11.09.2019  |   Advisory Report

Current financial situation of Deutsche Bahn

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The economic situation of the Deutsche Bahn Group (German railways company) has further deteriorated. By mid-2019, net financial debt had amounted to €25.4 billion thus exceeding the ceiling set by the parliamentary Budget Committee. A total funding gap of €3 billion has been projected for 2019. If the proposed sale of Arriva is delayed or fails to materialise, Deutsche Bahn will not be able to tackle the investment backlog from its own resources. We recommend restructuring Deutsche Bahn. This means selling off holdings that do not serve the federal interest and strengthening governmental influence as part of its ownership rights.

0 Executive Summary

0.1 Driver for audit
In a special purpose report dated 17 January 2019, we advised parliament and the government on how to refine the structures of Deutsche Bahn and on the steps we think the government needs to take to achieve this. The Budget Committee deliberated on the special report (parliamentary records 19/7050) on 20 February 2019 and formally took note of it.
In this report, we look at the current economic situation of Deutsche Bahn. Based on the consolidated financial statements of the years 2009 to 2018, we also present the outlook since plans for a partial privatisation have been dropped. The Federal Ministry of Transport and Digital Infrastructure has lead responsibility for shareholding management and commented on this report. The Ministry agreed its comment with those of the Ministries of Finance and for Economic Affairs and Energy. The collated comment has been incorporated into this report.

0.2 Subdued economic situation of Deutsche Bahn
In 2018, the economic situation of Deutsche Bahn further deteriorated compared to the previous year despite a significant sales volume increase particularly in non-railway business areas. The 2018 operating result (EBIT) before non-recurring items was achieved for the most part by infrastructure-related activities (€1.2/€1.8 billion). It was thus primarily attributable to returns from regulated, largely non-competitive business areas. The Group used financial engineering to generate a stable year-on-year operating result after adverse non-recurring items (adjusted EBIT). In FYs 2013-2018, the EBIT was well below the adjusted EBIT. Overall, the EBIT margin declined from 5.7 per cent in 2011 to 4.1 per cent in 2018 due to purchases abroad (Arriva plc.) and the expansion of international activities (Schenker AG). After financial and tax expenses and items directly recognised in equity, Deutsche Bahn reported a negative 2018 total income of €0.2 billion, which had an adverse impact on equity capital. Deutsche Bahn was unable to cover the increasing need for investments in the various transport segments through cash flow from operations. As a result, the Group’s debt hit new highs in 2018.

0.3 Multibillion financing gap
Deutsche Bahn faces major operative challenges in particular in German rail transport (decline in earnings and decrease in market shares of DB Regio, continued losses in DB Cargo). Deutsche Bahn was not able to set off the losses incurred not even with the earnings made in the expansion of international and non-railway areas. Already by year-end 2019, there will be a significant financing gap of almost €3 billion. New borrowing will not help closing this gap because this will mean exceeding the debt ceiling set in the conditional approval requirements issued by the Budget Committee on 10 November 2016. If the proceeds from selling off Arriva do not cover the financing gap in 2019 or if the intended sale even fails to materialise, Deutsche Bahn will not be able to finance capital expenditures from its equity. In the medium term, Deutsche Bahn also faces other financial challenges such as the procurement of new rolling stock, digital rail, Stuttgart 21 project which the Group cannot fund from operating cash flows.

0.4 Comments made by the relevant federal ministries
The federal ministries stated that the reason for this deterioration of the operating result was that DB Regio and DB Cargo “currently do not exploit their full potential”. They referred to the “Agenda for a better railway” developed by the DB management board. This Agenda was designed to enhance operational quality. The ministries considered the tight liquidity situation to be a temporary phenomenon only to last until 2023. According to the ministries, this situation was due in part to high aperiodic investments in long-distance trains and the Stuttgart 21 project. They said that Deutsche Bahn intended to cover these investments largely from its operating business earnings and the returns from the sale of Arriva. As from 2024, they expected no further extraordinary funding needs of a similar nature.
In their view, some indicators such as the unadjusted EBIT or the EBIT margin we included in our report to evaluate the economic situation were of limited use only. According to the ministries, to assess the trend in operational performance, the annual accounts needed to be reconciled for unexpected incidents and other

challenging situations potentially threatening financial stability. They also stated that the negative operating result of the Group’s business unit for other participating interests was fully attributable to the Group’s management costs not being adequately allocated.
The ministries stated that the federal government was committed to implementing our recommendations “in part” and “in close coordination with Deutsche Bahn”. Within federal government a survey was proposed to review the significant federal interest. The ministries stated that the resulting federal interest in Deutsche Bahn could serve as a basis for the owner’s mission statement. Furthermore, in their comments, the ministries referred to the “strong rail” strategy of Deutsche Bahn recently issued that placed focus on the core business of rail transport in Germany.

0.5 Final assessment and outlook
The aspects raised by the ministries responsible do not represent diverging assessments of the Group’s economic situation or of the segment related developments.
In particular, business trends over the first six months of 2019 highlight the negative trend and the urgency of a structural reform of Deutsche Bahn. Operating and financial indicators show another deterioration of the situation until 30 June 2019. Already on 30 June 2019, net borrowing exceeded the ceiling set by the Budget Committee for 31 December 2019. To comply with the debt limit set at year-end, cash injections from the intended sale of Arriva or from other sources are needed.
For the trend beyond 2019, the funding gap in the current medium-term planning will not be covered merely by selling off Arriva. On top of the medium-term financial challenges, there are also extra costs resulting from current and future pay settlements and from the recruitment initiative. Moreover, once sold, Arriva will reap no profit any more. However, profits of Arriva are still included in the medium-term financial planning. As to the Stuttgart 21 project, designed to start operating from year-end 2025, planning seems to include extra costs for the period from 2020 to 2023 only. There is also the risk of further costs so that the proposed share of equity of €5 billion would be exceeded. Required investments as part of the Group’s new overarching “strong rail” strategy and to expand the range of rail services have so far neither been specified nor quantified. Due to the targeted doubling of the number of train passengers investments in rolling stock will remain at a high level even after the current procurement campaign for new trains due to the targeted doubling of the number of passengers. Furthermore, unplanned losses of venture capital used for new mobility solutions can have a negative impact on the profitability and financial position.
Based on this assumption, the funding gap will continue to widen in the medium and long term. To avert the resulting risks posed to the federal budget and to ensure compliance with the debt ceiling set by the Budget Committee, we hold that the Group needs to focus on its core tasks and sell off other parts of the Group such as Schenker AG.

0.6 Conclusions and recommendations
The Group’s earnings continue to decline and thus also the capacity to fund future investments in rail transport from equity capital. This alarming trend is reflected in the current balance sheet data and the outlook for the future. This increases the need for action for the government as the sole owner of Deutsche Bahn.

We take this opportunity to recommend the following steps to the government:

  1. The economic and in particular the financial situation of Deutsche Bahn has further deteriorated. Therefore, now the time has come for government to clearly define the government’s goals based on its universal service mandate (Article 87e para. 4, German constitution) to provide Deutsche Bahn with a clear frame to scope its tasks. For this purpose, government should take prompt action to develop rail policy guidance and a strategy covering all modes of transport.
  2. Building on this, government should speedily develop a viable structure model for Deutsche Bahn. In doing so, government should take into account that currently two thirds of the Group’s EBIT have been generated by regulated segments. This should provide an impetus to review the “separation between rail network and rail transport”. Therefore, government should define what business activities Deutsche Bahn needs to engage in.
  3. Government should then direct the corporate purpose of Deutsche Bahn to the federal interest and the public weal and include the corporate purpose into the articles of association. Government should clearly define the extent (if any) and the conditions governing non-railway and business activities abroad.
  4. Then, the government should urge for a prompt implementation of the federal government’s targets and an effective and efficient mission performance of Deutsche Bahn. For this purpose, government should make better use of its sole ownership rights in particular via its shareholding management divisions and via the relevant departments and government representatives in the supervisory bodies.
  5. To speed up structural reform of Deutsche Bahn, government should urge for promptly selling off shareholdings that do not serve the federal interest. We hold that in addition to selling Arriva, another potential candidate for sale is Schenker AG. The government should establish a timetable for selling non-railway businesses no longer needed and/or companies operating mainly abroad. Government should closely monitor the sales to safeguard its interest in federal assets.
  6. When launching the urgently needed structural changes, government should help ensure a long-term and sustainable financing of its railways in Germany.

We studied press releases of April 2019 according to which the Supervisory Board had commissioned an opinion on whether it was permissible for them to furnish to us abridged minutes on the results of the discussions held at Supervisory Board meetings. Deutsche Bahn had refused to comment on the matter to the press. Upon request, in June 2019, the shareholding management confirmed to us that the Supervisory Board was dealing with this matter. Against this backdrop, we point out the following:

  • In compliance with applicable stock corporation law, the minutes of a Supervisory Board meeting need to include the key points of deliberations and the decisions made by the Supervisory Board. The stock corporation law does not permit abridged versions of the minutes.
  • Pursuant to Article 394, Stock Corporation Act, the government representatives on the Supervisory Board of Deutsche Bahn are authorised and required under civil service law to share the Supervisory Board meeting minutes with the shareholding management divisions. The duty to maintain secrecy for government representatives would be improperly tightened if they were prevented from sharing the long-form Supervisory Board meeting minutes in full with the shareholding management divisions.
  • Pursuant to the federal financial regulations (Article 69, Federal Budget Code), the shareholding management division has the duty to make the meeting minutes available to us. If the shareholding management division received an abridged version of the Supervisory Board meeting minutes only, this would significantly impede mission performance of the shareholding management division and of the SAI in tracking down any rationale for the actions taken by the government representatives on the Supervisory Board.

In case the Supervisory Board decides not to permit government representatives to pass the meeting minutes any longer to the shareholding management divisions, such a behaviour would infringe access rights of government representatives, of the Federal Ministry of Transport and Digital Infrastructure and of the German SAI. This would clearly prove both the existence of dysfunctional business structures and that the sole owner’s representation functions on the Supervisory Board are not guided by the federal interest in Deutsche Bahn. In this regard, federal financial regulations (Article 65 para. 1 No. 3) stipulate that being the sole owner of Deutsche Bahn, the federal government needs to encourage structures enabling the government to duly exercise its ownership rights.