Torpedoed in Germany?

How an American financier's U-boat play has gone awry

New York raider Guy P. Wyser-Pratte is not used to being trifled with. He is a veteran of many a fight to boost a company's stock price, and not just in the U.S. The well-known arbitrageur has recently been finding his targets in Europe, where he has notched up several victories. That's why his most recent deal is so galling: Wyser-Pratte thought the latest company to attract his attention and money, German engineering and defense contractor Babcock Borsig, actually had a chief executive who wanted to drive the shares up. But months after Wyser-Pratte bought into Babcock, the stock has cratered. And the CEO has turned on Wyser-Pratte by unexpectedly selling off Babcock's corporate jewels. Wyser-Pratte is vowing revenge.

The result is a first-class corporate dustup that also involves German and European Union politicians, U.S. weapons maker Northrop Grumman Corp., and a passel of lawyers. And this isn't just a grudgefest: At stake is Germany's reputation as a country where foreigners can do business and expect to see deals honored--especially deals that enhance stock value. "Deluding shareholders, lack of transparency, total repudiation of the rule of law--this is a showcase for what's wrong with Germany Inc.," fumes Wyser-Pratte.

The French-born financier claims he was deliberately misled. New York-based Wyser-Pratte Management Co. began buying shares in Babcock last November, eventually accumulating an 8.2% stake. Early this year, Wyser-Pratte met with Babcock's CEO, Klaus G. Lederer, at New York's posh Four Seasons restaurant to discuss the struggling engineering company's future. Over dinner, Wyser-Pratte recalls, the two men agreed on a plan to dump nonperformers and boost Babcock's holding in a profitable submarine maker, HDW.

Then, in March, in a stealth maneuver worthy of one of HDW's submarines, Lederer reversed course. Instead of upping Babcock's 50% interest in HDW, the onetime engineering professor forged an agreement to sell a 25% stake to One Equity Partners, a unit of Chicago-based Bank One Corp., for an estimated $325 million. In a deal sealed on June 7, One Equity acquired another 50% in HDW from Preussag, a Hanover-based conglomerate that owns 8.9% of Babcock. One Equity says it wants HDW to lead a consolidation of the European military shipbuilding industry. "HDW has good times ahead of it," says Christopher von Hugo, senior partner for One Equity in Germany.

Wyser-Pratte and his fellow investors are enraged, especially since Lederer is jumping ship--to run HDW full time. Now Babcock, based in the Ruhr Valley city of Oberhausen, is left with little more than an unprofitable unit that builds power plants. Even after booking $200 million in gains from the sale of the HDW stake, the company will post a net $120 million loss for the fiscal year ending in August, on sales of $4 billion, estimates analyst Eggert Kuls of Hamburg-based private bank M.M. Warburg. "The company can't afford to make any more mistakes," warns Kuls. Babcock's shares have lost 50% of their value since March.

At the heart of the controversy are the state-of-the-art submarines HDW builds in Kiel on Germany's northern coast. On Mar. 22, HDW christened the U31, the first in a series of superquiet subs that run on hydrogen fuel cells. The U31 can remain underwater for several weeks, a feat until now accomplished only by nuclear submarines. And unlike the hulking nuke boats operated by the U.S. and Russia, the U31 is small enough to navigate shallow coastal waters undetected. "[HDW] makes good boats. I don't think anyone would deny that," says Stephen Saunders, a former British Royal Navy commodore who is editor of the trade journal Jane's Fighting Ships.

HDW's technology has attracted the attention of American defense contractor Northrop Grumman, which is in talks with HDW about a possible collaboration. Northrop would love to sell HDW's subs to Taiwan, provided it overcomes German fears of infuriating Beijing.

But Babcock won't reap nearly as big a profit from any deal as it would have before Lederer sold off a chunk. The spurned Wyser-Pratte is attempting to block the sale of Babcock's remaining 25% in HDW to One Equity through the German courts. "They're taking the wealth of this company away from shareholders," Wyser-Pratte declares. The financier has obtained a temporary injunction preventing the deal from going forward. Now, he wants to convene a special shareholders' meeting to put it to a vote. Wyser-Pratte is even trying to put Lederer behind bars for allegedly ignoring court injunctions against proceeding with the HDW sale. Dusseldorf prosecutors are also investigating whether Lederer had a financial connection to a One Equity executive which he concealed from shareholders. A spokesman for Lederer, who is due to step down as Babcock CEO in June, calls the accusation a "fairy tale."

It is not clear whether Lederer was out to dupe investors. A spokesman says the 53-year-old CEO was simply forced to revise his strategy in response to financial realities: A deeply indebted Babcock couldn't possibly raise enough money to take over the submarine maker. The well-connected Wyser-Pratte says investment banking sources have told him Lederer was already looking to sell Babcock's HDW stake last year. If true, that would mean Lederer was secretly pursuing one strategy while peddling a different one in public.

In any case, it wouldn't be the first time Lederer has reversed course. After Babcock bought 50% of HDW in 1999, Lederer told supervisory board members that its management was first-rate. He then turned around and fired the three top executives a few months later. Says one supervisory board member: "Either Lederer's very spontaneous or poorly informed." Lederer assumed the helm at HDW in 2000 while continuing to serve as CEO of the parent company.

Officials from the European Union could step in, giving the saga yet another twist. Regulators could revoke their earlier approval of the deal if they determine that Babcock, HDW, and One Equity Partners weren't truthful about their intentions. Wyser-Pratte, meanwhile, is actually buying more Babcock shares to increase his leverage with management. "We think we can create value," he says. His optimism is hard to fathom, considering the company's meager profits over the last four years have come largely from asset sales.

One Equity Partners, for its part, maintains that its acquisition of HDW is in Germany's interest. Unlike Babcock, it has the wherewithal to invest in the submarine maker and make the most of its world-beating technology. To assuage the German government, One Equity granted steelmakers ThyssenKrupp and Ferrostaal options to buy 15% each in HDW, ensuring a measure of German control. And it has promised to give German companies right of first refusal on any sale of HDW for 10 years. If all goes well, One Equity will eventually realize a nice return on its HDW investment. Just watch out for Wyser-Pratte's depth charges.

By Jack Ewing in Frankfurt, with Christopher Palmeri in Los Angeles

    Before it's here, it's on the Bloomberg Terminal.