Government Guarantees for Siemens Energy?
How a Leader became a Beggar and the Challenges Ahead
Key Points:
Siemens Energy is afflicted with profitability woes due to wind turbine quality issues and legacy contract losses.
It is at risk of losing its investment-grade credit rating, which would prevent it from winning lucrative gas contracts.
It is seeking government guarantees, but legal risks loom over the potential state aid.
Without aid, Siemens Energy may weaken, leading to a potential wind industry duopoly.
Recent reports suggest that Siemens Energy is seeking government guarantees from the German government in order to support its order backlog. The request for a €15 billion guarantee came after a credit rating downgrade and mounting warranty costs. Now, Siemens Energy finds itself at a crossroads, grappling with the immediate challenges of stabilizing the wind unit amidst the looming specter of eroding market confidence.
As the company considers the possibility of state aid, the implications stretch far beyond its own fate, potentially reshaping the renewable energy landscape. How did it come to this, and what does it mean for the industry going forward? To understand the current situation, let's examine the company's recent difficulties, their impact on its credit rating, and the challenges ahead.
A Merger That Fell Short
Siemens Gamesa (now a unit of Siemens Energy) was created through the 2017 merger between Siemens’ wind business and Gamesa, a Spanish wind turbine manufacturer. The merger was initially greeted with optimism, promising an "unrivalled global presence" and complementary strengths.
Despite the soaring order book, Siemens Gamesa has struggled to turn a profit (see Figure 1). Cost overruns and delays hampered profits in 2020, while supply chain disruptions and resulting cost escalations made it unprofitable to fulfill legacy orders in 2021 and 2022.
Source: Siemens Gamesa Annual Reports
Credit Rating Downgrade
Then came the announcement on 6 June of this year. Siemens Energy, the parent company of Siemens Gamesa, withdrew profit guidance for the year and disclosed product quality issues in relation to its 4.X and 5.X onshore wind platforms. The company initially estimated the costs associated with repairing the onshore turbines “in excess of €1 billion”, and also alerted the market to productivity challenges associated with ramping its offshore division.
Companies typically make provisions for product warranties to reflect their expectations of future repair costs during the warranty period. The warranty period for turbines is typically 2-5 years but could be as long as 8-9 years if the turbine operator also takes out a service contract. Since Siemens Energy had been having relatively stable provisions up to this point (see Figure 2), the disclosure over the product quality issues came as a surprise to the market.
Source: Siemens Gamesa Audited Consolidated Financial Statements
In July, S&P Global Ratings downgraded the credit rating of Siemens Energy one level from BBB to BBB- (the lowest investment-grade credit rating) in response to these issues. S&P noted that it could lower Siemens Energy’s credit rating further if it expected the company to:
Continue to generate negative cash flows.
Be unable to improve profit margins.
Fail to maintain current leverage ratios.
Costly Warranties and Loss-Making Legacy Orders
In August, Siemens Energy put the expected future expenses for repairing onshore wind turbines at €1.6 billion and announced an additional €0.6 billion in charges for order-related losses (i.e., fulfilling legacy orders at a loss) in its offshore wind division. This total of €2.2 billion in provisions is expected to be spent over the next two years. This implies probably around €1.1 billion in annual negative cash flows at Siemens Gamesa, in addition to other planned capital expenditures and baseline warranty spends of around €0.5 billion a year (see Figure 3).
Source: Siemens Gamesa Audited Consolidated Financial Statements
Further compounding the uncertainty is Bloomberg’s report last week that Siemens Energy is considering pivoting to developing a new onshore product instead of salvaging the 5.X turbine model. If confirmed, this would likely to cost another €1.0 billion in research and development spending over the next two years.
In summary, the publicly available figures suggest a total cash drain of about €2.1 billion a year, comprising:
€1.1 billion per year from fixing quality issues;
€0.5 billion per year for baseline repairs and provisions; and
€0.5 billion per year for developing a new onshore product.
Maintaining an Investment Grade Rating is Paramount
While Gamesa is losing cash, other parts of Siemens Energy (gas and power businesses) remain profitable and have generated over €1.6 billion in free cash flow for the first 9 months of fiscal year 2023 and will probably produce more than €2.0 billion for the full year. Nonetheless, the ongoing uncertainties over the wind business at Siemens Gamesa now make it unclear whether Siemens Energy could achieve:
positive cash flows in 2024 and 2025;
improved profit margins, and
current level of leverage ratios.
From this perspective, Siemens Energy faces the risk of a further credit rating downgrade below an investment-grade rating without external interventions. Further eroding confidence is the 26 October announcement that stated “…order intake and revenue are expected to be lower than market expectations for fiscal year 2024, and net losses and cash outflow are expected to be higher than market forecasts.”
Losing an investment-grade rating would make it challenging for Siemens Energy to compete for new projects. For example, a new gas-fired power plant project would likely require Siemens Energy to provide a performance bond as security against the performance of the gas turbines. The performance bond would have to be issued by an institution with an investment-grade rating (see Article 36 of this contract for example). It would be for a percentage amount of the cost of the turbines and would have to be valid during the warranty period or until all warranty claims are resolved.
This ensures that Siemens Energy is on the hook if it does not deliver gas turbines that perform to an agreed standard or, if Siemens Energy is not around, the bank that issues the performance bond will be on the hook for the damages. Issuing a performance bond against a sub-investment grade entity would probably trigger additional due diligence requirements. Some banks might have a policy to not issue performance bonds for companies without an investment-grade rating, severely restricting Siemens Energy’s ability to even enter a bid in the first place.
If the project is intended to be financed through project bonds, then the credit rating agency would also consider the credit rating of Siemens Energy when deliberating on the credit rating for the project. Figure 4 below shows S&P's framework for assessing counterparty dependency assessment rating. This is particularly important in cases where the project owner also intends to enter into a long-term maintenance and service agreement for the turbine. A service provider with a weak credit rating would effectively put a cap on the credit rating of the project, raising borrowing costs.
Figure 4: S&P Framework for Assigning Counterparty Dependency Assessment Rating
Source: Standard & Poor’s
These examples illustrate why losing an investment-grade rating would seriously impede Siemens Energy's ability to compete for gas and wind projects. Why choose Siemens and go through all the troubles when a comparable gas turbine from BBB-rated General Electric is available? Siemens Energy needs to secure high-margin gas projects to generate cash to support its struggling wind unit.
Government Guarantee and State Aid
Siemens Energy is requesting €15 billion in guarantees, with the first tranche being €10 billion, 80% guaranteed by the German government and the remaining 20% by commercial banks. Siemens AG will be asked to guarantee the second tranche of €5.0 billion. The guarantees are likely to be used to backstop commercial banks so that they are willing to issue Siemens Energy new performance bonds.
As discussed in my previous article, Articles 107 and 108 of the Treaty on the Functioning of the European Union (TFEU) pertain to regulations governing state resources (state aid) favoring domestic firms, with the aim of preventing competition distortions across the European Union. Enforcement of these state aid regulations ensures a level playing field for businesses within the EU. A guarantee by a government to a private company is a form of state aid and is therefore prohibited by the TFEU. This is unless all the following conditions apply:
The borrower is not already in financial difficulty (Siemens Energy is still investment grade);
The guarantee must be linked to a specific financial transaction, for a fixed maximum amount and limited in time (€10 billion for 2 years);
The guarantee does not cover more than 80% of the obligation (the 80% ratio for the first tranche is not a coincidence); and
A market price is paid for the guarantee.
Compliance with the fourth condition poses the greatest challenge in this case. The fact that Siemens Energy needs this guarantee in the first place suggests that it is struggling to get performance bonds issued at a price that would make it competitive against other competitors, or at all.
If the state guarantee is granted, Siemens Energy’s competitors could try to challenge the legality of the guarantee. Imagine you are Vestas with a BBB rating now competing to sell turbines against a competitor with an advantage of effectively having an AAA rating. Alternatively, you could be General Electric with a BBB rating competing to sell gas turbines. If the challenge is successful, then the German government would have to recover the benefits Siemens Energy derived due to the aid. The legal uncertainty would certainly be unhelpful for everyone.
Challenges Ahead
There are only three providers of wind turbines outside of China: Siemens Energy, Vestas, and General Electric. The cost of wind projects in the West has been rising (see my article about the recent UK offshore auction). Despite the legal risks, without government aid Siemens Energy may not have sufficient financial strength to invest in new wind turbines or taking new orders. Their withdrawal from the wind market would leave us with a duopoly - the reduced level of competition would further slow the needed cost reductions for future wind turbines.
The problem at Siemens Gamesa is a lesson for the renewable energy industry. Yes, we have to move at speed to achieve net zero, but moving fast and breaking things cannot be the motto for this industry. Mistakes cost market confidence and undermine public trust in the entire endeavor.
Superb analysis of Siemens-Gamesa's woes and what this debacle means for the company and the wider renewables industry.
Great, well-researched article! Thank you for providing relevant links such as the 2008 GE contract.