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2020 report – Current findings on the economic situation of Deutsche Bahn and on extra funding needs for post coronavirus recovery

May 25, 2020

Symbolbild Corona-Pandemie - Deutsche Bahn

0 Executive summary
The federal government is the sole owner of Deutsche Bahn AG (German railways company) including a number of non-railway and global business activities. Currently, Deutsche Bahn is significantly affected by the COVID-19 pandemic. The corona crisis has further worsened the tight financial situation of Deutsche Bahn and its massive structural problems. Financial burdens have also further increased due to misguided policies dating back to times long before the corona crisis, in particular in the business areas of: “Cargo”, “Regio”, “Arriva” and “miscellaneous shareholdings”. Higher borrowing is permitted only if Deutsche Bahn can provide assurance on debt sustainability. The federal government must limit post coronavirus recovery grants to cushioning the impact of the pandemic. The universal service mandate of Deutsche Bahn does not authorise the Group to use these grants for non-railway and global business activities. Nor does the mandate provide any legitimacy for using the grants to make up for misguided policies and losses of Deutsche Bahn dating back to pre-corona times. The federal government needs to avoid interfering with competition in the railway market that took 25 years to build up. Deutsche Bahn needs to engage in considerable consolidation efforts, streamline global business activities and focus on core functions of federal interest. The federal government needs to take immediate action and launch the urgently needed structural reform of Deutsche Bahn. Although the reform has been long overdue, so far, the Federal Ministry of Transport and Digital Infrastructure (the Ministry) did not go beyond mere announcements.


0.1 Economic development before COVID-19
In financial year 2019, Deutsche Bahn slightly increased its sales revenue, in particular in long-distance passenger rail services. In the rail services of Regio and Cargo, the market share of Deutsche Bahn has declined in recent years. Deutsche Bahn has postponed the sale of Arriva and is sticking to the Schenker logistics subsidiary. So, currently, no one knows when the announcement of refocusing business activities on rail transport in Germany will be followed by effect. What is known, however, is that the Group still has almost 600 subsidiaries all over the world and generates more than 40 per cent of its sales revenue abroad.

In financial year 2019, the weak earnings situation continued to deteriorate. In 2019, the operating result (“earnings before interest and taxes” (EBIT) adjusted for non-recurring effects) declined from €2.1 billion to €1.8 billion. The EBIT margin of 4.1 per cent was the lowest since 2011, with the actual non-adjusted Group EBIT amounting to €1.4 billion only. Several business areas require urgent action to address the decline in earnings. Despite restructuring efforts, Cargo’s losses are still on the rise. The same can be said of bus transportation in the Regio business area. For several years, Arriva and Regio have suffered from eroding margins. Since Arriva allocated funds to contingency reserves the company did not make any relevant surplus in the years 2018 and 2919.

In 2019, total income of the Deutsche Bahn Group was at €0.0 billion. In the last six years, aggregated total income amounted to €0.6 billion with a sales revenue of €252 billion. This clearly shows the Group’s weak earnings situation in pre-corona times.

0.2 Debt trend prior to the pandemic
For many years, cash flows generated from operational activities have not enabled Deutsche Bahn to fund urgent investments. In 2019, debt increased by €2.4 billion (incl. hybrid bonds). While the debt ceilings were proposed to be lowered in the years ahead, at year-end 2019, with a net financial debt of €26.2 billion, Deutsche Bahn significantly exceeded the ceiling set by the parliamentary Budget Committee.

The federal government believes that Deutsche Bahn has complied with the debt ceiling since the hybrid bonds emitted by Deutsche Bahn in 2019 are left out of the debt calculations. The federal government justifies this approach by stating that hybrid bonds are recognised as equity pursuant to international accounting standards. However, we hold that the regulations of German commercial law pertain to this case. Pursuant to German commercial law, hybrid bonds have debt-like features and therefore need to be treated as borrowed capital. In our view, the fact that the question of whether or not hybrid bonds count in assessing the level of debt has not been referred to the Budget Committee for consideration, means circumventing the provisions set forth in the Committee’s conditional approval resolution. We hold that this violates parliament’s power over the budget.

0.3 Report of the federal government
The coronavirus pandemic has an impact on the operations of Deutsche Bahn and increases the need for immediate action. Being the sole owner of Deutsche Bahn, the federal government is now also to shoulder the financial risks associated with non-railway and foreign business operations. In addition to Arriva and Schenker, this also encompasses a large number of other businesses outside the federal government interest which Deutsche Bahn runs with government shareholdings.

The federal government engaged with Deutsche Bahn and developed a plan on funding needs and possible steps to be taken. This plan is based on an assessment of the situation of Deutsche Bahn. The assessment was done on the basis of limited and provisional data approximately six weeks after the beginning of coronavirus-related impacts. According to this plan, Deutsche Bahn expects a temporary deterioration in total income especially for 2020 and 2021. Based on a comparison with previous planning, Deutsche Bahn calculates a coronavirus-related funding gap of €11 to €13.5 billion for its global business activities. Pursuant to the report of the federal government, this funding gap is to be closed by means of three components: promised cost savings primarily in human and material resources, new borrowing, and federal government equity support of €5.5 billion or more.

In light of the current forecast uncertainty, we do not understand why the federal government in its owner function commits itself to supporting measures for five years ahead on the basis of an early and little reliable assessment of the situation. The report states that the federal government will provide a first capital injection amounting to €4.5 billion “within the next weeks‟. However, key matters that need to be settled before making available federal budget funding have so far not been addressed in a transparent manner. In particular, the relevant documents do not provide information on when exactly and in what amount the crucial bottleneck will arise that cannot be relieved from unused liquidity and loan facilities of Deutsche Bahn. Furthermore, the report does not state that all and any additional funding requirements estimated by Deutsche Bahn in its scenarios are attributable to the corona pandemic. However, such evidence needs to be provided in the first place. Also, the applicable subsidiarity principle stipulates two prerequisites for relying on federal funding as intended: Deutsche Bahn must have largely exhausted all other funding options or guarantees and the cash injection must not create a serious distortion of competition.

In addition to equity support, the debt ceiling is to be raised significantly. No proposal for the long-term structure of this funding has been submitted. Thus, it remains unclear what types of debt are to be included in future assessments, how these are to be verified, and what impacts any future structural changes may have. At this point of time, it is not certain whether Deutsche Bahn will still be in a position to ensure timely and full future debt servicing (interest and repayment). This poses the risk that sometime in the future the federal budget will have to step in to shoulder debt. This risk needs closer analysis before the debt ceiling is further raised.

The funds now budgeted are designed for the entire Group, which means that they may support all business activities, including competitive businesses. This raises significant regulatory concerns since such a unilateral support without an industry-wide solution would directly impair competition. Furthermore, there is the risk that the EU Commission considers the intended equity support to be questionable in terms of state aid rules.

0.4 Comments made by the federal government
On 22 May 2020, the Ministry that has lead responsibility for shareholding management commented on the report on behalf of the federal government. The Ministry pointed out that in the short time available, it had not been possible to make complete and reliable statements.

Based on the report submitted, the federal government intends in particular to ensure funding capacity of Deutsche Bahn for all business activities and to spend the first instalment of the proposed capital injection as soon as possible. The federal government does not state what the added value of equity support is nor compares it to other possible options conforming to the subsidiarity principle. The federal government envisages a one-time lift of the debt ceiling to €30 billion for the year 2020 but presenting a long-term mechanism to limit debt only by the fourth quarter of 2020. No justification is given for this approach. Apart from that, the Ministry states that evidence of coronavirus-related funding needs is to be provided to the EU Commission as part of the compliance review with state aid rules. In its comment, the Ministry fails to mention compliance with funding competencies of the federal government pursuant to Article 104a of the German Constitution and the federal regulatory structure. The Ministry’s comment has been incorporated into our report.

0.5 Overall conclusion
Irrespective of the forecast uncertainty, Deutsche Bahn largely sticks to earlier business policies and planning targets. Deutsche Bahn has only extended target dates for several years. After receiving federal grants, Deutsche Bahn intends to pursue its previous strategy although this strategy has so far failed to keep federal budget burdens within sustainable limits. After the modal shift from road to rail that had been of little success, this was the second key target of the railways reform in 1993 and 1994.

In the current crisis, it becomes obvious that Deutsche Bahn does not intend to rely on federal funding only for the universal service mandate. Rather than that, Deutsche Bahn seeks to transfer risks to the federal government that arise from non-railway and global business activities. At the same time, Deutsche Bahn seems to do business as usual and does not conduct restructuring efforts to help stop federal government funding from soaring indefinitely.

The financial impact of the pandemic could have been better buffered if the federal government had addressed long-standing flawed management practices that we had pointed out. To do so, the federal government should have taken the lead to implement the governance steps urgently needed. By initiating the structural and operational steps needed, it would have been possible to slow down the downward trend, to reduce operating losses and to initiate selling off Arriva (and Schenker) at an earlier stage. Now, the lacking structural changes add to the taxpayer’s burden of corona-related costs.

The federal government did not even act on the approach presented in the report to call for structural changes. The discussions on that matter announced by the Ministry for the year 2020 have yet to start.

By year-end 2020, Deutsche Bahn is to receive €1 billion from the climate action package in addition to equity support of €5.5 billion or more as stated in the report. Nevertheless, the debt ceiling of the Group would be at €32 billion (including hybrid bonds of €2 billion already emitted) at year-end 2020, and thus almost €8 billion above the current debt ceiling. As a result, funding needs including the cash injection would exceed current projections by €14 billion.

In light of the business losses and negative trends of the Group that become even more acute in the crisis, Deutsche Bahn may no longer do business as usual.

0.6 Recommendations
We have developed the following recommendations:
The intra-Group options to enhance the earnings and liquidity situation should be fully used. To that effect, the federal government representatives on the supervisory boards of the business units of Deutsche Bahn and the Ministry representing the federal government as a sole owner should make targeted and better use of their monitoring and governance functions.

Before taking a decision on the amount and timing of any equity support, Deutsche Bahn should list corona-related liquidity needs broken down into business activities. In addition, Deutsche Bahn should also provide insight into liquidity reserves still available and those needed for future business continuity. The federal government should commission an own mandatary to verify the evidence required.

The federal government report sets out information on Deutsche Bahn’s promised funding share. For better planning, such shares should be expressed in money terms and contractually be agreed to ensure that the instalments due are actually transferred. A staggered payment of the federal grants is a suitable approach to ensure that Deutsche Bahn actually transfers its share of contributions due.

Federal grant funding regulations set forth in Article 104a of the German Constitution should be complied with. In accordance with constitutional Article 87e para. 4, the federal government has no overall responsibility for performing the universal mandate services in local rail passenger transport. Such transport services have been devolved to the federal states. Federal responsibilities conclusively regulated in the Constitution do not cover the business activities of Arriva (local transport outside Germany across Europe), Schenker (global logistics solutions) and other forms of modern public transport. Therefore, such businesses should not receive the proposed equity support.

Furthermore, care needs to be taken to ensure that the government’s hasty willingness to pay does not cause potential damages to the German economy and in particular competitors of Deutsche Bahn. Instead of injecting fresh funds into competitive business units of the Group, the government would be well advised to adhere to the federal regulatory structure and seek industry-specific solutions for such businesses.

To address the current financial emergency situation of Deutsche Bahn and to ensure better funding terms and conditions, the federal government should not opt for fast cash injections but for grants that imply no heavy budgetary burden. For this purpose, the government should weigh the pros and cons of interest-free and conditionally repayable shareholder loans or letters of comfort.

As to the option of proposed government support in the form of renewed equity financing, the following aspects should be taken into account:

  • Any federal government grants and their payment are subject to the following requirements. The funds must not in the first place serve to increase equity. The funds must be transferred in a stepwise process and in line with eligibility criteria for liquidity needs and not as an advance payment.
  • There is a need for regularly monitoring whether the promised own funding share is actually paid, and how debt and debt sustainability are developing.
  • The federal government and Deutsche Bahn should directly report to the Budget Committee every six months, and in case of major trend changes they should do so at shorter intervals. Such reporting should cover the situation of earnings, sales income, liquidity trend, and the matters listed above.
  • These regular reports should also include information on the status of structural changes and on Deutsche Bahn’s return to its core functions.

The federal government should ensure that the equity support currently proposed is not used for funding misguided developments, inappropriate investments or other losses that Deutsche Bahn has caused prior to the COVID-19 pandemic.

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