In the past, this question was a no-go. On several occasions, speculation about at least a sale of non-core business units was put on the table, but quickly buried again. Over time Deutsche Bahn has accumulated so much debt that its barely profitable core operations cannot handle these obligations. An eternal zombie existence on government life support is not a viable solution. And then there is the ambitious investment offensive to modernize and expand the existing rail infrastructure. Is it finally time to break up Deutsche Bahn?

Summary and key takeaways from today’s Weekly
– Deutsche Bahn has been for years the problem child not only of politics, but also of frustrated passengers.
– Changes are needed and more urgently than ever before. A high and growing debt load is crippling DB while at the same time ambitious new investments are envisioned.
– This is why also the board of Deutsche Bahn openly started to discuss a sale of DB’s crown jewel, DB Schenker. It could bring in an urgently needed cash injection and help to reset the lost focus.

Deutsche Bahn is one of the largest mobility providers and is best known for its (untimely) passenger rail services in Germany. It has become one of Germany’s permanent building sites with an ever increasing mountain of problems that is sinking more and more money.

In terms of size and revenue, it is even one of the largest companies of its kind in the world and in Germany the single biggest public employer.

But, it is more than that.

In short also known as “DB”, the company has a world-class logistics unit under its roof which keeps the Group somewhat on track. In fact, it is the crown jewel and the only really profitable part of the whole business.

However, the whole state-owned enterprise (SOE) is a capital intensive and heavily indebted business on government life support. An unsustainable mountain of debt, paired with a new investment offensive are too heavy weights to shoulder with the current corporate structure.

In the past, there were already discussions and proposals to reorganize DB. But they were blocked quickly, especially from the political side.

In the last months, however, the winds have changed.

What categorically has been impossible to even think about, is now openly on the table. Changes will have to be coming, soon.

What surprises me is that although DB is one of the largest employers in Germany (forth-largest as of 2021 with over 200,000 people in Germany, see here) and the overall direction being as clear as clean water, this topic has not been on the front pages so far. Sure, you find some reporting here and there, but neither radio nor television have mentioned this topic.

No problem, that’s what Financial Engineering is there for to investigate and report!

This latest episode of my Weeklies aims to bring clarity to all this confusion. We’ll take a look at DB’s history to better understand its evolution to the present. Likewise, we will check its finances. Then we will evaluate recent developments and conclude with a possible outcome.

The result is a new research report on a German Dax company that could buy DB’s most valuable business unit. This is a rather bold statement from me at the moment, but not completely absurd. Even if it doesn’t materialize, the company currently has an interesting valuation and an estimated dividend yield of 5%.

Fasten your seat belt and let’s go!

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Historical overview of Deutsche Bahn (DB)

for sources see here, here, here, here, here, and here.

for DB specific sources see here, here, here, here here here and here.

Deutsche Bahn is notoriously known in Germany for being too late and unreliable. Wouldn’t it be so sad and annoying for all the passengers that are dependent on its services, one could make jokes about it.

Actually, there is even a joke here (exaggerated, not based on factual numbers): “DB is on time in about 50% of cases – but only if you don’t count the trains that have not even left the train station!”

DB was created as a stock corporation in 1994 by merging West Germany’s Bundesbahn with East Germany’s Reichsbahn into what is known today as Deutsche Bahn DB. The company, however, never became public in the sense that its shares were IPO’ed on a stock exchange, although this was originally the goal.

From the beginning, the German government is the sole shareholder until today.

Several attempts to take Deutsche Bahn public at least in part – the last one in 2008 – have failed miserably.

Today, DB is a blown-up holding that operates several business units in the fields of railway infrastructure, energy as well as railway transportation of passengers and goods plus a logistics division with international operations. In fact, DB even has operations in more than 130 countries worldwide with over 700 entities.

A bureaucratic and uncontrollable monster.

Under the then-CEO Mehdorn from 1999–2009, DB changed its course and lost its focus. The new target was to build an international empire to increase the value of the whole conglomerate. He is said to have expressed: “Our market is not Germany. Our market is the world.”. With this, Mehdorn intended to make DB more attractive for a later sale or IPO of Deutsche Bahn – fully or in part.

Like in most cases, megalomania leads not to big empires, but big disasters.

This was the beginning of the end of Deutsche Bahn as it was known back then.

About ten billion EUR have been spent on acquisitions. The three most important:

• in 2002, DB bought the German logistics company Schenker for 2.5 bn. EUR. DB Schenker, after been a problem for years, is now not only the German and European market leader in rail freight transport (with a strong and growing presence elsewhere), but suddenly even DB’s crown jewel that especially gained steam in the last years.
• in 2006, 1.3 bn. EUR were spent on the buyout of Baxter Global, a US logistics company that increased Schenker’s reach under the roof of DB.
• DB expanded also into short-distance travel via trains and busses. British Arriva was bought for roughly 3 bn. EUR in 2010. A flop until today.

What about a hundred million EUR in Romania, half a billion EUR in Spain or half a billion EUR more in Poland?

Instead of taking care of a functioning basic operation of the German railroad, DB started several domestic mega-projects in parallel – “Stuttgart 21” (complete reorganization of the Stuttgart rail hub in South-Western Germany) being the most known and expensive billion EUR grave. It started in 2009 and is said to finally open in 2025, after several delays and of course cost overruns.

I wouldn’t be surprised, if it didn’t open before 2030.

With time, especially after the departure of CEO Mehdorn in 2009, criticism grew alongside the operating problems and results. Existing trains and infrastructure were neglected due to the big spending on new seemingly prestigious projects, the service level decreased and unreliability as well as unpunctuality became the hallmark.

Since about 2015 / 2016 there were several demands to reshape DB, slim it down and set the focus straight. In 2016 for example, the board of directors of DB itself openly proposed a separation from the at that time flopped acquisitions of DB Schenker as well as Arriva which were non-traditional businesses.

In 2015, Schenker was seen as a low-margin and low return on capital business, operating in a very competitive environment that could be sold for maybe 6–8 bn. EUR at best – in case it improved its results massively to catch up with competitors. However, only a partial 49% sale was more seriously evaluated, but later dismissed.

Arriva Group has operations in 14 European countries. Its core is the train and especially bus operation in the UK. In 2016, the sale process ended prematurely with UK’s vote to leave the EU and DB being afraid of realizing a lower price. In 2019 discussions emerged again.

If DB were able to sell Arriva today for about 4 bn. EUR, it would thankfully take it to pay down at least a small portion of the more than 30 bn. EUR in debt.

With time, DB accumulated not only more and more operations.

Likewise, the debt load increased. At the end of 2018, i.e. before the disrupting external forces of 2020–2022, DB had “only” net debt of 20 bn. EUR and nearly 25 bn. EUR including unfunded pension liabilities. At 30 June 2022, this numbers grew rapidly in only three and a half years to reach 32 bn. EUR, respectively 35 bn. EUR.

Unfortunately for DB, every year until 2031, at least 2 bn. EUR of debt become due:

Between the end of 2018 and 2021, revenues could only be increased by less than 10%. During 2022, operations were stronger again.

But the draught horse was the logistics business DB Schenker, not the passenger transports. Without it, DB would have posted an operating loss:

Being a capital intensive business by nature, the mistakes of the past will only require even more capital for the future:

• modernization of old trains and existing infrastructure
• increases of capacities (more new trains, more new connections needed)

The requirements for capital only increased.

At the same time, management – together with the government – are not tired of announcing new goals for the future. One such goal is to double passenger numbers by 2030 – good luck with that!

By 2030, Deutsche Bahn intends to spend a total of 170 bn. EUR or nearly 20 bn. EUR yearly on average, with more than half of the expenditures being reserved to modernize the existing infrastructure:

Ambitious and costly plans are facing high debt and weak operating results.

With a rough overview of the history, the current operations and future plans of Deutsche Bahn, let’s have a look at the most recent developments that should likely bring in more action.

And finally changes to Deutsche Bahn.

Recent developments and likely coming changes

For sources see here, here, here, here, here, here, here, here, here and here.

As we have seen, Deutsche Bahn is not profitable on a sustainable basis within its core operations and at the same time plagued by a high debt load. More so, since 2020 and 2021 massively harmed the financial side with billions of losses.

There is the schedule until 2031, where at least 2 bn. EUR every year are due for refinancing. This inevitably will increase borrowing costs dramatically within the now higher interest rate environment. Profitability on a sustainable basis will under these circumstances be far away, even if operations improve.

Whether wanted or not, DB has to raise a rather not insignificant amount of cash. The earlier, the better – although they rather seem not to be in a hurry, it would be wise to act sooner than later.

The only thing that seems safe to say is that kicking the can down the road becomes less likely the more time passes.

After the flopped attempts to publicly float shares of DB, several efforts to reorganize and break up the conglomerate have been made. One of the proposals circulating was and still is to separate Deutsche Bahn into a railway operator (passenger and freight transports) on one side and an infrastructure and energy company on the other side.

In its current form, critics say, private operators of passenger and freight transport are disadvantaged and inefficiencies are maintained, instead of solving them.

The German Monopoly Commission is an early advocate in this regard. Established in 1973, the commission is tasked with advising the German government primarily on competition law issues. Its members are allowed to publish their opinions openly, even if they don’t fit into the government’s plans.

The oldest idea is to separate the “DB Netze” division, which includes the rail infrastructure, the stations and the energy supply.

The remaining “DB transportation company” – the operating business – would together with competitors pay license fees to the independent infrastructure company for using its routes. Regional, long-distance and freight transport operations (DB Schenker) would remain under one own roof.

“DB Netze” shall, however, stay under federal control due to being critical infrastructure. The talk is about creating a so-called “public benefit oriented infrastructure division”. I couldn’t find a precise definition of what this exactly is, but it seems as if profitability won’t be a central element.

Usually governments do not nationalize companies because they are profitable, but rather to hide losses and inefficiencies as well as to claim that they have protected jobs in view of the next elections. For example, I wrote about the operator of French nuclear reactors, EdF, in my article about “Zombie companies – The Walking Dead?” (see here).

Until now, the crucial bottleneck has been the biggest block of the currently ruling three-party coalition, the SPD which is the equivalent to the labour parties in English speaking countries. It is no secret that they are afraid the most, because a separation would likely come with job losses – the core clientele of the SPD. But there are also two different labor unions – one supports the plans, the other categorically does not.

The SPD’s partners, however, the officially more business friendly FDP as well as the Greens – somewhat surprisingly – are in favor of a break up.

Especially the FDP is in favor of selling profitable as well as non-core assets to pay down debt and this way to free up capital for necessary investments. Plus, due to more competition (DB has a quasi-monopoly on long-distance transports), utilization rates could be improved and thus the railway network used more efficiently. This is the basic idea behind these proposals.

The European commission likely would welcome such a move, too.

These thought experiments have been making rounds for some years now.

More recently, a completely different proposal came to the surface. I am surprised that there are several sources reporting about it, but the topic in itself hasn’t created major waves until now.

Instead of breaking up DB into an infrastructure and an operator company, the more interesting and likewise more sensible solution is to sell what is now the crown jewel, its internationally operating freight transportation subsidiary DB Schenker.

Especially, as it was reporting record results and profitability while at the same time economic activity for this cyclical business is slowing down.

The FDP and the Greens do not see it as being a core operation of DB.

The federal minister for Digital Affairs and Transport, Volker Wissing, from the FDP, has said that an internationally operating business (Schenker) could be better off without (a more domestically focused) DB. And DB itself shall focus on its core tasks, especially its neglected infrastructure in Germany.

The undeniably stressful condition with more than 30 bn. EUR of debt (even slowly approving 40 bn. EUR) has left DB in its current form in a desolate as well as hopeless condition.

To really move the needle, something bigger has to happen.

Here DB Schenker comes into play. The once unloved and seemingly flopped acquisition has become the only really profitable part within the conglomerate.

After strong years 2020, 2021 and the first half of 2022, Schenker is accountable for around a third of total revenues within Deutsche Bahn. Its profitability also massively improved. In the first six months of 2022, Schenker made an operating profit of 1.2 bn. EUR – the deciding factor for DB to “have returned to profitability” as a whole.

Schenker, like other transport and logistics firms, has gained in value during the last three years.

First rather in secret, now more openly, concrete steps to prepare a potential sale or a listing of its logistics unit have been undertaken. Sooner than later is the time to strike in order to achieve the highest possible price for these precious assets.

Of course, there are some skeptical voices warning that “German silverware would be sold off”. The cash injection would only be a one time event and subsequent loss of Schenker’s profits would allegedly weaken the remaining business of DB.

I would rather see it this way: DB won’t be able anymore to hide behind Schenker.

Even the supervisory board of DB has started to openly discuss this step:

The key question to answer is, how much capital could such a move raise for DB?

Keep in mind that not only is DB not in a strong position for negotiations. Likewise, the slowing economy will put pressure on Schenker’s results. Time is ticking.

First estimates have been 15–20 bn. EUR – this sum could relief DB of half or even more of its debt. This number is of course dependent on the overall state of the economy and the business cycle. Realistically, 20 bn. EUR should be rather a too optimistic maximum and the best case for DB.

The lower boundary, however, could also be set a bit lower, should business turn sour. My personal guess would be somewhere in the ballpark of 12–15 bn. EUR. What I don’t know, however, is whether a complete or only a partial sale will be favored. But a complete sale hasn’t been ruled out anymore.

Potential buyers could be private equity or sovereign wealth funds that like infrastructure investments.

Schenker could also attract rival logistics companies.

For example, Danish DSV A/S (ISIN: DK0060079531, Ticker: DSV) with a market cap of around 35 bn. EUR, has already openly expressed its interest, in case the German government would give the green light. Swiss Kühne & Nagel (ISIN: CH0025238863, Ticker: KNIN) could likewise enter the game.

But there is one other potential bidder.

One of the potential prospects is a German Dax company. And this is were I personally see the highest probability, especially from the standpoint of national interests, a viable solution from a political perspective and to form a truly global champion from Germany.

DB Schenker operates freight transports by land, air and sea. Due to its global activities and particularly strong presence on the railways, it would be a perfect match for the German Dax company in question. But even without a successful acquisition, the underlying business is already strong.

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Conclusion

Deutsche Bahn has been for years the problem child not only of politics, but also of frustrated passengers.

The can could be kicked down the road until it couldn’t anymore. Changes are needed and more urgently than ever before. A high and growing debt load is crippling DB while at the same time ambitious new investments are envisioned.

This is why also the board of Deutsche Bahn openly started to discuss a sale of DB’s crown jewel, DB Schenker. It could bring in an urgently needed cash injection and help to reset the lost focus. Together with a potential sale of Arriva, Deutsche Bahn could raise around 20 bn. EUR.

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