual report, "will inevitably cause losses in the first few years, but these losses have been taken into account in the valuation of the acquisition and will therefore not have a negative effect on [Kugelfischer's] earnings position. For this reason, the pro-rata reorganization losses of DKFL ... in the stub period from July 1 to December 31, 1990 did not affect the earnings of [Kugelfischer] in the past fiscal year." At year-end 1990, Kugelfischer's balance sheet showed a special reserve for losses from DKFL in the amount of DM 198 million. (See Exhibit 12.1.)

Following the fall of the Berlin Wall in 1989, a burst of economic activity related to the reunification of the country (the "unification boom") shielded Germany, to some extent, from the recession elsewhere. Soon after, however, the economic slowdown also hit Germany. Germany was particularly vulnerable because its production costs were high relative to those of many foreign competitors. An increase in taxes imposed by the government in order to help pay for the reunification effort also had an impact. In the spring of 1992, the umbrella union for 4,250,000 metalworkers—the country's largest private-sector union—began strikes at selected sites because of a dispute with a federation of businesses that it was negotiating with. The workers wanted a 9.5 percent pay hike, while the employers were offering 3.3 percent. The largest public-sector union then went out on strike as well, with similar wage demands.5 In many cities, public transportation, garbage collection, and postal service came to a halt. Although this was the first strike by the public-sector union since 1974, Chancellor Helmut Kohl warned against giving in too easily to union demands. Eventually both private-sector and public-sector unions settled on 5.4 percent wage increases.

In May 1992, Kugelfischer announced a sharp reduction in its dividends and forecast a net loss for the year. The downturn was not affecting Kugelfischer alone. It also affected the market leader, SKF, badly, as well as other competitors. This was to be the steepest downturn in the bearings industry in a half century.

Kugelfischer did have special problems, however, with the East German company it had acquired. Prior to 1990, DKFL's sales had been running about DM 400 million a year. When Kugelfischer took the company over, it planned to reduce DKFL's workforce from 7,500 to 4,000 by 1995. In the months following the German currency union of July 1,

'In Germany, collective bargaining agreements between management and labor were negotiated on a countrywide level, rather than company by company.

1990, however, DKFL's eastern European business largely disappeared as customers were unable to make payments in hard currency. Kugelfischer also found that DKFL's manufacturing facilities were quite outdated. The company was kept going largely because Kugelfischer diverted orders to it from its other businesses, worth about DM 80 million in annual sales. Kugelfischer management believed that the subsidiary would be profitable in the long run and provide important access to the potentially huge East German and eastern European bearings markets. By the end of 1991, however, the workforce was reduced to 3,000 and three of the company's eight plants were closed. For 1991, DKFL recorded a loss of DM 142 million on sales of DM 113 million. In late 1992 Kugelfischer announced plans to close an additional DKFL plant in Berlin, which would involve about 500 layoffs.

For the first time, Kugelfischer also found itself facing a cyclical downturn in both its bearings markets and sewing technology markets.

Kugelfischer's banks became very concerned. (As Exhibit 12.1 shows, DM 2,069 million of Kugelfischer's debt was owed to banks as of the end of 1992.) A group of them asked Kajo Neukirchen for advice about the situation.

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