An Unpleasant Bill Could Increase The Tax Burden For BASF, Bayer And Siemens

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Includes: BASFY, BAYRY, BAYZF, BFFAF, SIEGY, SMAWF
by: The European View
Summary

What the three large German cyclical industrial companies BASF, Bayer and Siemens have in common is that they each have different problems of their own.

Hardly noticed by investors outside of Germany, the current German government brought up a legislative initiative which has further far-reaching consequences for the companies.

The German federal government plans to change the taxation of share deals. The new rules will already apply to transactions from 1 January 2020.

At the latest when 90 percent or more of the shares of a listed company in Germany are transferred to new shareholders, real estate transfer tax is due.

The effects of implementing the law are too significant and the government's intention is too definite to allow companies and investors to be careless.

Introduction

What the three large German cyclical industrial companies BASF (OTCQX:BASFY; OTCQX:BFFAF), Bayer (OTCPK:BAYZF; OTCPK:BAYRY) and Siemens (OTCPK:SIEGY; OTCPK:SMAWF) have in common is that they each have different problems of their own. The problems are partly cyclical (Siemens and BASF) and partly homemade (Bayer). I will discuss the individual problems in the context of an analysis later in the article. First of all, I want to show that all three companies could now have a new problem because hardly noticed by investors outside of Germany, the current German government brought up a legislative initiative that has far-reaching consequences for the companies.

The legislative initiative

(Olaf Scholz, German Federal Minister of Finance and Vice Chancellor)

The German federal government plans to change the taxation of share deals. To this end, it has submitted an appropriate draft bill. The aim of the law is to prevent certain behavior aimed at avoiding tax payments. Because so far some companies have used a loophole. Companies did not sell the real estate, but shares in the company that owns the real estate. Furthermore, the previous legal situation was that if the buyer acquired a little less than 95 percent of the shares, he did not have to pay any real estate transfer tax at all. According to the bill draft, the tax liability should now also apply if more than 90 percent of the shares change hands. The starting point is that this is now also to apply to shareholder changes in corporations with domestic real estate in Germany. The change therefore also affects all of the three shareholder companies. At the latest when 90 percent or more of the shares of a listed company in Germany are transferred to new shareholders, real estate transfer tax is due, which ranges from 3.5 percent to 6.5 percent. According to the bill, the new rules will already apply to transactions from 1 January 2020.

Analysis

For all three companies, this news comes at an inopportune time. All problems are currently confronted with a variety of problems. Due to their size, the three companies are also traded extremely frequently and with high volume. This is also facilitated by the fact that the majority of the shares are in free float.

Company BASF Siemens Bayer

Free float in percent (incl. global investment corps.)

100 89.25 100

Siemens initially appears to have an advantage here, as less than 90 percent of the shares are in free float. But this is misleading for two reasons.

  • A closer look reveals that Siemens itself holds more than 4 percent of its own shares. These could be returned to the free market at any time through employee compensation.
  • In addition, the following legal sophistry must be observed. It is not clear whether a total of 90 percent of all shares (i.e. the very concrete shares) will have to be sold and bought at some point, or whether it is sufficient for a total value to be traded that corresponds to 90 percent of all shares. In the latter case, it therefore makes no difference whether less than 90 percent of Siemens shares are in free float or not. The decisive factor is that all three companies are largely or completely free float.

This could result in an extremely high taxes. In an interview with the German newspaper FAZ, Wolfgang Haas, head of BASF's tax department, said that pure stock market trading in BASF shares could lead to a tax burden in the hundreds of millions. I will show below that it can also be more than that if you are guided solely by the market cap of the taxed companies. That would be the case every time after 90 percent of the shares were traded. In addition, this tax burden is independent of turnover or profit.

There are also other problems. For example, it is difficult to determine the exact number of share transactions immediately as a company. This is where companies run the risk of being fined for late reporting. In addition, the trading of shares is generally only subject to reporting if certain thresholds are exceeded. New regulations would also have to be created for this. The resulting uncertainties therefore represent a high financial risk for the companies.

Nevertheless, there's a solution. A stock exchange clause in the later law must make it clear that the mere acquisition of shares on a recognized stock exchange does not trigger real estate transfer tax if no real estate is acquired. However, it is not at all clear whether such a system will be implemented. The federal government is showing itself to be open to discussion. However, the federal government has already announced that it will not depart from the substance of the amendment. This adds further problems to a long list of existing problems for the three companies.

BASF

BASF struggles with cyclical problems. The downturn in the car industry, especially in China, and the customs dispute within the trade war are increasingly affecting BASF. In the second quarter of 2019, sales fell by 4 percent year-on-year. EBITA almost fell 40 percent. In order to make BASF more profitable, management launched a new savings program that is expected to contribute two billion euros a year to the EBITDA from the end of 2021.

In addition to these problems would came the real estate transfer taxation. According to the calculation of the "Deutsches Aktieninstitut" (German Stock Institute), BASF, Siemens and Bayer would have to pay the real estate transfer tax every 14 months on average. To get a realistic impression, I used the 2018 numbers for the analysis. Taxation would have had the following effects:

Market cap Tax 3.5 % EAT without 3.5 % tax
EUR 55.476 billion EUR 1.9 billion EUR 4.97 billion

A conservative calculation with a tax rate of 3.5 percent and a trading volume of 100 percent of market capitalization would result in a tax burden of almost EUR 2 billion for BASF. In 2018, this would have destroyed almost 40 percent of earnings (after taxes). Such a tax payment would then become necessary every two years for BASF, regardless of how profits develop until then.

Siemens

Siemens is also in a process of change, but seems to be acting from a position of strength. CEO Kaeser is particularly trying to break up the conglomerate structure and float parts of the company on the stock exchange. This creates more autonomy and better growth opportunities for the spun-off companies. Furthermore, in the recent past, Siemens has been able to win a number of good contracts. Siemens has won an USD 828.8 million order from the U.S. Navy to build, operate and maintain energy conservation systems at Naval Base Guantanamo Bay in Cuba. Furthermore, the company won a EUR 284 million contract to supply gas and steam turbines as well as generators for an Iraq power plant.

Nevertheless, the latest quarterly figures were disappointing. Sales climbed by four percent. On the other hand, adjusted EBITA in the industrial segment fell by twelve percent (below analysts' expectations). Although the forecasts were confirmed, the EBITA margin should remain at eleven to twelve percent. However, Siemens now expects to reach the lower end of the corridor.

In addition to these problems would came the real estate transfer taxation. Given that BASF, Siemens and Bayer would have to pay the real estate transfer tax every 14 months on average, taxation would have had the following effects:

Market cap Tax 3.5 % EAT without 3.5 % tax
EUR 82.77 billion EUR 2.9 billion EUR 7.12 billion

(Note: To get a realistic impression, I used the 2018 numbers for the analysis.)

A conservative calculation with a tax rate of 3.5 percent and a trading volume of 100 percent of market capitalization would result in a tax burden of almost EUR 3 billion for Bayer. In 2018, this would have destroyed 42 percent of earnings (after taxes). Such a tax payment would then become necessary every two years for Siemens, regardless of how profits develop until then.

Bayer

Bayer is particularly confronted with homemade problems in connection with the acquisition of Monsanto. The number of U.S. plaintiffs continued to rise by 5,000 to 18,400. Although the sums awarded for damages have been greatly reduced so far, a large financial burden is still almost inevitable. Despite that, the company has already warned that its 2019 earnings target has become harder to reach. Otherwise the last results were not so bad. The company continued to grow in the second quarter of 2019. Sales of Bayer rose by 0.9 percent Crop Science registered a 3.1 percent decline in sales which resulted primarily from extreme weather conditions. Pharmaceuticals posted sales growth of 3.9 percent. Somewhat disappointing was that Animal Health sales declined by 2.7 percent. Bayer's EBITDA before special items rose by 24.7%. EBIT after special items fell by 31.2% due to impairment losses in connection with the agreed divestment of our Dr. Scholl's foot care portfolio.

Here, too, the real estate transfer tax would be added. Given that BASF, Siemens and Bayer would have to pay the real estate transfer tax every 14 months on average, taxation would have had the following effects for Bayer:

Market cap Tax 3.5 % EAT without 3.5 % tax
EUR 56.475 billion EUR 2 billion EUR 1.8 billion

(Note: To get a realistic impression, I used the 2018 numbers for the analysis.)

A conservative calculation with a tax rate of 3.5 percent and a trading volume of 100 percent of market capitalization would result in a tax burden of almost EUR 2 billion for Bayer. In 2018, this would have destroyed all of the company's earnings (after taxes). This shows in particular what effect the tax could have, as it is not based on profit or turnover, but on the transaction value.

Performance

Overall and with the exception of Bayer, all three companies have performed well since the end of the financial crisis. In particular, dividend payments still have to be taken into account. Nevertheless, the growing problems are also reflected more and more in the performance of companies' shares.

Chart Data by YCharts

(Note: The grey area on the left of the charts is part of the great recession 2009).

Fundamental

With regard to the fundamental key figures, the three companies are valued fairly, especially Bayer. Possible convictions are essentially one-time charges. They will considerably hurt the profit for some years, but beyond that, it will have no further effect. This is particularly true because, apart from the general cyclical problems, business operations are running well. Bayer has a P/E ratio of about 8 and investors seem to have already priced in extremely high fines.

P/E ratio Yield Payout ratio
BASF 14.5 5.39 % 66.64 %
Siemens 14.1 3.97 % 28.12 %
Bayer 8.4 4.81 % 41 %

(Note for foreign investors: The German capital yields tax including solidarity surcharge withheld may be reduced under double taxation agreements existing between the Federal Republic of Germany and the respective state.)

Overall, the companies are very cyclical. In this respect, they are already relatively far away from their highs. Anti-cyclical investors could therefore have a chance of a return here. On the other hand, it should be keep in mind that macroeconomic developments may continue to weigh on the world trade. It is not yet possible to predict that the conflict with China will be resolved. Conflicts with Iran and North Korea persist. The existing escalation potential here could further weigh on the revenue in the nearer future.

Further procedure regarding the bill and expected time frame

After the bill is presented next week, the Bundestag will vote on its approval. After approval in the Bundestag, for which a simple majority is sufficient, the draft is submitted to the Federal Council. The federal Council can appeal against the law to the Mediation Committee within three weeks. All this can take many months. It cannot therefore be ruled out that the law may still be amended in accordance with a stock market clause. Investors must, however, continue to monitor developments closely. However, according to the bill, the new rules will already apply to transactions from 1 January 2020.

The problem with possible exceptions for companies such as BASF, Siemens and Bayer is that the more exceptions there are, the more loopholes there will be. However, the law is intended to close existing loopholes. The so called "zeitgeist" also speaks against stock companies. In Germany, there is no real support for stock companies in society. In particular, the companies Bayer (because of Monsanto) and now even Siemens (because of job cuts) have a bad reputation among the people in Germany. I therefore believe that it is not at all unlikely that the law will come.

Investor takeaway

According to the bill, the new rules will already apply to transactions from 1 January 2020. As shown above, this could result in immense tax burdens for globally active German companies like BASF, Siemens and Bayer. The effects of implementing the bill into law are too significant and the government's intention is too definite to allow companies and investors to be careless. Nevertheless, as a long term investor, I will keep my Siemens and Bayer shares for now. The actual implementation is not yet one hundred percent certain. The federal government is showing itself to be open to discussion. Long term, I expect that there will have to be a compensation or exemption system for large stock companies that are not active in the real estate sector.

As always, I look forward to discussing this with you in more depth in the commentary section.

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Disclosure: I am/we are long BAYZF, BAYRY, SIEGY, SMAWF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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