First Europe Gave Us Airbus, Now Railbus

(Bloomberg Gadfly) -- First Europe gave us Airbus, now “Railbus”?

On Tuesday, Siemens AG and Alstom SA are expected to sign off on a merger of their rail equipment activities to create a new European champion, according to Bloomberg News. A deal has appeal for the German and French companies' shareholders but governance, antitrust and cost-cutting could yet disrupt the journey.

While a combined entity would control only about 14 percent of the 110 billion euro ($130 billion) rail equipment market, according to my rough calculation,  the footprint would be bigger in parts of Europe.

So will Europe's antitrust authorities block it? That depends. After the 2015 merger of two Chinese rolling stock companies, the new entity CRRC Corp. dwarfs its international peers.

CRRC has won rail contracts as far afield as Chicago and Kenya and China's Belt and Road initiative will bring yet more international business its way. The fear is that the Chinese company's size plus access to cheap finance will let it crush rivals unless they bulk up too. In absolute terms, CRRC spends seven times more on R&D than Alstom, notes Morgan Stanley.

But it isn't unbeatable, at least not yet. International customers accounted for only 8 percent of CRRC sales last year, when its railway equipment sales declined. The Alstom and Siemens train businesses have performed quite well in the meantime, as rapid urbanization spurs demand for less polluting mass transit.

So why risk a big cross-border merger? Unsurprisingly, Siemens isn't wedded to its comparatively low margin rolling-stock business : the unit does lots of manufacturing in high-cost Germany, while rail companies regularly suffer delays and cost overruns on long projects. CEO Joe Kaeser has form in unlocking value via spinoffs and separate listings, so folding the business into Alstom is worth a shot.

The French company has a big and globally diverse order book, very little debt and is poised for a 2.5 billion euro cash injection related to the sale of its energy activities to General Electric Co.  

A merger is appealing to Alstom too. First, there's the risk that Siemens could do a deal with Bombardier Inc. instead. Plus Siemens's rail business is more profitable than Alstom's because it sells more high-tech signalling and rail automation products. Siemens would contribute about 60 percent of a combined group's operating profit.

Alstom investors spy higher margins: the company has added almost 700 million euros of market value since Bloomberg reported the Siemens talks last week. A combined entity should spend proportionally less on R&D and will have a stronger hand in price negotiations with customers and suppliers -- although regulators might not like that.

Yet cutting production costs won't be easy. Last year, Alstom had to row back on job cuts at a French plant amid government and trade union pressure. Besides, rail companies are building factories overseas to win international contracts, while customers tend to want bespoke trains to fit their country's needs. This makes economies of scale difficult. Joining forces might also cause some customers to take their business elsewhere (so-called revenue dis-synergies).

Governance is a worry too. While Siemens would probably own slightly more than half of the combined entity, according to Bloomberg News, Alstom's CEO Henri Poupart-Lafarge will be in charge and the headquarters will be in France. The two companies haven't always got on.

Still, a merger would give Emmanuel Macron and Angela Merkel a prized example of European business cooperation. So, if regulators can be persuaded, this Railbus will no doubt roll on regardless.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

1. Based on data from Unife, a European rail industry association, cited in Alstom's annul report. The figure applies to markets western rail companies can access.

2. In Siemens tried to hand Alstom some of its rail business in exchange for the French group's turbine activities. General Electric won that battle.

3. Alstom still holds a put option on its remaining energy stakes, worth roughly billion euros, which accounts for about almost one third of the company's market capitalization. 

4. Depending on which business Siemens decides to inject into Alstom.

To contact the author of this story: Chris Bryant in Berlin at cbryant32@bloomberg.net.

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net.