Texas-based private equity firm Lone Star is buying ailing German bank IKB. Some ask if Lone Star will squeeze too hard for profits
The furnishings and managers are part of the insolvency estate. The head of the operation wears a cloth cap and has facial piercings, while his office mates are dressed in camouflage trousers and sneakers. The group, headed by Andr? Kegel, managing director of Strike-Bike in the eastern German town of Nordhausen, puts little stock in appearances. Their main concern is to keep the remains of their former company alive.
A few dozen new bicycles hang forlornly on shipping hooks in the production building. A pot used to boil sausages stands on a hotplate in the corner of the break room, and the wall decorations include an old map of the former East Germany and a copy of the "Big Humor Calendar." The monthly aphorism for August reads: "People don't recognize their own paradise until they have been pushed out of it."
Kegel nods. It's an all-too-familiar sentiment. In late 2005 Lone Star, a US private equity firm, acquired Kegel's then employer, a medium-sized company called Biria, one of Europe's largest bicycle manufacturers at the time. The acquisition was intended to be the beginning of a large-scale investment program by Lone Star in German small- and medium-sized companies.
But after only 18 months, which saw a steady stream of management consultants appearing at Biria, Lone Star pulled the plug in Nordhausen. Kegel and some of his co-workers occupied the factory grounds, staged demonstrations in front of the corporate raider's Frankfurt office and even produced a new bicycle they dubbed the Strike Bike.
They eventually formed a company, Strike-Bike, which has been operating out of the former Biria buildings for the past four months. The group, which consists of four full-time employees and 17 part-timers, is determined to prove to the world of high finance that it can make the concept work. "Lone Star claims that we cannot be profitable here," says Kegel during a tour of the ghost factory. But the company has already sold almost 2,000 of its Strike Bikes and, according to Kegel, is both covering its costs and actively proving Lone Star wrong.
Nordhausen is not the only place where the relationship between German small- and medium-sized companies and Lone Star is severely strained. Indeed, one could even characterize that relationship as one of hysteria, panic and dark accusations, at least since the week before last. That was when KfW, Germany's state development bank, sold its stricken subsidiary IKB to the ruthless corporate raiders from Texas, just ahead of a possible economic slump.
The Americans are buying IKB, the largest German lender to small- and medium-sized businesses, for the modest of price of roughly ??115 million ($169 million)??ith the blessing of German Finance Minister Peer Steinbr??ck. And while the purchase may be a bargain for Lone Star, German taxpayers will be paying for the billions in bad investment decisions made by IKB's former management.
But the IKB takeover comes amid growing resistance in Germany against similar deals with a company that has already generated many an ugly headline for its practice of buying up troubled real estate mortgages. At IKB's most recent company meeting last Thursday, frustrated shareholders vented their frustrations accordingly.
The High-Finance Cowboys
While the pro-business Free Democratic Party (FDP) hesitates, the Green Party and Left Party are already calling for the formation of a parliamentary committee to investigate the acquisition. Germany's Federation of Taxpayers has denounced the deal, saying that IKB was sold for far less than it was worth. Meanwhile, executives at countless small- and medium-sized companies are worried that they too could end up being crushed in the high-finance cowboys' stampede, especially now that Lone Star will gain access to the files of IKB's thousands of small-business customers, including their business plans, financial statements and lending histories.
Josef Schlarmann, a Hamburg corporate lawyer, knows exactly what is behind these fears. As the head of the small- and medium-sized business alliance run by the conservative Christian Democratic Union (CDU) and its Bavarian sister party, the Christian Social Union (CSU), Schlarmann has registered "enormous concern" among member companies.
Bavarian business owner Robert Drosten, for example, earns his money in such highly investment-intensive fields as automotive technology and aviation. Although he is not one of IKB's roughly 20,000 corporate customers, he understands their apprehension, especially with Lone Star being "served all of their sensitive data on a silver platter."
Even in London, the global financial center where John Grayken, the founder of Lone Star, now lives, the sense of outrage in the German business community is not hard to understand. The executives at D??sseldorf-based IKB kept far too many ailing businesses afloat for far too long, all the while seeking to make up for the resulting losses by speculating in the US mortgage market.
"It's time for weak IKB customers to put on warm clothes," says one investment banker, adding that in the future Lone Star, seeking to expand its profit margins, will demand "risk-appropriate lending rates." The weaker the company, the more costly its borrowing??r the more painful its ultimate liquidation.
In an interview with the German weekly newspaper Die Zeit, Karsten von K??ller, chairman of Lone Star Germany, conceded: "The current crisis will lead to higher lending rates at all banks." The group already demonstrated its approach to rigorously whipping an ailing bank into shape once before when it acquired AHBR, a former union-backed mortgage bank.
After a debacle that ended in losses numbering in the billions, the Texans were able to acquire the ailing bank for next to nothing. They promptly eliminated numerous jobs, sold off loans and spun off divisions.
Lone Star's business model has quickly earned it a reputation as a ruthless corporate raider. But financial restructuring a la Biria is not even the main focus at Grayken's Dallas-based outfit. Indeed, Lone Star's preferred modus operandi is to buy up bankrupt banks or packets of generally bad bank loans at a fraction of their true value. The company boasts returns of 20 percent and more, but only as a result of its aggressive selling of assets.
Many a German homeowner has also gotten a taste of Lone Star's less-than-refined methods. Major German real estate lenders, including giants like Dresdner Bank, Hypo Real Estate and ING-Diba, have sold packets containing billions in bad loans to financial investors like Lone Star in the past. Hudson Advisors, the company's mortgage servicer, then turned the loans into cash, often riding roughshod over minimum moral standards.
Were the loan sales always legal? Were the foreclosure sales above board? Were some of the loans that were foreclosed on still healthy? Were banking secrecy laws violated? These are the kinds of questions that are now being asked with growing frequency. But K??ller, the Lone Star Germany chairman, denies any wrongdoing: "We never foreclosed on a healthy loan."
Nevertheless, the company has been keeping German courts busy. A recent case in the northern city of Kiel attracted attention after a savings bank sold real estate mortgages to Lone Star on behalf of a developer. But Lone Star's attempt to begin foreclosure proceedings in May 2007 failed when the Kiel Regional Court ruled that the sale of the loans was presumably illegal. Now that an attempted out-of-court settlement has failed, the case will be brought before an arbitration panel.
Julius Reiter, the attorney for the developer in question, says that his experiences with Lone Star lead him to conclude that politicians should take decisive action: "The IKB customer should be granted the right to terminate their loans at no charge to them." Reitler's law partner, former FDP Interior Minister Gerhart Baum, openly criticizes the sale of IKB to Lone Star: "It's as if you were putting a wolf in charge of a herd of sheep."
But no matter how radically the new owner restructures IKB, the scandal-ridden bank's past has yet to be addressed. The federal government and KfW pumped about ??10 billion ($14.8 billion) into the ailing financial institution in the past 13 months, only to sell it now for ??115 million ($169 million). KfW and the German government have also assumed the risk for a portion of the bank's remaining bad loans and securities, which could turn into a loss of another ??750 million ($1.1 billion).
How Could the Disaster Have Occured?
The government is accommodating Lone Star for taking the bank off its hands??legantly taking on the problem. Oddly enough, another financial investor had also submitted an attractive offer: The RHJI Group, headed by Leonhard Fischer, the former CEO of the Winterthur Group, had wanted to buy IKB and preserve it as primarily an investment bank for small- and medium-sized businesses. "In fact, they had the more coherent concept," says a senior government official.
Why the sale then? Why now? And why to Lone Star, of all buyers, which, as a result, gains highly inexpensive access to thousands of business secrets and pieces of financial information? And how could the disaster have occurred in the first place? Whose fault is it? These are the kinds of questions that an investigative committee the FDP had vocally demanded could soon address. But, more recently, the liberals appear to have become afraid of their own courage. Party leader Guido Westerwelle met with Finance Minister Steinbr??ck last week to discuss the issue. After that, Westerwelle did exactly what he had always accused Steinbr??ck of doing when it came to IKB: He said nothing. The two men had apparently agreed to keep the content of their meeting confidential.
Party supporters believe that the FDP's sudden hesitation could have something to do with relatively close ties between several senior FDP leaders and Deutsche Bank, which played an extremely nontransparent role in the demise of IKB.
According to a report by the KfW advisory board, Deutsche Bank was connected to IKB in four ways. Among other things, it sold IKB the disastrous loan packages that drove the bank to the brink of ruin??nd did so at a time when Deutsche Bank had already eliminated these types of securities from its own portfolio, as CEO Josef Ackermann admitted indirectly. According to media reports, which have not been denied, the bank had even actively bet on the decline of such securities.
In a March report for CSU Member of Parliament Peter Gauweiler, Walter Perron, a criminal lawyer specializing in business law, concluded: "The behavior of employees of Deutsche Bank toward IKB can serve as evidence of the elements of a criminal offense." Perron now believes that a lawsuit filed against Deutsche Bank in the United States supports his argument, as he wrote in his report to Gauweiler.
A few weeks ago Axel Boetticher, a judge on the German federal supreme court, also called for a criminal investigation of the events and of the collapse of IKB.
According to Perron, the members of IKB's board of directors and its supervisory board, as well as the relevant senior executives at KfW and government officials, could also be guilty of breach of trust??nless they file possible claims for damages against Deutsche Bank.
Gauweiler has sent both the report and another letter to Finance Minister Steinbr??ck. In the letter, he writes that wants to minister to tell him "whether and how" a possible claim for damages against Deutsche Bank for "an exceptionally large amount" was "factored into the determination of a purchase price for IKB." The CSU politician says that he has "not received a straightforward answer yet."