The poisoning of a powerhouse

From the courtrooms of rural West Virginia to the power stations of Germany's Ruhr valley, all the news about Europe's second largest engineering group is spectacularly bad.

Grim reports began filtering back to ABB's head office in Zurich from its operations around the world in September but took a few weeks to sink in. In the US, the company had lost its last chance to control spiralling asbestos compensation costs. In crucial market such as power equipment, customers had failed to return after the summer lull, putting billions of dollars of infrastructure spending on hold. When senior management came clean with already nervous investors on Monday, the backlash was sudden and severe.

The engineering downturnCustomers tightened their belts, and ABB groaned.Read

ABB has been pitched into a liquidity crisis and downward spiral of confidence from which many fear it may never recover. Its share price halved on Tuesday; its bonds traded for as little as 45 per cent of face value - a sure sign that many investors believe some form of debt default is inevitable.

The Swiss-Swedish giant, once admired as Europe's answer to General Electric, has admitted it will probably seek bankruptcy protection for Combustion Engineering, a US subsidiary at the centre of the asbestos crisis. But the big fear is that lawyers will simply target the parent company instead and force ABB group to seek similar protection from its creditors.

If asbestos liabilities do overwhelm the already weakened parent company, the repercussions will be far-reaching. Dozens of US industrial groups are already bankrupted by asbestos compensation claims: ABB would be the biggest yet - and the first in Europe.

ABB's difficulties extend far beyond its asbestos liabilities, however. Last autumn Percy Barnevik and Göran Lindahl, two previous chief executives, were forced to hand back part of SFr233m ($154m) worth of severance packages that had been awarded in almost complete secrecy. Potentially more serious corporate governance issues emerged with the profits warning that Jürgen Dormann, the current chief executive, delivered on Monday. Only five weeks earlier, he had insisted that group operating performance was healthy. That change of message has done much to undermine ABB's credibility.

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On Tuesday Mr Dormann was bullish about the long-term future but unwilling to make specific forecasts. Since taking over as chief executive, he revealed, many managers had been exaggerating the performance of their divisions to hide problems - making it hard to trust internal reporting processes. "I am not promising anything short term because the issues are too numerous," he said. "I have to change the culture, especially to encourage more openness and transparency internally, and this makes me cautious [about making promises].

Mr Dormann apologised for misleading investors with his previous comments and failing to alert them earlier to the problems facing ABB. "This warning came too late and I have no problem in admitting that I perhaps should not have said anything just eight days into the job," he added. "You gain experience in times like this and I hope people will understand."

Some suspect, however, that Mr Dormann is trying to shift the blame for problems he must have known about. Although he took over as chief executive only in September, he had been chairman for nearly a year.

"Mr Dormann's comments this week [about the scale of the problems facing ABB] were surprising," says Gideon Franklin, an analyst at Morgan Stanley. "They were consistent with what you might expect from someone who has just come into the company, rather than from a person who had been chairman for a considerable time."

Either way, the shattered credibility of ABB's reporting procedures has led to a collapse in investor confidence. "ABB as a company is finished," says one banker. "There might be parts that survive . . . but my view is that the company as such is gone".

Traditional financial ratios may no longer be reliable indicators of ABB's stability. Sentiment is more likely to determine the company's future: big customers will require reassurance and cash guarantees before agreeing to new contracts. "It is a black box meltdown in many respects," says Simon Marshall-Lockyer of Cheuvreux, a Zurich research house.

Crucial to ABB's prospects is whether it can put into place long-term bank financing in the coming months. Estimates differ but it is expected to need bank facilities worth about $2bn to ensure adequate liquidity.

Behind Monday's plunge in ABB's bond prices is a concern that the company may lose its investment grade ratings and even default on its debt. "ABB needs a committed bank line," says John Scoffin, analyst at Barclays Capital. "Its profit warning and the equity sell-off won't help its negotiations with banks and there has to be an increasing question over whether ABB can get unsecured finance."

Moody's Investors Service has reduced ABB's senior debt ratings to Baa3, the lowest investment grade rating, and warned it may cut further. To maintain its investment grade rating, Moody's said, ABB would have to present "a convincing plan to achieve sustained improvements to operating cash flows and a successful execution of ABB's refinancing strategy".

Moody's said debt maturing over the next 12 months added up to $3.7bn but did not break down that total into bonds and bank loans.

ABB reports third-quarter results tomorrow. Monday's earnings warning and announcement of increased asbestos claims were accompanied by reassurances that its $1.5bn debt reduction target would be met. But bond investors are waiting to receive further guidance on free cash generation.

This year ABB set up a $3bn bank facility via Barclays Bank, Citigroup and Credit Suisse, of which $1bn is outstanding. This is due to be repaid in December from proceeds of ABB's sale of its structured finance business.

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ABB may be able to extend the maturity of the $1bn loan by a few months if the proceeds from the $2.3bn sale of its structured finance division to General Electric do not arrive by December. The deal is awaiting European Union antitrust approval. But a fresh, longer-term debt facility would require separate negotiations.

Any future refinancing is likely to be overshadowed by ABB's damaged credibility: this week's profits warning came just six weeks after earnings targets were reaffirmed.

"Whichever way we look at the numbers, it looks as if ABB will have sufficient cash to cover its debts due next year," says Karl Bergqwist, head of credit research at Gartmore Investment Management. "However, the company has a history of relentless disappointments and investors just don't know if they can trust the numbers any more."

More sympathetic analysts maintain the risk of collapse is overstated. According to Mr Marshall-Lockyer of Cheuvreux, ABB can escape a short-term liquidity problem provided it completes the sale of its structured finance business on time. He worries, however, about the deterioration in the terms of trade with big customers and suppliers. Mr Dormann is a "tremendous crisis manager who is out to save the company. You need that sort of pugnacious character to be able to deal with this type of crisis," he adds.

Others fear the delicate debt negotiations and restructuring will be swept away by continuing asbestos liabilities. ABB sought bankruptcy protection for Combustion Engineering after the US subsidiary failed to block a new wave of compensation claims in the Supreme Court. Facing a huge trial in West Virginia involving 250 cases and 8,000 claimants, it chose to settle out of court and then try to ring-fence the parent company.

Yet few lawyers believe this tactic will succeed. "Any resolution, including splitting off companies, ultimately may not be effective as long as states like West Virginia can hear cases from all over the country," says Walter Dellinger, of O'Melveny and Myers, who recently represented companies appealing to the US Supreme Court.

Pierre Tissot, a veteran ABB watcher at Geneva's Lombard Odier Darier Hentsch, says putting Combustion Engineering into Chapter 11 could make it difficult for ABB to continue operating in the US, where it has 14,000 staff in other businesses. But, he adds: "We do not think it will bring ABB down."

The fact that such a question is even being entertained is humbling. Mr Dormann, 62, the fourth ABB chief executive in little more than five years, arrived at the company with a tremendous reputation a proven record in shaking up slumbering European industrial giants.

He dismantled Germany's Hoechst, once the world's biggest chemicals company, floated off its Celanese chemicals business and then merged the remaining pharmaceuticals business with France's Rhône-Poulenc to create Aventis, one of Europe's fastest-growing pharma companies.

On Tuesday he was putting on a brave face despite obvious regrets about the performance of his fellow managers. "ABB will not go bust," he insisted to investors. "[Recovery] is going to take us a little bit longer. I really have to sort out what is wishful thinking and what is reality."

<em>Additional reporting by Aline van Duyn, David Firn and Tobias Buck</em>

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Customers tightened their belts, and ABB groanedBy Peter Marsh

ABB's warning comes during a gruelling year for its customers in Europe. According to projections to be released later this week by Orgalime, a Brussels-based trade association, capital spending by engineering groups on the continent - some of which buy ABB's equipment - will fall 4.5 per cent in 2002. That is far more than the 2.7 per cent drop the organisation forecast six months ago and the biggest year-on-year decline in a decade.

The poor business climate has been evident for some time to many of ABB's rivals in the global automation business, which has annual sales of $100bn. Rick Haythornthwaite, chief executive of Invensys, a London-based group that competes with ABB, said this month that demand was "flat and fragile" and warned that no substantial recovery was likely before 2004. Executives at Siemens of Germany, France's Schneider and Emerson of the US have also been aware of the worsening market conditions.

Did Jurgen Dormann underestimate the scope of the downturn? Analysts were puzzled on Tuesday as to why ABB's chief executive gave a relatively upbeat view about the company as recently as mid-September. "It is remarkable that the company changed its position [on the business environment] so significantly in just one month," said Gideon Franklin of Morgan Stanley.

Many of ABB's customers in the manufacturing and energy sectors have also pared spending on capital equipment this year. Their decisions reflect concerns about overcapacity and a common realisation that an upturn in the world economy - which many expected later this year - is almost certain to be delayed.

RWE, the German electricity utility, is cutting back on the kind of products and services that ABB has to offer. "The market for building new power stations has collapsed over recent years; the market is saturated," it says. Carmakers - traditionally big purchasers of automation equipment - are spending less on new plants. Although investments by some component makers in specific, fast-growing fields such as electronic brake systems have held up, the mood among suppliers of equipment to the industry is downbeat.

"There is no indication of a substantial economic recovery," says Stephan Rojahn, who has been named chief executive of Dürr, a Stuttgart- based company, the world's biggest maker of paint systems for car plants.

BASF and Bayer of Germany, Europe's largest chemical groups, and Eon, the German utility, are also heavily cutting spending.

More encouragingly, oil and gas companies continue to spend. BP is spending $12bn-$13bn this year and expects to keep the level the same next year - abo ve the figure in the late 1990s.

But these companies are likely to remain in the minority. Until there are clear signs of a global economic recovery, many of ABB's customers will continue to spend cautiously, if at all.

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