FAG Kugelfischer A German Restructuring

1. FAG Kugelfischer A German Restructuring Analysing Corporate Governance and effects on strategic choices. Joseph Biedenharn Dhylan Hyland Dimitra Patrokarakou Olufunlola Pearce Antonio Roig Kimihiro Tateishi Anthony Turner

2. Agenda • FAG Kugelfischer background / history • Corporate Governance – Definition • Corporate Governance – Comparison of UK / Germany Structure • Corporate Governance - Development of Organisational Capabilities • Corporate Governance - Influencing strategy and growth • Financial Analysis / Evaluation / Possible courses of action • Recommendations / Options • Implications Analysis • AOB

3. Background • Founded in 1883 and acquired by George Schafer in 1909 • The company was strategically important company during both world wars where ball bearings were of critical importance to the German war effort. • During the 60’s the company grew aggressively though acquisition and attempted diversification. • In 1985 the company became a corporate partnership with just under half of its shares being traded publicly. By the 1990s Morgan Stanley assessed FAG to have an outwardly looking investment viewpoint. • After 1985 further diversification was pursed in an attempt to protect the core ball bearing business from the cyclical nature of the industry. • The ball bearings industry is a high labour intensive industry where demand tends to track industrial activity, ball bearing manufacturers compete on product cost and efficiency of service. • In 1992 FAG Kugelfischer is know for its high quality and extensive product range (Over 320,000 product variations) • FAG Kugelfischer are the fourth largest manufacturer in the world with approx 9% of market share. The world leader is SKF, a Swedish company with 18-20% market share.

4. Corporate Governance “Corporate Governance is concerned with holding the balance between economic and social goals and between individual and communal goals. The corporate governance framework is there to encourage the efficient use of resources and equally to require accountability for the stewardship of those resources. The aim is to align as nearly as possible the interests of individuals, corporations and society" -Sir Adrian Cadbury in ‘Global Corporate Governance Forum’, World Bank, 2000 “Corporate governance is to conduct the business in accordance with owner or shareholders’ desires, which generally will be to make as much money as possible, while conforming to the basic rules of the society embodied in law and localcustoms.” -Milton Friedman

5. International Governance StructuresLiberal Market (UK), Coordinated Market (Germany), FAG Divergent Capitalisms, The Social Structuring and Change of Business Systems (p65-72) Richard Whitley, 2000

6. International Governance StructuresLiberal Market (UK), Coordinated Market (Germany), FAG Divergent Capitalisms, The Social Structuring and Change of Business Systems (p65-72) Richard Whitley, 2000

7. International Governance StructuresLiberal Market (UK), Coordinated Market (Germany), FAG Varieties of Corporate Governance: Comparing Germany & the UK (Varieties of Capitalism: p337-360) Sigurt Vitols, 2001

8. Development of Organisation Capabilities • Liberal Market Economies • Labour Markets • Flexible and Mobile • Equity Markets • Dispersed Shareholders and Less Restriction on M & A • Corporate Structures • Highly Centralised Decision-Making • Inter-firms Relations • Market Based

9. Development of Organisation Capabilities • Coordinated Market Economies • Industrial-Relations Systems • Dominated by Unions and Trade Associations • Corporate Structures • Dampened by consensus decision making • Training Systems • Industry Specific • Contract Laws and Intercorporate Linkages • Encourages LT relationships • Corporate Governance

10. FAG Organisational Capabilities Source: Divergent Capitalisms

11. Corporate Governance influencing Strategy Varieties of Corporate Governance: Comparing Germany & the UK (Varieties of Capitalism: p337-360) Sigurt Vitols, 2001

12. Expenses to Sales Stock Turnover FAG Financial Evaluation • Following 1989 total expenses were over the level of sales. This figure balances once considering the extraordinary items* that additionally measure up the “output” of the company. • On average, 49% of total expenses came from employee costs. • * Increase in inventories of finished goods and work-in-progress; company-produced additions to plant and equipment; and other operating incomes. • From average debtors settlement period, we conclude that money comes in every 433 days on average. This could reflect a serious problem of collecting procedures. • On the other hand, cash goes out on average every 22 days. This figure shows that FAG is not taking full advantage of its credit facilities. • These two situations reflect serious problems of collecting procedures and cash flow problems.

13. FAG Financial Evaluation Gearing Ratio • The uprising gearing percentage provides evidence that this company was relying more on debt than in previous years (from 0.24:1 in 1988 to 0.48:1 in 1992). • The debt:equity ratio gives further evidence that this company is riskily relying on more external loan debt cover (from 0.67:1 in 1988 to 2.06:1 in 1992). Interest Cover • The up-trend of the FAG medium-term liabilities demonstrates a decreasing and dangerous level of interest cover (from 3.45 in 1988 to 1.56 in 1992). In 1992, the company was barely covering its levels of interest expenses from PBIT (see interest cover table). • In general, FAG was losing its liquidity power over liabilities. Factors affecting this situation were its low levels of operating cash flow* and its reliance on medium/long-term liabilities. • * Deduced from gross cash flow shown in Exhibit 2.

14. FAG Financial Evaluation • Lack of reserves • FAG over recent years have relied on a considerable reserve ‘pool’ of cash, currently (1992) they have no reserves left. • “Using accounting to “smooth income” from one year the next went on to a considerably greater extent in Germany than in the Unites States. The general presumption is that income smoothing reduces the volatility of earnings and thus the perceived riskiness of a company’s stock…The well-known use of “reserves“ in German accounting.” • Deducing from the quote above, FAG could have used its reserves to cover different expenses and amortizations.

15. FAG – Possible courses of Action • Possible Cost Reduction Alternatives • Reduce workforce with forced redundancies • Reduce employee costs by reducing benefits and training i.e. Pensions • Move towards a more flexible workforce with contract staff in non key posts • Drastically reduce inventories which could be achieved by narrowing the product range. • Slash capital expenditure and R&D investment to free up cash for core product range • Negotiate a reduction in purchasing costs for core inventories • Call in debtors and push out trade creditors to improve cash flow. • Capital Generation • New share issue • Raise more debt • Sell non core business divisions to raise capital!!!!!!!!!! • Request capital injection from Schaefer family

16. FAG Final Recommendations FAG recommendation should be focused not only on the interest of banks but also Schafer family, employees, shareholders, and geopolitical matter (Stakeholder Capitalism) Reduce cost / Raise Capital • Continue to move the capital of the company from Debt to Equity with the objective of reducing interest payments • Sell off non-core business to raise capital to shore up the short term cash flow problems. • Reduce costs by improving worker efficiency • Business Process Re-engineering • New IT system solutions to improve supply chain efficiency(SAP alliance) • Reduce inventories and focus on core successful product ranges • Approach similar companies to form strategic buying consortium to reduce costs.

17. FAG Recommendation Implications • In recent history, access to capital markets has been limited, however a new generation of investors is emerging increasing the ability of firms to acquire funds. • It may be difficult to find a buyer in a downturn market given German laws on retaining staff • Improved IT solutions and BPR if leading to staff reductions would be difficult • Stock reduction and product rationalisation plan may reduce competitive advantage • In Germany it is normal for alliance and JV so buying consortium would not be a problem