German Utilities Get Back to Their Roots

They're eager to spend the take from sales of noncore holdings

Düsseldorf-based e.on likes to spell its name in small letters. Don't be fooled: It's one big company, with first-quarter sales of $19 billion and vast holdings. It's supposed to be an integrated electric utility, but it's also in chemicals, transportation, real estate, and silicon chips. The product of last year's merger of Veba and Viag, e.on is Germany Inc. at its mightiest--and most unwieldy.

Probably not for long. Reversing decades of diversification, co-CEO Ulrich Hartmann is focusing the company on energy. The same is going on at e.on's Essen-based rival RWE, which has slightly less eclectic holdings. The two are by far the largest of Germany's 600-plus utilities.

Why the urge to demerge? It's largely the surprising result of a landmark change in the German tax code. From Jan. 1, the new law lets companies sell stakes in other companies tax-free and has targeted banks, which since World War II have pulled the strings of German industry through their holdings. But e.on and RWE are proving the nimblest in using the law, intended to help the economy break free from interlocking shareholdings that tie up capital and hinder the restructurings that often follow a change of ownership.

Meanwhile, Germany's big banks are floundering about for deals. Deutsche Bank, for instance, has made little progress in selling stakes in builder Philipp Holzmann or food company Sudzucker. That's in sharp contrast to the two utility giants, which are preparing to cash in. "They will benefit quite massively from this," says Fabrice Farigoule, an analyst at B. Metzler seel. Sohn & Co., a private bank in Frankfurt. Both companies say they'll take their time, but analysts bet they'll act fast in case politicians rescind the tax break. The latest deal was on July 16, when e.on said it will sell its Veba Oel unit to British Petroleum PLC. The deal values Veba Oel at $5.5 billion. To get the tax break, BP won't take full control till next year.

That's just a start. Next year, e.on is expected to unload its $1 billion stake in transport company Stinnes. It also plans to shed much of its 64.6% stake in chemical maker Degussa, valued at $3.5 billion. Not to be outdone, RWE plans to sell stakes in Heidelberger Druckmaschinen, a maker of printing machinery, and builder Hochtief, which could fetch some $3 billion.

There may be more riches lurking in their balance sheets because German companies don't have to disclose stakes smaller than 5%. Analysts were surprised to learn earlier this year that e.on owns some 2% of Dresdner Bank, valued at $408 million. Analysts also peg RWE's oil refining and distribution business, which it's also expected to shed, at $2.1 billion. Schroders Salomon Smith Barney estimates that RWE has noncore holdings and other assets worth $8.5 billion that it might convert to cash, thanks to the tax bill. E.on may have $17 billion worth, says SSSB.

German Chancellor Gerhard Schröder can pride himself that his bill launched Corporate Germany's restructuring. What shareholders think will depend on how companies spend the cash. For decades, Germany's major utilities have invested outside the power business, with mixed results. E.on collected $3 billion last year when it sold off its stake in mobile-phone provider E-Plus to Dutch telecom provider Royal KPN. But e.on's silicon-wafer business, which it plans to sell, lost money--$33 million in the first quarter of 2000 alone--even before the chip industry crashed this year.

HUNTING TRIP. Company executives say they've learned their lessons. "We are only making acquisitions in our core businesses," says RWE Chief Financial Officer Klaus Sturany. He's half-right: RWE is sticking to utility businesses. But both companies are determined to become global players. Trouble is, say some analysts, they have little track record abroad. "I can't see where the added value is, or the expertise," says Thomas Deser, a fund manager at Union Investment, an asset management firm in Frankfurt.

The other danger is that the utilities will overpay in their haste to go global. SSSB analysts say that concern is depressing RWE and e.on share prices, which have been flat this year despite gains in operating profit. "The number of targets is limited," allows Sturany. The Germans are hunting in the U.S., a market e.on will tap through its $7 billion purchase of Britain's PowerGen PLC, which controls Louisville-based LG&E Energy Corp.

Some investors, meanwhile, want the companies to pay special dividends, not embark on foreign adventures. "They should give the money back to shareholders," says Union Investment's Deser. How well German companies manage this windfall will be the true test of the law's effectiveness.

By Jack Ewing in Frankfurt

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