Sagging sales. Disappearing profits. Missed targets. Investors are used to hearing bad news from Siemens, the German electronics-and-engineering giant. But few were prepared for Chief Financial Officer Heinz-Joachim Neubürger's surprise disclosure on Nov. 13. He announced that he had pumped $800 million into the company's various pension funds the previous month to help narrow a rapidly widening gap between their assets and liabilities.
Neubürger had already bolstered the $12.8 billion in funds with a $1.8 billion infusion earlier this year. But with stock markets plunging and pension payouts rising, he had no choice but to pour in yet more cash--thus further squeezing Siemens' already lackluster profits. As if that weren't enough, Neuburger also warned shareholders that he would have to transfer another bundle of money in 2003.
Siemens isn't alone. Many large European companies are struggling to pay pensions to a growing band of retirees at a time when their pool of investments is stagnant or shrinking. Analysts estimate that 100 of the euro zone's 300 largest listed companies have a pension-funding shortfall, totaling more than $110 billion--equal to half of their forecast profits this year. In Britain, the situation is just as bad: 81 of the FTSE 100 companies have deficits totaling $80 billion. All this has investors increasingly worried that company retirement funds could swallow a bigger and bigger share of earnings. "Some shareholders are getting panicky," says the investor-relations chief of a large Dutch company. "They keep phoning to ask whether we have a gap in our pension fund and how much we need in order to close it."
To be sure, few European companies are as burdened by unfunded pension liabilities as some U.S. companies, particularly in old-line industries. In October of last year, Bethlehem Steel Corp. filed for bankruptcy-court protection, in part because it couldn't cope with rising retirement benefits. Analysts don't see anything like that happening in Europe.
One reason is that fewer Continental companies offer employees retirement plans that promise specific payments upon retirement, known as defined-benefit plans. Instead, they simply top up the often-generous state-run pensions from current cash flow. In Germany, for instance, the law doesn't require companies to fund their pension schemes. Some do set aside money for pensions, but the money can be used for other purposes if management wants. Also, European companies that run defined-benefit plans typically prefer to invest a bigger slice of the assets in bonds, so they haven't been as badly hit by slumping share prices as have U.S. companies.
But whether they offer defined-benefit plans or not, European companies are suffering from mounting pension woes. That's partly because of demographics: Former employees are living longer, while the average retirement age is falling. A typical European male retired at 65 in 1960 and lived until he was 67. By 2000, he was retiring on full pension at 60 and living until he was 75. And women survive even longer. "In other words, companies have to support more retirees for longer--just like Europe's creaking state-run [pension] schemes," says Patrik Schöwitz, an expert in company pensions at HSBC Investment Bank in London. So pension payouts account for an increasingly large share of employee costs, even if a company doesn't have a special plan.
Meanwhile, European companies that have bought subsidiaries in the U.S. have found themselves encumbered with costly defined-benefit schemes there. Take German auto maker DaimlerChrysler (DCX ). CFO Manfred Gentz says that the company expects a $5.5 billion shortfall in its defined-benefit plan by yearend, with the U.S. responsible for $3.1 billion of that. At the same time, European companies that already had defined-benefit plans have been far slower than U.S. companies to convert them to defined-contribution schemes, in which companies make matching payments into an employee's pension account but don't pay anything after retirement. So pension problems at European companies tend to be growing, while they're fading in the U.S.
The falling interest rates and tumbling equity prices of recent months have driven home the scale of the problem to company managers and shareholders. Overall, the value of European pension assets has shrunk by about a quarter so far this year. In Britain and the Netherlands, which set minimum funding requirements for defined-benefit funds by law, the downturn has been accompanied by a flurry of cash injections. In the Netherlands, where one-third of company pension funds are underfunded, the pensions regulator recently gave companies one year to get back to the minimum funding level.
That will take a toll on earnings. Dutch postal-and-logistics company TPG is already paying up. In August, it wowed shareholders with what Chief Executive M. Peter Bakker described as "highly satisfying" first-half earnings of $590 million. But later the same month came the announcement that its pension fund had run up a $206 million deficit and needed an additional $70 million a year pumped in. Its stock fell more than 15% over the next few days.
Investors are clearly getting anxious--the more so because most European companies publish little information about their pension funds. In August, worried investors barraged Swedish telecom-equipment manufacturer Ericsson (ERICY ) with questions after analysts at Nomura Securities Co. suggested that they couldn't tell whether the company would be forced to shift money into its pension funds and take an earnings charge, because the company wasn't disclosing enough about its pension program. Nomura said it suspected Ericsson's pension liabilities were greater than the $1 billion it had set aside on its balance sheet. Ericsson responded that it had reserved enough funds under government recommendations to avoid a charge and that it didn't have a problem.
For investors, some help is on the way. By 2005, Europe's 7,000 listed companies must start using International Accounting Standards when they compile their results. That will force companies to disclose more information and record pension-fund shortfalls as liabilities on their balance sheets--much as British and American companies already must do. But worries about corporate pension liabilities will doubtless get worse before they get better. A further downturn in the markets coupled with another few quarters of lackluster earnings will give CFOs such as Siemens' Neubürger lots more to fret over, not to mention the employees threatened with a parsimonious retirement.
By David Fairlamb in Frankfurt