TheChek News Flow

Germany to launch limited military service in push to be ‘war ready’

Increased Russian threat prompts move to a Swedish-style selective approach to army recruitment

Germany is to reintroduce a limited form of military service, though the plan falls far short of the defence ministry’s original goal of restoring the system of conscription scrapped 13 years ago.

“Everyone must ask themselves what they’d be prepared to do if we were attacked,” said defence minister Boris Pistorius on Wednesday. “The question is . . . how do we secure our civilian life if war breaks out?”

Russia’s invasion of Ukraine has prompted Germany to take a much more robust approach to defence, investing heavily in its armed forces and preparing to station an armoured brigade in Lithuania — its first permanent foreign deployment since the second world war.

Pistorius has said the Bundeswehr, the German armed forces, must be made “war ready” as concerns increase about Russian President Vladimir Putin’s aggressive intentions towards Nato, the western military alliance.

Defence ministry officials described the minister’s model, which borrows heavily from a system used by Sweden, as a “selective form of military service based on a voluntary principle but containing obligatory elements if necessary”.

Under the plan, men aged 18 will be required to fill out a form with information about their willingness and ability to serve in the army and then, if selected, to undergo a medical examination. Recruits will then be chosen from those tested.

But opposition politicians expressed disappointment with the proposal. “Considering the minister has been talking about [reintroducing] military service for nine months, the plans are pretty thin and vague,” said Serap Güler, the Christian Democrats’ spokesperson on defence.

Former chancellor Angela Merkel scrapped the military draft in 2011, but the Bundeswehr has since struggled to overcome persistent troop shortages.

The government has plans to increase the size of the army from 182,000 to 203,000 by 2031. But military officials believe it needs as many as 460,000 soldiers to defend Germany in the event of an attack.

Pistorius said his plan would lead to the recruitment of 200,000 reservists — in addition to the 60,000 the Bundeswehr currently has.

Of the 400,000 18-year-olds who would be approached by the Bundeswehr under his plan every year, he estimated about a quarter would likely express an interest in serving. Of these, 40,000 to 50,000 would be invited to undergo a medical examination.

“We will select the most motivated, the fittest and the most suitable,” Pistorius said.

He noted the Bundeswehr only had the capacity to train 5,000 additional recruits a year, though that number would rise in the coming years.

The armed forces had shrunk significantly since the end of the cold war, he said, leading to the divestment of barracks, munition dumps and military accommodation “on a massive scale”, he said.

Those who sign up will be offered six months of basic training which can be extended to a total of 23 months of service. Recruits will then become part of the reserve force, with an obligation to undergo annual training.

Pistorius’s more ambitious plans, including a scheme to bring back compulsory military service, encountered strong resistance from military chiefs, who were wary about an influx of raw, untrained young men, and leftwing politicians in his Social Democrat (SPD) party, who feel uneasy about Germany’s new focus on the military.

Chancellor Olaf Scholz, who like Pistorius is from the SPD, in May said he considered a return to a conscript army “unworkable”.

The ministry then shifted to a hybrid service model, which would not involve mass compulsory service but would instead be aimed at encouraging more voluntary participation. Pistorius was keen to emulate the kind of national service models used in many Scandinavian countries.

The Bundeswehr hopes the model will improve recruitment by identifying potential candidates and encouraging enrolment, through a range of incentives and training opportunities, in understaffed niche fields such as cyber security and medicine.

Innovation prize targeting urinary tract infections boosts effort to tackle pathogens that develop immunity to drugs

A 10-year challenge to find ways to combat the growing scourge of antibiotic resistant “superbugs” has yielded a new generation of diagnostic tests that offer rapid identification of infections. 

The £8mn Longitude Prize was awarded on Wednesday to Sysmex Astrego, a Swedish company whose method cuts the analysis time for urinary tract infection patient samples from two or three days to less than an hour.

The prize is a response to the increasing threat posed by antimicrobial resistance (AMR), or the evolution of pathogens to beat existing essential drugs. Countries are due to hold talks on tackling AMR on the sidelines of the annual UN General Assembly in September.

“Without antibiotics, modern medicine as we know it is in real danger of collapse,” said Dame Sally Davies, UK Special Envoy on AMR and a Longitude committee member. “The prize winner will help healthcare workers around the world make the best decisions for their patients with confidence that they are prescribing the right drug, first time.”

AMR, which has been stoked by the careless use and disposal of existing antibiotics, contributed to almost 5mn deaths worldwide in 2019, according to a 2022 study. Climate change is forecast to intensify its development, as higher temperatures speed bacterial growth and disasters such as flooding spread antibiotic-resistant pathogens.  

Sysmex Astrego has focused initially on urinary tract infections because they are so common, afflicting an estimated 50-60 per cent of women during their lifetimes. It is thought that up to half the bacteria that cause the conditions are resistant to one or more antibiotics.

Deploying technology from Sweden’s Uppsala university, Sysmex uses a smartphone-sized cartridge to analyse tiny samples of less than half a millilitre. Tests suggest it can detect a bacterial infection in 15 minutes and identify the right antibiotic to treat it in 45. Like other emerging technologies up for the Longitude AMR prize, it has potential to be developed to detect other kinds of infection.

Sysmex’s system is on the market in Europe and being considered by UK regulators for adoption in the country’s National Health Service.

Mikael Olsson, Sysmex’s co-founder and chief executive, said the company’s goal was “to be able to roll this technology to as many parts of the world as possible”. It costs about €4,750 for the analysis equipment and €29 per cartridge test, but Sysmex hopes more sales of the product will enable it to scale up manufacturing and reduce prices.

“[The set-up] is very user friendly,” Olsson said. “It’s just plug and play and quite small compared to a lot of the lab systems — so it should be applicable in quite a lot of different settings.”

Another Longitude Prize contender, made by British company Llusern Scientific, aims to ease the problem of antibiotics being prescribed even when no infection is present. It can rapidly confirm the presence of the six most common pathogens that cause 85 per cent of urinary tract infections.

Emma Hayhurst, Llusern’s co-founder and chief executive, said the company had been in talks about licensing production of the technology to Indian manufacturers. She said AMR was “pretty terrifying” but welcomed the renewed focus on it after the Covid-19 pandemic.

“It’s obviously on people’s agenda but there are still some chronic misunderstandings about what it is and what the impact will be on us,” she said. “But I do think governments are beginning to take it seriously.”

The Longitude Prize is funded by Innovate UK, a government agency, and Nesta, a British foundation that works in areas such as health, climate and education. India’s Biotechnology Industry Research Assistance Council and pharmaceutical companies including UK-based GSK and Merck & Co of the US provided funding for entrants’ international development efforts.

Energy watchdog forecasts spare pumping capacity to rise as demand growth wanes and supplies surge

Global oil markets are headed toward a major glut this decade, a global energy watchdog forecast, citing surging supplies and slowing demand growth for crude thanks to lower-emissions energy sources.

The International Energy Agency, whose members include the world’s biggest oil consumers, predicted in its closely watched medium-term oil market report that so-called spare capacity—the amount of pumping capacity left unused because of adequate supply—could surge in coming years to levels only seen during the Covid-19 pandemic.

Oil-demand growth is set to peak by 2029 and start to contract the next year, reaching 105.4 million barrels a day in 2030 as the rollout of clean-energy technologies accelerates, according to the Paris-based organization. Meanwhile, oil-production capacity is set to increase to nearly 113.8 million barrels a day, driven by producers in the U.S. and the Americas.

“This would result in levels of spare capacity never seen before other than at the height of the Covid-19 lockdowns in 2020,” the IEA said on Wednesday. “Such a massive oil production buffer could usher in a lower oil price environment, posing tough challenges for producers in the U.S. shale patch and the OPEC+ bloc.”

Despite the slowdown, global oil demand in 2030 is still forecast to rise by 3.2 million barrels a day from 2023, the agency said. The increase will be driven by strong demand from economies in Asia, particularly in India and China. But rising electric-car sales, fuel-efficiency improvements and the use of renewables for electricity generation will increasingly offset gains.

In advanced economies, demand is forecast to fall from around 45.7 million barrels per day in 2023 to 42.7 million barrels per day in 2030. Excluding the pandemic, the last time that oil demand was that low was in 1991, according to the IEA.

Meanwhile, global production capacity growth will be led by producers outside of the OPEC+ alliance—particularly the U.S., Brazil, Canada, Argentina and Guyana—which are forecast to account for three quarters of the expected increase to 2030.

OPEC+ oil-production capacity is forecast to grow by 1.4 million barrels a day from 2023 through 2030, led by Saudi Arabia, the United Arab Emirates and Iraq. According to the IEA, the group’s total oil market share dropped to 48.5% this year—the lowest since the alliance was formed in 2016—due to its voluntary output curbs.

The IEA cited various risks to its demand forecast, including economic growth estimates, the trajectory of oil prices and the pace of adoption of electric vehicles worldwide.

In the short term, the agency cut its forecast for global oil-demand growth to 960,000 barrels a day this year from previous estimates of 1.1 million barrels a day, as weak deliveries in OECD countries pushed global demand in a narrow contraction in March.

Oil-demand growth for next year is now forecast at 1 million barrels a day, down from 1.2 million barrels a day previously, on lackluster economic growth, the increasing use of electric vehicles and efficiency gains. Total demand is expected to reach an average of 103.2 million barrels a day in 2024 and 104.2 million barrels a day in 2025.

Wednesday’s reports came as Brent crude trades around $82 a barrel, while West Texas Intermediate is around $78 a barrel. Both benchmarks rallied about 3% earlier this week as traders seem to be buying on the back of a dip following an oil selloff sparked by OPEC+’s plan to unwind some of its production cuts.

Prices are supported by expectations that summer fuel demand and output curbs from OPEC+ will lead to a sizable deficit in the third quarter. Bearish sentiment continues to dominate the market, with prospects of higher-for-longer interest rates in the U.S. damping the commodity’s demand outlook.

The agency’s projections remain well below OPEC’s. The cartel forecasts global oil-demand growth of 2.2 million barrels a day this year and 1.8 million barrels a day in 2025.

Total oil supply is now expected to be higher, reaching an average of 102.9 million barrels a day this year and 104.7 million barrels a day the next from previous expectations of 102.7 million barrels a day and 104.5 million barrels a day, respectively, the IEA said. Non-OPEC+ countries are still set to lead global supply, the agency said, with production expected to grow by 1.4 million barrels a day in 2024 and 1.5 million barrels a day in 2025.

OPEC+ production is forecast to fall 740,000 barrels a day this year if the group keeps its voluntary output cuts in place, and to flip to a growth of 320,000 barrels a day the next. The cartel and its allies agreed to extend voluntary curbs of 2.2 million barrels a day to the end of September and said they aim to gradually unwind them from October 2024 to September 2025, contingent on market conditions.

Meanwhile, Russian crude exports rose by 100,000 barrels a day in May to 7.7 million barrels a day, while export revenue fell 0.6% compared with the previous month to $16.8 billion, the IEA said. Russia’s oil production is expected to decrease by 260,000 barrels a day this year to 10.7 million barrels a day as the country carries out deeper OPEC+ production cuts, but supply is forecast to remain broadly steady through 2030 supported by the Vostok Oil project in the Arctic.

Argentina loses appeal over $1.5bn payment to hedge funds

Ruling is setback for Javier Milei’s cash-strapped government as it faces series of cases brought by former foreign investors

A London court has rejected Argentina’s appeal on a ruling that left it facing a $1.5bn payment to four hedge funds who bought its GDP-linked securities, in a blow to the cash-strapped government of libertarian President Javier Milei.

In 2013, Argentina changed the way it calculates GDP, which it argued meant it did not need to pay interest on the euro-denominated securities — issued between 2005 and 2010 as part of a debt restructuring — which were tied to GDP growth.

Palladian Partners, HBK Master Fund, Hirsh Group and Virtual Emerald International Limited, which hold about 48 per cent of the securities and which like many emerging market bonds are governed by English law — brought a case against Argentina in 2019 asking to be compensated for their losses and the court ruled in their favour in 2023.

Argentina’s economy is in the depths of a severe economic crisis, with inflation running close to 300 per cent, foreign exchange reserves dangerously low and billions of dollars in payments to foreign creditors looming. The country’s lawyers had argued that paying the hedge funds would affect its ability to service its other debts and cause “harm to the people of Argentina”.

Buenos Aires has faced a series of legal challenges from former investors, including several dating to the 2007-2015 government of leftist president Cristina Fernández de Kirchner. Last year, a New York court ruled that Argentina was liable to pay $16bn to two former shareholders of state energy company YPF, which was renationalised in 2012 — the largest-ever ruling against a sovereign in a New York court.

Sebastián Maril, a director at consultancy Latam Advisors who has followed Argentina’s overseas litigation closely, said that Wednesday’s ruling was “proof that Argentina’s legal strategy is not working”.

“We have almost always lost these cases, and continuing to appeal and delay is throwing money away and allowing interests and legal costs to build,” he said.

In April, a New York court ruled against plaintiffs in a similar case relating to Argentina’s dollar-denominated GDP-linked securities, saying they had not complied with steps for bringing such a case laid out in the bond contracts. The plaintiffs are appealing.

Earlier this year, as a condition of its appeal Argentina deposited €310mn to be held in escrow pending the London court’s ruling.

It is unlikely that Argentina will be able to pay the full judgment — worth €1.33bn plus interest — in the short term. Its foreign reserves, excluding liabilities, are hovering around zero, even after a months-long push by the new government to build them up.

“The government should sit down with all of its judgment creditors to negotiate a macro deal with them,” said Maril. “Not to pay now, because it’s very difficult to do so, but to agree on a timeline to pay in the future.”

Green party unveils £50bn wealth tax in pitch to disenchanted Labour voters

Anyone with assets above £10mn would face new levy to fund housing and eco policies

The Green party has pledged to impose a dedicated wealth tax on the most well-off to invest in health, housing and a decarbonised economy, as it seeks to capture the imagination of disenchanted Labour voters.

The party on Wednesday said it would introduce a wealth tax of 1 per cent on people with assets above £10mn, and 2 per cent on those with assets of more than £1bn, as well as aligning the rates of capital gains tax with income tax rates.

It also said it would charge the basic 8 per cent rate of national insurance contributions on the upper earnings limit, up from 2 per cent today, which it estimated would impact only 5mn people in the UK. 

These changes would raise between £50bn and £70bn per year in 2024 prices, the party said. It said it would raise up to £80bn from a carbon tax to be set initially at £120 per tonne of carbon emitted, while adding that it was “prepared to borrow to invest” further. 

“Our manifesto is based on investing to mend broken Britain and offer real hope and real change,” Carla Denyer, co-leader of the party, said at the party’s manifesto launch in Brighton on Wednesday. 

“At the heart of this would be a tax on the very richest, the top 1 per cent of people, requiring them to pay a bit more into the pot,” she said. “From the Tories and Labour, we’ve been hearing a race to the bottom on tax.”

The party has sought to expand beyond its core policy focus of the environment and climate to become a foil to Labour, stealing away leftwing voters who feel uninspired or unsatisfied with Sir Keir Starmer’s position on issues ranging from the conflict in Gaza to taxation and public investment.

The Labour party ruled out imposing a dedicated wealth tax last year and has also said it has no plans to bring capital gains tax in line with income tax rates. It has also said it will stick to tight fiscal rules on borrowing, including that debt must be falling as a share of GDP by the fifth year of the forecast — a policy also held by the Conservatives.

In the seven-way BBC leaders’ debate last week, Denyer accused Starmer of having changed Labour “into the Conservatives”.

The Greens are targeting four seats at the election on July 4 including Brighton Pavilion, which they already hold, and Bristol Central, where Denyer is in a tight race with shadow culture minister Thangam Debbonaire. They are also targeting Waveney Valley and North Herefordshire. 

But the party faced a setback last week when it was forced to block four candidates from running in the election after a dossier of information was released about allegedly antisemitic comments the individuals had made, shared or liked online.

The Greens said they would invest £50bn in health and social care to “defend and restore the NHS”, including a guarantee for an NHS dentist for everyone, and £29bn over the next five years to insulate homes. 

They also set out plans to bring water companies, railways and five retail energy companies into public ownership, and to scrap university tuition fees. 

On housing, the party vowed to create 150,000 new social homes every year by the end of the next parliament and invest £30bn over five years to insulate homes.

It also said it would stop all new fossil fuel projects and cancel ones that had been licensed recently, including Rosebank in the North Sea.

The pest control group clearly has problems that the activist investor believes he can solve

Rentokil Initial specialises in ridding premises of pests. The London-listed company now has one on its shareholder register. Activist Nelson Peltz’s Trian says it has a top 10 holding in Rentokil. That lit a fire underneath Rentokil’s otherwise soggy share price, which was up 13 per cent by late-morning trading.

That reaction reflects the impact that activists can have in equity markets, like the beleaguered and unloved UK market, that are highly sensitive to any positive catalysts. And Rentokil clearly has some problems that Peltz believes he can solve.

Top line growth looks sluggish at under 4 per cent per year in the two years through 2025. In North America, both the world’s largest market and well over half Rentokil’s business, that pace should be even slower. Acquiring Terminix in the US for $5.4bn back in 2022 gets part of the blame. While that deal meant Rentokil leapt to leadership in the US pest control market by revenue, integration has been slow.

As a result, Rentokil’s share price has underperformed badly, trailing both the broader UK market and its largest US-listed peer Rollins. Whereas Rollins trades at a forward price to earnings multiple around 45 times, similar to three years ago, Rentokil has only gotten cheaper at 17 times.

Whether that gap has to do with Rentokil’s so-so growth profile compared to Rollins or its London listing could offer a topic of discussion between Peltz and chief executive Andrew Ransom. As Lex has noted, it is not clear that simply moving a listing makes a difference. Yet, one can see why Peltz might have questions.

He has something to work with at least. For starters, Rentokil has around 30 per cent market share in the US, followed by Rollins’ one-fifth share by revenue. The former has consistently delivered organic free cash flow, and should manage an average of £600mn annually this year and next, according to Visible Alpha consensus estimates. That easily covers the dividend. But against that financial strength sits a net debt to ebitda leverage of roughly 2.5 times, using S&P Capital IQ data.

More than a change of address is needed for Rentokil. Higher interest rates means Rentokil needs to get its debt down. At a time of sluggish revenue growth, that is a tricky proposition that could benefit from an activist’s insistence on more aggressive changes.

Tech companies may soon be on a shopping spree, as the world adjusts to high interest rates and companies start looking for ways to juice growth. And for investors inclined to make a bet on potential targets, they need not go much further than two enterprise tech firms: GitLab and DocuSign.

That’s our conclusion from wading through numerous publicly traded software firms identified by Wall Street analysts, and after talking with investors. Both stocks are reasonably priced, measured as a multiple of the next 12 months’ sales, and would supplement the businesses of several bigger tech firms or could be private equity targets. A few other firms, such as Paycom and Paylocity, might also fit the bill, but not quite as well.

What makes us so confident? After all, we’ve been in a bit of a deal drought for 18 months. But clearly attitudes toward mergers and acquisitions are changing. Last week SAP announced plans to buy WalkMe, while private equity firm Bain Capital said it would take PowerSchool Holdings private. Both deals involve the buyers paying a hefty premium of roughly 40% to where the stocks were trading beforehand. DocuSign has clearly been on buyers’ target lists recently: Both Bain Capital and Hellman & Friedman were in talks to buy the company in January, Reuters reported, although conversations stalled.

At the same time, midsize software companies have good reasons to sell. Businesses have become more careful in their spending on software, a trend that continued into the most recent quarter, as numerous software executives signaled, including GitLab’s CFO. That has dampened growth rates for a wide range of software companies. Bain & Co. partner Adam Haller, who leads its merger integration group, notes that a lot of small companies may have already sold—such as cloud security startup Lacework, which sold to Fortinet—but there’s another layer of midsize firms “that haven’t done great…not bad enough that they were forced to sell,” which offers an opportunity for buyers.

KeyBanc Capital Markets’ lead enterprise software analyst, Jackson Ader, is among those who think there will be even more software deal activity in the coming months. In reports published last week, Ader and his team named dozens of publicly traded software firms that they reckon could be viable targets for takeovers in the near future. After taking into account factors like potential regulatory hurdles and uncertainty about how artificial intelligence advances will change attitudes, Ader’s team honed in on just 10 prospective targets. From that list, a few stand out as particularly attractive—none more so than GitLab.

GitLab is a business similar to GitHub, acquired by Microsoft in 2018: Both run services to help developers write code, including open-source software code repositories. Under Microsoft, GitHub has flourished, sometimes at GitLab’s expense, as The Information reported in January. GitLab’s revenue growth rate has slowed to 37% in the year to January from 68% a year earlier, and its growth rate is expected to decelerate further to 27% this fiscal year, according to S&P Global Market Intelligence.

That competition could give GitLab’s co-founder and CEO, Sytse Sijbrandij, who has a 46% voting stake, a reason to sell. As for potential buyers, GitLab could be appealing to a smaller cloud provider, such as Oracle or Google Cloud. As The Information noted in January, Google Cloud is now one of GitLab’s most important resellers and owns about 6% of its stock. Oracle, meanwhile, experienced a slowdown in its cloud revenue growth rate in the May quarter, it reported on Tuesday, which could give it motivation to pursue a GitLab acquisition.

Another potential buyer is IT automation technology provider ServiceNow, whose CEO Bill McDermott used to run SAP, where he led some of that company’s largest acquisitions, including Concur and Qualtrics. GitLab could be ServiceNow’s first major acquisition and would help it maintain the 20%-plus annual revenue growth it has enjoyed since it went public.

GitLab wouldn’t be too hard to digest. It has a market capitalization of around $7 billion, but after taking into account roughly $1 billion on its balance sheet, a purchase would cost only $6 billion. And it is now generating cash.

DocuSign is another software firm some investors think is poised for a takeout. Its forward revenue multiple of under 4 times is a huge step down from the 9.8 times at which it was valued in 2019 (the pandemic-era tech boom lifted that metric to over 20 times).

The trouble is that its expected sales growth—6% for the next two years, according to analysts polled by Koyfin—is meager. DocuSign has long been perceived as a single-product firm that enables employees to sign business contracts online, but as competition from Adobe’s similar product ramps up, the company has been trying to reshape the narrative and kick-start growth. To that end, earlier this year it launched a more comprehensive platform for businesses to manage their agreements with other companies.

Perhaps Adobe could try to subsume and expand DocuSign. Adobe, which is also trying to find new ways to grow, is licking its wounds after its offer for design firm Figma didn’t pass muster with antitrust regulators. But other potential buyers, such as Salesforce or even private equity firms, might be eyeing the same target, according to software investor Logan Bartlett of Redpoint Ventures. As The Information noted in an M&A Special Report on Monday, Salesforce, Adobe and Oracle are overdue for acquisitions given their past history.

In some ways, DocuSign is well suited for a private equity–led buyout. It threw off nearly $1 billion in free cash flow over the past 12 months, representing a 32% margin as a percent of revenue—on the high end for the typical software firm. Web design firm Squarespace, which buyout shop Permira said last month it planned to purchase for $6.9 billion, has also seen slowing sales growth but similarly generates a healthy amount of cash.

Plenty of other software companies might be suitable for private equity buyouts. Marcin Majewski, managing partner at tech investment bank Aventis Advisors, thinks some of the most probable targets for private equity takeovers are companies that generate less than $300,000 in sales for each full-time employee on their payroll, a relatively low level that suggests they have ample room to cut costs. E-commerce software firm Shopify, for instance, generates nearly $900,000 in revenue per employee, according to Aventis. But human resources software providers Paycom and Paylocity are both below the $300,000 threshold.

Paycom and Paylocity are also free of debt. Their operations are concentrated in the U.S., which, according to the KeyBanc analysts, presents an opportunity for them to unlock a new source of growth by expanding internationally. That’s true of human resources software firm Paycor, too, although with private equity firm Apax Partners already owning a large chunk of its shares, brokering a fresh sale could be complex.

Predicting what deals will get done isn’t easy, but savvy public market investors could benefit from beating private equity to the punch.

After a turbulent few years, Bob Sternfels talks about revamping the company’s structure and employee development; ‘Not everyone gets an A’

Soon after Bob Sternfels took the top job at the consulting giant McKinsey a few years ago, he embarked on an around-the-world tour to meet with the lowest rung of managers at the firm.

The conversations largely took place outside; Sternfels is prone to walking meetings and finds that a jaunt out of an office can elicit more candid feedback than staring at someone across a conference table. What many of the young managers discovered, though, is that a walk with Sternfels, a former Stanford water-polo player, is more often akin to a light jog.

“Some end up a little sweatier than others at the end of these things,” he says.

It is with a similar level of intensity that the 54-year-old is approaching his next task: helping to “rewire” McKinsey. The firm, which advises many of the world’s biggest companies and governments, has weathered a bruising period marked by a downturn in demand, layoffs and legal challenges tied to its past work with opioid makers.

Sternfels sat down with The Wall Street Journal for a long-ranging, exclusive interview at a critical junction for the century-old partnership.

McKinsey said in 2021 it would pay $641 million in settlements for its work with OxyContin maker Purdue Pharma and other pharmaceutical companies. The Justice Department has opened a criminal probe. Congress has grilled Sternfels over the firm’s work on behalf of Saudi Arabia and in China.

An election for global managing partner earlier this year stretched to three rounds, laying bare dissatisfaction within the firm. Sternfels survived and kept his position, but the process highlighted an unusual structure that gives McKinsey’s 750 senior partners the power to choose their leader every three years.

As his new term begins next month, Sternfels and his colleagues are planning for much change. With clients, McKinsey is adjusting some of its fee structures, taking on more work in which it defers payment until companies reach agreed-upon results. Asutosh Padhi, McKinsey’s current head of North America, will work on such experiments, part of a broader leadership shake-up across the firm.

Rodney Zemmel, who faced off against Sternfels in the final round of the election and heads a growing practice called McKinsey Digital, will spend time on how McKinsey consultants should adapt their work in the era of artificial intelligence.

The firm is also rethinking how it runs itself. It launched a 30-person “partnership modernization” task force, which is debating issues tied to McKinsey’s governance, including the length of a term for the firm’s leader and how often it conducts elections.

“We’ll ask some questions of…when are elections helpful to a partnership, and when are they divisive?” Sternfels said, adding that he wants the group to wrap up by year-end.

One of the task force’s first moves, taking effect July 1, is to separate McKinsey’s senior management team from its board to better differentiate between those overseeing the firm and those running its operations. Board members will still include partners, including well-known leaders such as Liz Hilton Segel, McKinsey’s chief client officer.

3,000 partners

What has made running McKinsey challenging, those inside and outside the firm say, is that the company has grown significantly in recent years. McKinsey has roughly 45,000 employees around the globe and about 3,000 partners. While that is still a fraction of some of its broader consulting-industry peers—Accenture had about 740,000 employees at the end of February—it is still a steep increase from its past. As recently as 2021, McKinsey had about 30,000 employees.

Sternfels said he is spending time thinking about how to make the firm feel smaller, while maintaining its global structure. In addition to organizing groups geographically or in functional areas, such as private equity, McKinsey is debating how it might set up internal “communities” within the firm, pulling people from across divisions.

These communities, for example, might be devoted to infrastructure work, as companies from oil giants to semiconductor makers invest in big projects, requiring consultants with business expertise and experience navigating government policies and subsidies.

At a recent leadership retreat for partners in Copenhagen, Sternfels also emphasized that, no matter what shape McKinsey takes, he wants the organization to be a place where employees get “unrivaled development.” That goal means doubling down on feedback—and lots of it—for staffers.

Top leaders at McKinsey don’t anticipate additional layoffs following some cuts last year.

Up-or-out culture

McKinsey has long had an up-or-out culture, where consultants either ascend through the ranks or are shown the door and invited to join an active McKinsey alumni group. Earlier this year, the firm put about 3,000 employees on notice with unsatisfactory performance ratings. Some consultants feared they would be “CTL’d,” or counseled to leave, in McKinsey speak.

Sternfels said McKinsey is a meritocracy, and that its ratings are in line with its historical averages. “The great reveal is people have always been rated that way,” he said. “Guess what? Not everybody gets an A.”

He added: “It’s not just the feedback, sink or swim, but it’s done with a sponsor, so that you have somebody who’s going to be in your corner to help change the odds that you can actually do something about that feedback.”

McKinsey laid off some nonclient-facing staffers last year and elected a smaller new class of partners. It also deferred start dates for some new hires.

Sternfels and other senior partners said they don’t foresee additional layoffs. Some of the previous cuts came after a burst of hiring during the pandemic when demand for McKinsey’s services soared.

“We’re back in balance now,” Sternfels said. The company plans to hire 6,000 people this year, roughly the same as the year before, and Sternfels expects net employee growth at McKinsey in 2024.

As McKinsey veterans talk about the future of the firm, and what it means to be a consultant, AI looms large.

When a summer intern recently asked Segel, McKinsey’s chief client officer, for tips on how to succeed at the firm, she didn’t hesitate. “My advice to her was to be an outstanding prompt engineer” on an internal McKinsey generative AI tool.

Consultants should know how to use such tools, streamlining their work, she said, so they can then focus on offering higher-value services, such as counseling clients to put new processes in place.

“I think the word ‘consulting’ is a misnomer. I have not figured out the new word,” Segel said. “What we do is we effect change: change in results, change in capabilities.”

McKinsey is best known for offering strategy ideas to companies—a proposition the firm increasingly views as table stakes in the AI era. “That part of the profession will get disrupted,” Sternfels said.

Instead, the firm wants McKinsey’s people delivering ideas while also helping clients through the often-difficult process of changing how they work, said Shelley Stewart, a senior partner on Sternfels’s new leadership team.

Challenges remain. The Justice Department is conducting a criminal investigation into McKinsey’s work with opioid manufacturers, the Journal previously reported. A former senior partner also recently sued the firm and Sternfels, alleging that McKinsey made false statements when it fired him in 2021 for allegedly violating the firm’s document-retention policies.

Asked how he thought the Justice Department investigation would end, Sternfels said, “My sense is just with all the regulators that we’re talking to, we are on a path to come to a resolution.”

McKinsey’s work with Saudi Arabia’s sovereign-wealth fund has also come under scrutiny, including on its ambitions to be an international player in golf. McKinsey established an office in Saudi Arabia in 2010 that now has more than 400 employees. Sternfels testified its work in Saudi Arabia predated the launch of LIV Golf and a proposed merger with the PGA Tour.

U.S. lawmakers have criticized McKinsey for advising the U.S. government while also consulting for Chinese state-owned enterprises. Sternfels said the firm’s footprint is under “constant evaluation” and that it doesn’t work directly with the national or provincial governments in China. The vast majority of the firm’s work in China is with multinational corporations and other private-sector clients, he said.

McKinsey is debating how it might set up internal ‘communities,’ pulling people from across divisions within the firm.

A 30-year McKinsey veteran, Sternfels studied economics at Stanford University and was a Rhodes scholar at Oxford. He rose through McKinsey’s ranks as an operations guru and is known for giving multipronged responses to questions, occasionally peppering his sentences with words like “orthogonal.”

During a recent conversation, dressed in a trim navy suit with a white shirt, he appeared as at ease discussing the nuances of the carbon-credit market as he was in highlighting the emerging alliances forming between Japanese chief executives and Indian companies—a takeaway from an early June trip to Tokyo.

Colleagues say Sternfels is known for a decisive, do-it-now attitude, an approach that also has brought criticism. He has tried to change McKinsey’s culture, in part, by focusing on humor, sometimes at his own expense, to make people feel more comfortable.

While visiting a McKinsey office, he played a game called “How hot can Bob go?” Sternfels would attempt to eat four curry dishes of escalating spice levels as employees asked him questions.

“By the third one, it was a wet towel on my head,” he said. At the fourth station, Sternfels gave in.

“What it did was the whole room got a laugh, and we had a great conversation after that,” he said.

These days, Sternfels splits his time equally between internal meetings and conversations with leaders of McKinsey clients. When chatting with a client CEO, Sternfels will often ask: What can McKinsey do differently?

Many CEOs respond that the firm should keep telling them what others don’t. Sternfels said he views this as a reminder that McKinsey must keep evolving and be distinctive. Then, summing up the challenge, he returns to a favorite word.

“How do we bring orthogonal ideas to the CEO?”