Future developments

Outlook

The real gross national product (GNP) of the developed industrial countries is likely to contract in 2009. Growth rates of the emerging markets will slow down perceptibly, but could still exceed 5 %. It remains to be seen whether the global efforts being undertaken to stabilize the finance sector and to stimulate investment will be sufficient to reduce the scale of the global economic downturn. If the wide range of measures already adopted fail to restore confidence in the financial markets, it is likely that a longer-term recession could take hold. The US economy and consumers will almost certainly suffer most from less favourable and more restrictive financial conditions. Reduced consumer confidence is also likely to have a negative impact on European economies. It is predicted, for example, that unemployment figures will rise in Germany for the first time since 2005. A further consequence of the economic downturn is that the drop in prices of raw materials seen in 2008 will continue.

In Europe, the addition of new air separation plants will successively reduce the proportion of products/materials bought in by Messer. Taking advantage of the new production capacities will not, however, revolve around a straight-forward volume strategy. More to the point, the objective will be to focus on profitable expansion of business with existing customers. We also see an enormous potential for demand in region such as South Eastern Europe where the current usage of industrial gases per person is not even one half of the level prevalent in Western Europe. This applies to all sectors, one good example being the steel processing industry in Turkey. Our investment in an air separation plant near to Istanbul is seen as an important step towards tapping the potential of this market and creating an even wider basis for strategic growth there. The Chinese market will continue to grow, even though our forecasts have become more modest than in recent years, reflecting the knock-on effects of the global economic downturn, especially on the steel and chemical industries.

With the contractual agreement not to use the Messer brand in Germany having expired in May 2008, the Messer Group now has a presence in almost all parts of Europe. The German company, Messer Industriegase GmbH, will use the strong brand awareness that still exists to strengthen its position on the Germany market. The two major on-site customers already gained in Siegen und Salzgitter provide a good base from which to grow.

As far as energy costs are concerned, we expect a perceptible reduction in costs as a consequence of our long-term procurement strategies and the economic downturn.

We will continue to forge successful alliances with our customers and business partners in order to sell our products and technologies.

In the medium-term forecasts for 2009 and 2010, we plan further organic sales revenue growth and, above all, a sustainable improvement in profitability. The start of operations of air separation plants in Spain and Bosnia-Herzegovina in 2008, the completion of plants in Germany, Poland, Rumania, Switzerland, Turkey and Vietnam in 2009 and the completion of one plant in France and of the second plant in Germany in 2010 will boost our product capacities at a sustainable level. This will also be complemented by the new CO₂ production plant that will be completed in Belgium at the beginning of 2010. The product bottlenecks experienced in the past and the resulting additional costs caused by buying-in products at higher prices (in some cases involving a certain dependence on competitors) will therefore be successively reduced. Transport costs can also be reduced and logistics further optimized by entering into swap contracts with competitors on terms that are normal for the industry. All of these factors will result in improved operating margins in the medium term.

Our forecasts for the main key performance indicators of the Messer Group for the financial years 2009 and 2010 are as follows:

 

Significant opportunities and risks affecting the future development of the Group

As an international supplier of industrial gases, the Messer Group is exposed to opportunities and risks which inevitably arise in connection with entrepreneurial activities. It is the task of all concerned to take advantage of opportunities when they arise, whilst at the same time ensuring that risk is kept to a minimum. Future earnings will depend both on the operating performance of the gases business and on the state of the economies in individual countries. The main risks which could be significant for the net assets, financial and earnings position of the Messer Group are as follows:

• The industrial gases business is subject to intense competition. The level of competition is increasing in conjunction with the process of globalization. This highly competitive environment could reduce Messer’s earnings and cash flows in the future.
• We supply a cross selection of industries and sectors (including steel, metal processing, chemicals, petrochemicals, food and beverages, healthcare and glass) on the basis of long-term contracts over periods of up to 15 years in Europe and up to 30 years in Asia. A significant reduction in market demand in any one of these key industries or sectors could adversely affect future operating results. However, the Messer Group’s revenues are not dependant to any significant degree on any single customer.
• The Messer Group operates globally, making it susceptible to local political, social and economic conditions and to the resulting risks arising in each market. Eastern European currencies have come under pressure in the wake of the financial crisis; exchange rate fluctuations have therefore gained even more importance.
• Expansion in various markets involves greater demands being placed on the Group’s infrastructure. We endeavour to avoid business interruptions for our customers through regular maintenance and monitoring of equipment. In the event of breakdowns or defects, emergency plans and instruments are in place to reduce the financial consequences of a business interruption at one of our customers. The Messer Group is currently expanding its supply structure to ensure that supplies to customers are safeguarded even in emergency situations.
• The reoccurrence of crisis situations within oil-producing countries, the growing demand for energy in emerging economies, particularly in China and India, give reason to believe that – notwithstanding the current recession – oil and energy prices will continue to rise in the long term with a corresponding impact on the prices of materials and primary products necessary for the Group’s business. Although Messer is often able to pass on cost increases partially to its customers, it is possible that price increases for energy could adversely affect the profitability of the Messer Group.
• We require funding to finance our growth and ambitious capital expenditure program. We are therefore dependant on the finance sector remaining stable and liquid.
• Messer is reliant on cash flows from operating activities to repay debt. This is dependent to a large extent on the ability to generate positive cash flows from operating activities.
• The Group has recognized goodwill in the consolidated balance sheet. The application of IAS 36 (i. e. the performance of impairment tests) could result in the requirement to recognize impairment losses on goodwill, if the business prospects of a group subsidiary deteriorate compared to the original date of measurement.
• Enterprises are confronted from time to time with allegations that they have infringed industrial rights or legal obligations that defective products have been supplied or that environmental protection laws have not been adhered to. Regardless of their prospects of success, this type of claim can result in very high defense costs. In cases like these, the Messer Group defends itself energetically with the support of both in-house and external experts.
• The importance of information technology for day-to-day work is constantly growing. Our IT center in Germany gives us the scope to create a modern and efficient infrastructure and to improve our business processes where necessary. This concentration does, however, mean that there is a greater risk of business interruption due to natural hazards or human error. In order to avoid these risks, the IT center has its own IT risk management system.
• The integration of new member states into the EU entails risk in that many previously state-run businesses will need to be privatized and restructured in accordance with EU and International Monetary Fund requirements. The number and scale of state grants could be drastically reduced, culminating is numerous closures and mergers in these countries, and an adverse impact on the Group’s net sales. In these circumstances, the downward pressure on selling prices would probably increase.
• Our international operations are subject to a wide range of country-specific environmental legislation and regulations in areas such as gas emissions, groundwater pollution, the use and treatment of dangerous substances as well as ground surveys and decontamination. This can give rise to liability risks in conjunction with either past or current operations. New environmental requirements, partially resulting from the adoption of EU directives in the new EU member states, necessitate that our existing environmental standards (which are already at a very high level) are brought into line with the new requirements. This may result in higher production costs and modifications to the production process. The financial year 2008 shows, however, that the implementation of stricter environmental regulations often results in a more efficient production process and a higher quality product.
• The sale of entities or business activities can result in retrospective risks for the Group. Whenever a risk is probable, appropriate provision is recognized in the consolidated financial statements.
• Economies have weakened all around the world in the wake of the financial crisis. The Messer Group is being affected to a different extent in the various countries involved and is observing developments very carefully. Programs have already been initiated and implemented to reduce costs and capital expenditure in order to count the potential impact of the financial and economic crisis. The potential future deterioration in the creditworthiness of our customers increases the risk of bed debts and even the discontinuation of joint projects. The structure of the Messer Group’s receivables is disclosed in the notes to the consolidated financial statements.

The risks presented above are not the only ones to which the Messer Group is exposed. Some risks, which have not yet been identified or which are not considered to be significant from today’s perspective could have an adverse impact on the Messer Group if general business or economic conditions were to change. At present, however, we do not see any significant macro-economic risks for the Messer Group. No risks were identified in 2008, either individually or in aggregate, which could have a material adverse impact on the going concern status of the Messer Group. No such risks are pending in the foreseeable future.

We see opportunities for the Messer Group in the balanced presence it enjoys in growth industries and dynamic markets. Our broad customer base and diversified product portfolio enable us to overcome a weaker economic phase without losing sight of our long-term objectives. The recession which has set in during the fourth quarter of 2008 caused energy prices to drop, a trend that is likely to continue. This will have a direct positive impact on our cost of sales and selling expenses. Tax rate reductions in a number of countries are reducing the Group’s tax expense. Some markets that are relevant for us continue to perform positively. This will result in ongoing demand for our products, thus creating the opportunity for a sustainable improvement in the performance of the Messer Group. Through investment, we have the opportunity to respond to tougher competition and to maintain our market position. We are taking advantage of the opportunities arising from internationalization – in particular in the light of positive developments on the emerging economies and the eastwards expansion of the EU – by purposefully expanding our facilities in these regions. This also enables us to engage in new markets with long-term growth potential. The investments we are making are helping us to strengthen our competitiveness. We are convinced that this is an important aspect of getting through the financial crisis. We are aware, however, that it is not easy to expand business during a time of economic crisis. The number of European and even globally valid standards requiring a more environmentally compatible approach is on the rise. The Messer Group supports this by pursuing a strategy of continuously developing new and innovative concepts (e. g. CO₂ recycling in conjunction with the current debate on climate change).

 

Risk management

Risk management is an important component of the decision-taking and business processes of the Messer Group. The management structure and reporting processes which are in place ensure that not only developments that could jeopardize its going-concern status are reported regularly and in good time to the relevant levels, but also that other developments which pose a threat to the achievement of short-term performance targets (such as EBITDA or cash flow) are reported. This allows management to initiate measures at an early stage to mitigate any business and/or financial risks. Risk managers have been designated at each of the subsidiaries with responsibility for ensuring the proper functioning of local reporting systems. Working together with local risk managers, the group risk manager prepares a risk report for the Messer Group as a whole at the start of each year which is discussed by the Executive Management and communicated to the Supervisory Board of the Messer Group in good time. Risk management is directed at safeguarding the going-concern status of group entities and increasing the value of the business.

Messer is adequately insured against potential claims or liability risks, to which it is exposed; these policies ensure that the financial impact can be kept within defined limits or completely avoided. The scale of insurance coverage is continuously optimized in response to the specific situation of Group companies.

Internal audits were performed at four Messer Group entities during the financial year 2008. This included testing compliance with corporate guidelines and sample testing of controls applied to vouchers within the various business processes, in order to check the effectiveness and commercial sense of processes as well as the accuracy and reliability of financial reporting. Critical issues were clarified and recommendations made to improve the transparency of business processes. Recommendations made by the Internal Audit department were prioritized and implemented before the end of the financial year. Messer Group entities will again be subject to regular internal audits in 2009, primarily in Western Europe.

The Group’s Safety, Health, Environment, Quality (SHEQ) departments continue to carry out audits and risk analyses in order to reduce the accident ratio even further.

State-of-the-art technologies are employed in the IT area in order to keep the risk from electronic data processing to a minimum. Unauthorized access to data and systems and a significant loss of data are virtually ruled out. The efficiency, operational availability and reliability of systems are constantly being monitored and improved. Messer’s security concept also includes a detailed emergency plan. In order to minimize risks, the various technologies employed by the Messer Group are regularly tested to ensure that IT-based business processes are safe.

Tax laws and competition regulations can also give rise to business risks. For this reason, the Group obtains a full range of advisory services from in-house and external experts.

 

Financial risks

Despite the prevailing adverse economic environment and potential drops in sales and earnings, we need to ensure that the Messer Group is at all times able to comply with the covenants contained in the Senior Facilities Agreements, Note Purchase and Guarantee Agreement. One of the principle covenants in this context is the Net debt / EBITDA Covenant. We have therefore initiated and implemented programs to reduce costs and capital expenditure in order to counter the potential negative impact of the financial and economic crisis and to ensure that we comply with the commitments made in the Senior Facilities Agreements, Note Purchase and Guarantee Agreement.

Financial risks can also arise for the Messer Group from changes in exchange and interest rates.

The management of interest rate, currency and liquidity risks is carried out by Group Treasury based on guidelines laid down by management. Group Treasury identifies, measures and hedges these financial risks. Treasury guidelines contain general risk management principles and specific rules for defined areas such as the exchange rate risk, interest rate risk, the use of derivative financial instru-ments and the investment of surplus cash.

Income and operating cash flows are, to a large extent, unrelated to market interest rates, since the Group does not hold any significant interest-bearing assets. Loans or credits subject to variable interest rates are hedged partly with the aid of interest rate swaps (cash flow hedges of future interest payments). Under these arrangements, loans with variable interest rates are converted in substance to ones with fixed rates. In conjunction with the interest rate swaps, the difference between fixed interest rates and variable interest rates is settled at specified intervals (computed by reference to an agreed amount). At the balance sheet date, derivative financial instruments had only been entered into with renowned international financial institutions. In view of these measures, an exchange rate and interest rate change risk are regarded as minimal.

Management considers, as a result of the overall assessment of the risk situation, that risks are limited and manageable and that they do not endanger the Messer Group’s going concern status.

 

Events after the reporting period

Messer Group GmbH, as borrower, concluded a new, Senior Facilities Agreement for an amount of € 100 million (SFA II) on January 19, 2009. The new credit is equal in rank (pari passu) to the existing Senior Facilities Agreement (SFA I) / Note Purchase and Guarantee Agreement (NPA). The lenders are banks that are party to the existing Senior Facilities Agreement. All amounts outstanding in connection with the SFA II, together with any amounts still outstanding under the SFA I, are repayable on February 2, 2012. The terms and conditions of the SFA II are, in most respects, identical with those of the SFA I. The principal differences are:

• the initial margin of the SFA II is 1.5 % p. a. The agreement includes a mechanism to adjust the margin based on the change in the net debt/EBITDA ratio of the Messer Group (consolidated).
• The SFA II is unsecured whereas the SFA I (and the NPA) are secured by guarantees and shares pledged as collateral. The existing collateral remains in place for the SFA I / NPA arrangements and are not available to the lenders under the terms of the SFA II.

On February 27, 2009, ASCO Kohlensäure AG, Switzerland, acquired a majority shareholding in ASCO Carbon Dioxide SARL, France. This latter entity manufactured dry-ice-making equipment which is sold by ASCO Kohlensäure AG. The Purchase Agreement provides for the remaining shares to be transferred, subject to conditions precedent, with effect from September 30, 2010. For this reason the Company will be consolidated as a 100 % subsidiary with effect from February 27, 2009.

In February 2009, Messer concluded a cooperation agreement with the Chinese steel manufacturer, Panzhihua Iron & Steel (part of the Pangang Group) relating to the acquisition of four existing air separation plants and the construction of three new ones in the Chinese province of Sichuan. Messer holds a 60 % interest in the joint venture which will be investing in excess of € 100 million in the plants referred to. This move clearly underlines Messer’s long-term commitment to the Chinese industrial gases market. From today’s perspective, the arrangements will fulfil the criteria for a lease as stipulated by IFRIC 4. For this reason revenues will be recognized from the date on which the lease arrangements commence on the basis of the present value of the minimum lease payments.

Messer Danmark A/S, Denmark sold the cylinder business (along with 4,000 gas cylinders, its customer base and existing receivables) on March 4, 2009 with effect from April 1, 2009.

Our thanks to Messer employees

Management would like to express its gratitude to all employees for their loyalty, commitment and personnel efforts during the financial year 2008. Your commitment has made a vital contribution to Messer’s success in 2008. Despite the financial and economic crisis, it is not intended to lay off staff as part of our current programs to reduce cost and make capital expenditure savings. We firmly believe that this approach will best serve the interests of the business as the Messer Group continues to grow.

 

The management of Messer Group GmbH has fairly presented the business performance, the results of operations and financial condition of the Messer Group to the best of its knowledge and has appropriately evaluated and described the opportunities and risks which are relevant for the future development of the Messer Group.

 

Sulzbach/Taunus, March 5, 2009


Messer Group GmbH