Following a strong second half last year, buyout activity tailed off in the first half of 2006, but has been recovering in recent months, according to the German venture capital and private equity association, the BVK. This may be due to recovering sentiment towards the Germany economy, which appears to be emerging from years of slow growth. There has been an increase in consumer spending, investment and continued strong exports, as well as falls in unemployment. Despite this, support for Angela Merkel’s ‘grand coalition’ government of social democrats and conservatives appears to be sagging, according to polls.
The BVK reports that equity investment in buyouts was €575m in the first half of 2006. This was up on the same period for 2005 but down significantly on the active market of late 2005. In 2005 €1.8bn in equity was invested in buyouts, says the BVK.
BVK managing director Holder Frommann points out that these figures are lower than some other calculations because they don’t include some of the very large real estate deals that have been seen in Germany in recent times by funds such as Cerberus, Fortress and Lone Star.
The main trend he has seen, he says, is a decline in the number of large buyouts in Germany in the last two years, because large German corporates are no longer selling off non-core assets to the same extent. “This trend has been offset by a growth in small and mid-market transactions, as succession issues become more pressing in family-owned companies,” says Frommann.
But there are still some large deals going on. In July, the biggest deal of the year so far was announced, when Bain Capital said it was selling chemical distribution business Brenntag in a €3bn secondary buyout to BC Partners. Bain had acquired the company two years previously.
Frommann says that, when it comes to fund raising, there has been significant success by domestic funds focusing on the mid-market, or Mittelstand. For example, Deutsche Beteiligungs (DBAG), one of the country’s longest-established funds, closed its DBAG Fund V at the beginning of 2006 with €434m, after attracting commitments from 26 institutional investments and easily exceeding the original target of €375m. DBAG’s previous fund closed in September 2003, with €228m. Others included Steadfast Capital, acquired by AXA, which raised over €200m and a new fund launched by Buchanan Capital Group. The Buchanan Unternehmer-Fonds, which will invest in mid-market family-owned companies in German-speaking countries, is aiming to raise €150m and is open to private individuals with a minimum investment of €500,000 and institutions, who must commit at least €2.5m.
Buchanan partner Peter Blumenwitz, formerly at Apax, says: “The mega funds are getting bigger and bigger, and that’s fine, although perhaps their returns won’t be as high in the future as they have been so far. But those funds are no longer for entrepreneurs but are all about financial engineering.”
He adds that he and the other Buchanan partners were looking for where the best opportunities in the future would lie, and concluded that the mid-market was highly attractive. Many mid-market companies need capital, he argues, and in recent years have found it harder to get it from traditional bank loans. That is one reason mid-market companies have been seeking new ways of funding, such as mezzanine finance, which allows the families to hold onto majority control.
Blumenwitz also believes that the controversial speech last year in which SPD chairman Franz Muntefering compared private equity investors to “locusts” stripping bare German companies may have had some positive consequences: “It certainly got people talking about private equity and many Mittelstand people became better informed about the industry.”
Holger Frommann of the BVK agrees that the locusts controversy was not entirely negative: “It was really just part of an electioneering pitch but it did show us that we needed to become more transparent because a lot of people don’t really understand private equity. Since then we’ve had discussions with the various political parties, so that they now understand our sector better.”
Andre Mangin, a board member of DBAG, believes that there is a change in the mindsets of Mittelstand founders or their successors. “More and more are considering private equity as an exit and many of these companies are looking for growth capital to compete internationally or even globally, and private equity is one source.”
He adds that Germany has seen the equity capital markets become more open for IPOs this year and that flotations are now a viable option for some of the larger mid-market companies. DBAG itself made €98m following the flotation of its portfolio company Bauer, a building company, on the Frankfurt exchange in July.
Peter Blumenwitz of Buchanan says that the new generation of owners of many Mittelstand companies are much more open-minded than their forebears. “They have usually been well-educated and often worked in the world of finance.” But he acknowledges that there have, so far, been relatively few Mittelstand buyouts, considering the huge number of such companies.
One of the reasons there have not been more Mittelstand deals, he believes, is that in the past the financial houses servicing this market were often owned by the German banks and therefore had a more conservative attitude to finance. “But now there is a new generation of private equity houses, including us, who understand both the Mittelstand sector and have wide experience of international finance,” says Blumenwitz: “We can talk the language of the Mittelstand owners and understand the importance to them of family values.”
But there continue to be barriers. Mittelstand owners are not familiar with auctions, due diligence and other elements of the buyout process. A key obstacle, argues Blumenwitz is that many of the Mittelstand advisers are stuck in traditional ways of doing things. “The lawyers, tax accountants and other advisers often don’t have any experience of selling companies or raising finance,” he says: “Some of them have been working for 40 years and their knowledge is 40 years old.”
As a result, buyout houses have to steer Mittelstand owners and their advisers through the process and it can be painful for the owners to see a price tag put on their life’s work. “During due diligence a problem will often come up, such as problematic tax advice in the past, which reduces the value of the company a little,” says Blumenwitz: “But the owners and their advisers sometimes think the private equity house is trying to put one over them, and so are reluctant to negotiate.”
Although the upturn in expectations on the domestic economy is likely to benefit private equity in Germany, Karsten Hartmann, head of HgCapital in Germany, points out that the country’s traditional strength in exports means that domestic conditions are not always as influential as they may appear. HgCapital has not made any acquisitions in Germany this year, which Hartmann puts down to the quieter market of the first half of 2006. They did acquire Schenck, a company specialising in industrial weighing and measuring, at the end of 2005. Schenck does a lot of its business in Asia, as well as on mining deals in Australia and Brazil. Hartmann says: “A lot of German companies are exporting to Asia and so have benefited from the strong growth there. The fact that many companies here are global players means that a weak domestic economy is not a reason to turn away from Germany.” He adds that this year HgCapital acquired a US-based company to add on to Schenck.
At 3i the focus has been on selling this year, says Germany chief Stephan Kruemmer: “Prices are generally high, perhaps at their peak, and so like some other houses we’re in a selling mindset and are very careful about what we buy because of the valuations.” Early in the year 3i sold pharmaceutical company betapharm to India’s Dr Reddy’s Laboratories in a deal worth €480m.
The private equity house first invested €110m in the company, which markets generic drugs and employs 370 people, in 2004. The transaction only came about after 3i won over the family owners. A large amount of time was spent by 3i in talking to the family and building up a rapport, as they were not familiar with the world of private equity and did not make decisions based purely on financial rationale.
3i has also used the public markets this year. In April, Berlin-based international multimedia software company Magix was listed on the Frankfurt stock exchange. The IPO was 13.2x oversubscribed and 3i divested itself of 40% of its shares in the company, making a 3.8x money multiple on its original investment. Among the investments during the year was the MBO at industrial supplier Rasmussen. The company, which has around 800 employees, produces fasteners, hose clamps and fluid systems, mainly for automotive manufacturers in Germany.
Stephan Kruemmer says: “We’ve seen business pick up since the first half in our market segment. I’m not sure why the market was quiet earlier in the year but I think people are now feeling more positive about Germany and the stock market has been more positive.”
On the stock market he adds that, although some flotations had to be pulled earlier in the year when the market was struggling, there have still been some good quality companies that have succeeded, such as Magix.
One of the key sectors 3i is seeking to focus on, says Kruemmer, is infrastructure. He defines this in broad terms, to include transport, logistics, utility companies, distribution and hospital chains. “A lot of people are interested in this area and we see a lot of potential, which is why we are putting together a specialist team to follow this market in Germany,” he says.
But all private equity investors in Germany are grappling with the heated market and the increase in valuations.
Chris Day, head of leveraged finance at Commerzbank, points out that some sectors have seen greater increases in leverage than others. He says: “For example, not many years ago cable was in trouble and companies were restructuring, then a couple of years ago they were being financed at three to five times EBITDA, and today that’s become eight to 10 times. Cable transactions have helped drive up the market’s average leverage figures.”
He believes that, despite the high valuations and leverage levels, Germany is probably in a better position than a year ago: “This time last year I was more worried for the market than I am now, as we see a lower percentage of portfolio exposures running under plan than at the same time a year ago.”
Carola Babcock, head of Germany for mezzanine provider ICG, says that half of all deals over €100m are using mezzanine to fill funding gaps. She notes that in the past three or four years there has been a significant change in the senior debt and mezzanine market, with new players entering.
“A few years ago institutional investors, such as CDOs, only made up 4% to 5% of primary debt syndication but now it’s about 40%,” she says: “These institutional investors are not necessarily driven by long-term investment and often have constraints on them, which may force them to sell holdings.”
This volatility introduced by new players in the market opens up opportunities for long-term mezzanine investors like ICG, she says, especially in the big deals: “In the Brenntag transaction €400m was in mezzanine finance,” she says.
Babcock says that the €1bn-plus deals, of which she says Germany typically has three to four each year, are the main recipients of mezzanine. “Probably 50% to 60% of mezzanine is going into the very large deals,” she says.
Ralf Huep, head of Advent International in Germany, says many in the market have been expecting prices to stabilise or fall for some time now, but they have continued to rise. “I expect in the next 12 to 18 months there will be a gradual fall in prices, but nothing abrupt,” he says. The reason for a fall may be down to problems emerging in certain highly leveraged transactions, and the fact the some of the lending banks are already becoming a little nervous at leverage levels, he says.
“But there is little likelihood of a major drop in valuations, simply because there is so much dry powder in the market and so many people chasing deals,” says Huep.
Among Advent’s investments this year have been the acquisition of nursing home group Casa Reha Betriebs from a financial consortium. The company has a portfolio of homes providing 3,500 beds and facilities for a further 700 beds under construction. As in other markets, increased life expectancy is expected to benefit the nursing care market over the next 20 years. Other recent investments by Advent in Germany include the acquisition of Herlitz, a manufacturer and supplier of stationery products, Synventive Molding Solutions, which designs and manufactures products for the plastics industry, and HT Troplast, a global plastics manufacturer. Advent also acquired RWE Solutions Group from electricity and gas supplier RWE. Financial details of the deal were not disclosed but the three companies in the group had sales of €1.7bn with around 9,500 employees. The two largest companies within the portfolio were SAG and Nukem. SAG provides energy-related infrastructure services to utilities, while Nukem is an international leader in nuclear fuel cycle and decommissioning services.
Ralf Huep said of the acquisition that the diversity and international profile of the company was characteristic of the kind of investment Advent sought and that it would require a high level of Advent involvement and value-add support.
He says that, in an environment of very high prices, Advent’s strategy is to try and identify those particular opportunities in which good returns can still be made from active and smart management: “It’s looking at complex deal situations and doing a lot of homework, analysing the skills in the target company and what we can do with the asset.”
In broader terms the environment for exits is fairly good. Not only has the secondary market become increasingly important, but strategic buyers have also been returning in the past 12 to 18 months.
The BVK’s Holger Frommann says that since the summer of 2005 strategic buyers have been active: “The large corporates sold off non-core assets to private equity, in order to increase shareholder value, but now find that they need new opportunities to grow and they have deep pockets at the moment.” While the presence of trade buyers is good news for private equity houses when it comes to exits, the other side of the coin is that they face greater competition in acquisitions, notes Frommann.
In the longer run, the health of the German private equity industry will be shaped, partly, by government regulation and that is a topic of current controversy. In November 2005 the coalition Government said it recognised the economic impact of private equity and announced that it would improve the regulatory environment. But private equity houses have been worried about other plans, for a corporate tax reform, which they fear could negatively affect portfolio companies and hamper the development of the market.
The Government has now said it will work out a private equity bill simultaneously with its plans for corporate tax legislation. The BVK sees this as a positive move, as it thinks it will help avoid “collateral damage” to private equity from tax reform. The Government’s intention is that legislation on private equity and corporate tax reform will become effective from the beginning of 2008.
Karsten Hartmann says that the Government’s changes are a “moving target” because of uncertainty surrounding what the proposals will be: “I just hope for a resolution that will not leave German private equity disadvantaged compared with other European countries.”
Stephen Kruemmer agrees that currently it is not clear what will happen: “I hope the Government will see the important role private equity plays, especially in the mid-market, where we are helping improve companies’ competitiveness and improving their equity base.” He adds that a lot of these companies can’t easily access bank funding and that private equity is often playing a positive role, rather than being the “locusts” presented by some politicians: “Our strategy isn’t about splitting up companies and selling off the bits, but about building companies and making them more competitive.”
The BVK has a “wish list” for the proposed private equity law, including clarification of the tax treatment of carried interest and of the management fee. It also wants, if possible, for the legislation to help portfolio companies, especially in innovative and technology companies, in areas such as the tax treatment of losses. Others, such as DBAG’s Andre Mangin, would like to see issues such as the tax deductibility of interest payments covered in the new law.
Assuming the future legislation does not negatively affect private equity investments, there is a positive outlook for German buyouts, practitioners say, particularly if the Mittelstand companies finally begin to seek private equity involvement in a major way. “Germany continues to be a buoyant market and offers one of the strongest growth trends in Europe,” says Commerzbank’s Chris Day.
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