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All Bets Are Off With TKMS

Summary

Investors and observers are puzzled with what to make of TKMS and its foggy future.

Rumors of a sale of its marine division are yet to be confirmed, with no saying of how successful the operation would be.

But before addressing the future, the German manufacturer needs to deal with the recent past, in which several scandals, political and industrial, have erupted.

No one knows where TKMS isgoing, least of all TKMS, and the current instability is revealing areas ofvulnerability.

TKMS, the ThyssenKrupp subsidiary in charge of shipbuilding, had, throughout the years, built itself a reputation for impeccable quality, and ethical conduct on the global market. As such, it was seen as a German national symbol, and a safe vehicle for investors around the world, with products rolling out with standards equal to the rest of Germany’s luxurious and robust industry. As recently as 2013, TKMS had won the Singapore contract, and made clients happy. “German submarines are like BMWs, so we are very glad we decided on this class of submarine”, said Singapore official Cheong. But the future of the company has taken a turn for the worse in recent years, with allegations of corruption, falling standards and heavy losses in economic performance, leading investors to take a step back, in a wait-and-see position. Handelsblatt reporter Martin Murphy writes: “Special payments were made in connection with submarine deals with Turkey, South Korea, Pakistan and Indonesia. A court in Munich convicted two managers of corruption-related charges in sub sales to Greece in December 2011”, before another scandal broke out in Israel.

A few months ago, TKMS lost the tender for the Australian submarine-replacement contract, for having overstepped the financial envelope, by a very large margin, showing cracks in TKMS’s reputation for economic performance. Defense specialist Phillip Tarrant says The cost tendered by German SEA 1000 Future Submarine bidder ThyssenKrupp Marine Systems (TKMS) was revealed in the Senate this week, showing a disparity of $30 billion compared with Naval Group’s proposition, which secured the contract to replace Australia’s Collins Class submarines. Centre Alliance senator Rex Patrick released the TKMS cost details, furnishing a letter from TKMS sent to Defence Minister Marise Payne reaffirming a previously made offer of "a fixed maximum cost of no more than $AU20 billion for the project" with all 12 submarines to be built in Australia.” Should this suspected trend be confirmed, the German shipbuilder’s worth on the market will plummet. ThyssenKrupp’s yearly financial statements highlight the under-performance of the submarine division: “Adjusted EBIT at Industrial Solutions was significantly lower year-on-year due to weak order intake in previous years, partial underutilization and low earnings contributions from Marine Systems. Marine Systems and the chemical plant engineering business recorded a substantial temporary decline in margin and earnings. Adjusted EBIT margin at Industrial Solutions came to 2.0% overall in the reporting year, well below the target range of 6 to 7%".

TKMS had already taken a major blow to its image for quality last year, when maintenance and reliability problems called all six submarines of the German fleet back to the shipyards, simply depriving the country of a submarine fleet. TKMS simply painted itself into a corner: it reduced investments in its own investment-hungy activity, due to poor economic performance and large financial reserves to be squirrel away, likely in view of the corruption scandals it was bogged down in. Without these vital investments, the German shipyards were mechanically unable to line up with their competition in terms of quality, hence the case of F125 frigates, and the outright exclusion of the MK180 deal. “The German Navy’s six-strong fleet of submarines is completely out of commission after the only operational sub had an accident off the coast of Norway on Sunday”, said Defense News Sebastian Sprenger. “The submarine joins three ships already being overhauled at the Kiel shipyard. German military news service Augen Geradeaus, citing sea service data, reported that the U-31 will be in the yard until December, and the U-33 and U-36 are undergoing maintenance until February 2018 and May 2018, respectively. Additionally, the U-32 and U-34 are out of service and awaiting maintenance spots at the shipyard.” he added.

The slipping of TKMS has reached a scale which has led the Unions, traditionally allied to their companies in Germany, to openly blame TKMS management for the collapse of the company, causing investors to fear additional shockwaves, such as social unrest within the engineering firm. Maritime website HSN reported: “The trade union IG Metall Kueste attacked the federal government for being at least partially responsible for a “looming disaster” in the Germany shipbuilding industry. The trade union’s comments were made in response to reports that industrial conglomerate ThyssenKrupp was considering divesting its Kiel-based shipbuilding business ThyssenKrupp Marine Systems (TKMS) after being passed over in a public tender to build a series of new MKS 180 frigates for the German navy.” The German government had initially considered buying national, but then reconsidered, due to quality issues.

TKMS is also facing further uncertainty abroad in a new Israeli scandal. At the end of 2017, the Israeli government discovered evidence of deep corruption of one of its officials, Michael Ganor, by TKMS, thus compromising the entire contract. Globes reporter Assaf Oni writes: “Michael Ganor, the state witness in the submarines affair received about €10.2 million from German company ThyssenKrupp [...] The company is by no means certain that the deal for Israel to procure three more submarines, and which has been approved by a memorandum of understanding (MOU) between Israel and Germany last month, will actually go ahead. The doubt is due to a clause in the MoU requiring approval by Israel's Attorney General that the essence of the deal has not been tainted by corruption.” And, because military contracts are highly politicized, and TKMS deals mainly with governmental contracts, the Israeli scandal may further reduce TKMS’ ability to acquire other contracts.

Rumors float of a possible sale of TKMS to the highest bidder, if the company is too badly damaged to be fixed, or of a possible fusion with Swedish military contractor Saab - which had previously bought Kockums naval shipyards from TKMS. Here again, investors feel far too uncertain to make any move regarding the German shipbuilder. TKMS’s main shareholder, Cevian, is showing signs of eagerness at the idea of getting rid of its portfolio’s underperformers, namely TKMS and TK Steel: “There is now an urgent need and opportunity to address the significant and persistent underperformance of the industrial businesses”, writes Reuters. The recent resignation of Thyssenkrupp AG’s chief Heinrich Hiesinger does absolutely nothing to reassure other shareholders, observers, and clients.

Investors and observers are still to understand if there is a correlation between the loss of governance and the industrial standards slipping. And, if there is, which one was the cause of the other. If the root problem comes from governance, then investors will probably stay away from TKMS until a new CEO/Chairman is appointed. If the recent industrial failures led the company to overstep the red line in Israel in order to make up for recent losses, then the market will probably be contented if a new policy is designed. But even then, more heads will probably need to roll.