Analysis

ROUNDTABLE

SPONSORS CAPVIS • DEBEVOISE & PLIMPTON • DEUTSCHE BETEILIGUNGS AG • NEUBERGER BERMAN

German ’s growing disquiet

Hands-on value creation is more important than ever thanks to high valuations, four market experts tell Carmela Mendoza

rivate Equity International land- Limited partners fear a looming reces- operational improvements by growing the ed in Frankfurt a week after the sion and have become more sensitive when top line and making the businesses more ef- European Parliament elections. they assess business models and their resil- ficient as they grow, he says. Germany’s established centrist ience to an economic downturn, says Andre- “What we then find when we compare parties had lost votes, weak- as Simon, a partner at mid-market pan-Eu- the market spectrum is that the most suc- ened by a new political gen- ropean firm Capvis. cessful GPs invest more in infrastructure, Peration focused on urgent climate change High levels of dry powder combined invest more in functional capabilities, such action and social justice. with low interest rates have also led to a rise as operational teams, digital teams or fi- In German private equity, investors and in transaction multiples – another major nancing teams. This also means investing managers are also facing new opportunities concern for LPs and general partners alike. in infrastructure as it pertains to industry and challenges brought about by tighter An influx of names from the US entering expertise.” regulation, high valuations and a new breed the German market has increased competi- In summary, GPs have to work much of entrepreneurs, four market veterans note tion and driven up prices. harder to create value, compared with 10, in our roundtable discussion. High valuations mean managers have 20 years ago, and continuously evolve doing While fundraising and deal figures re- started to assume a multiple contraction on so, Patschkowski adds. main stable, the over-riding sentiment in exit, according to Patschkowski. To counter- the German market – and across Europe – is act this, GPs must try to increase the EBIT- New views, new challenges still one of caution and nervousness, partic- DA of their portfolio companies through A tougher environment for returns means ipants agree. investors are more closely scrutinising and Philipp Patschkowski, a managing di- monitoring their own portfolios. rector at Neuberger Berman in London, “LPs are looking at compliance issues says investors are taking a cautious look at more closely. They are asking more ques- underlying investment themes and focusing tions on operations, conflicts of interest on resilience and growth, even more so than €2.8bn policies, due diligence processes and com- a year ago. “GPs are proactively trying to Average Germany-focused pliance with ESG standards and requests conclude another fundraising on this side fundraising over the last five years for excuse provisions in certain cases,” says of the cycle. We continue to see them fund- across buyout, growth, venture Patricia Volhard, a partner at international raising earlier and holding dry closes before capital and mezzanine funds law firm Debevoise & Plimpton. they start investing,” he adds. “They are also investigating more on

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PHOTOGRAPHY: THORSTEN JANSEN

Andreas Simon Patricia Volhard Philipp Patschkowski Torsten Grede

Partner, co-head of industry & Partner, Debevoise & Managing director, Spokesman of the board technology, Capvis Plimpton Neuberger Berman of management, Deutsche Beteiligungs AG Andreas Simon joined Capvis Patricia Volhard is a partner Philipp Patschkowski is in 2007 and has more than in Debevoise’s Frankfurt a managing director at Torsten Grede began a decade of private equity and London offices, and Neuberger Berman, where his career at Deutsche experience. Simon was is a member of the firm’s he leads primary and Beteiligungs AG in 1990 previously a director for private equity and funds/ secondary fund investments and now has nearly three mergers and acquisitions investment management and direct co-investments. decades of experience in at Siemens in Munich and groups. She previously Prior to joining the firm, private equity, specialising in a financial analyst in the served as chairwoman of Patschkowski was a principal Germany’s mid-market. He division Invest Europe’s tax, legal & at Coller Capital where he was appointed to managing of in London. regulatory committee, and is worked for more than eight director in 1995 and became the incumbent chairwoman years and was responsible a member of the firm’s board of its financial services/ for originating and executing of management in 2001. In regulatory working group. secondary and strategic 2013, Grede was appointed Volhard also sits on the primary fund investments spokesman of the board of legal committee of BVK, and co-investments, and management, working on the German private equity leading fundraising activities establishing and leading association. with clients, particularly in DBAG’s country-specific the DACH region. Earlier operations. in his career, he worked in investment banking at UBS and at Sal Oppenheim.

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“LPs are looking at compliance issues more closely. They are asking more questions on operations, conflicts of interest policies, due diligence processes and compliance with ESG standards and requests for excuse provisions in certain cases”

PATRICIA VOLHARD Debevoise & Plimpton

Fundraising between 2011-18 focused on buyouts or (€bn) costs and fees and expenses and ask for more detailed disclosure.” Volhard adds that LPs 3.5 in recent years have shown strong interest in debt funds – from those with long-term 3.0 strategies and a very PE-like approach to debt funds supporting leverage buyouts, as well as those providing subscription facili- 2.5 ties. One reason LPs are favouring debt Generalist products is regulation. From a Solvency II 2.0 Mezzanine perspective, debt investments often enjoy a Buyout better capital reserve treatment than equity 1.5 investments, Volhard points out – although reserve requirements under Solvency Venture capital II are also improving, boosting appetite for 1.0 PE investments. German private equity is also facing new

0.5 challenges that cross national borders. “Brexit is only one example of the grow- ing nationalism across Europe, which is also 0 a problem for PE because the industry is 2011 2012 2013 2014 2015 2016 2017 2018 very much relying on being able to act on Source: European Data Commission/BVK, as of February 2019 a cross-border basis – from the way you set

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up your structures with a broad, often very management of Deutsche Beteiligungs, a global, investor base, to the investment side longstanding domestic private equity firm. where most funds invest in several jurisdic- “You go into the marketplace and see tions,” Volhard says. restructuring situations as well as fami- “In the case of a hard Brexit, even though ly-owned companies which need some sup- we say it doesn’t make a huge impact imme- port, looking to take investors on board via diately, it will be a problem over time to the minority investments,” Grede says. extent no arrangement can be found.” “There are all sorts of situations and Comparing the risk-return profile of there are plenty of choices to get financ- opportunities in areas across the region, ing for these situations. That has definite- the UK has become less attractive since the ly changed compared with 10 [or] 15 years Brexit referendum, Patschkowski says. “On ago.” the portfolio company level what we have Grede adds there is no shortage of cap- seen and anecdotally heard is not just how ital for the DACH region, and DBAG has the Brexit uncertainty affects capital expense seen increased appetite from overseas LPs decisions, but also that a lot of supply chains for country-specific funds. Some investors have been remodelled to reduce a potential from the US might not have chosen to com- Brexit risk by including more suppliers from mit to German funds 10 years ago; at the continental Europe.” time, country funds were often not sizeable The private equity industry has become enough to accommodate larger investors much more efficient in Germany, says Tor- with their huge allocation needs, he says. sten Grede, spokesman of the board of The DACH region was the third most

“It seems to me that the owners of these first-gen companies have a different view – they don’t have a dynastic view. They are 55 years old, thinking about their personal life. They want to enjoy life and don’t want to stay in the office until they are 75”

TORSTEN GREDE Deutsche Beteiligungs

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“You can consider technology a threat for established businesses but also as an opportunity because new business models are emerging, founded by a relatively young generation who have a different approach”

ANDREAS SIMON Capvis

attractive market in Europe in 2018 when venture capital and mezzanine funds, data it came to deal activity, accounting for 18 from German private equity association percent of transactions, behind France and BVK show. Benelux (30 percent) and the UK and Ire- There’s still a lot of untapped poten- land (22 percent), according to industry tial in the German market: private equi- body Invest Europe. ty-backed investments in the country last Germany-focused fundraising has also year as a proportion of gross domestic been stable in the last five years, averaging product was just less than 1 percent, accord- around €2.8 billion across buyout, growth, ing to data from Invest Europe.

The public sector dominated investor type in 2018 (%) 2017 was a boom year for investment volume

Investment volume (€bn) Number of deals 0 5 10 15 20 25 30 35 40 45 16 1,600 Public sector 12 1,200 Pensions and private 10 1000 individuals Foundations and academic institutions 8 800 Companies 6 600 Funds of funds and other asset managers 4 400 Credit insitutions

Insurance companies 2 200

Others (includes capital markets, 0 0 GPs and sovereign wealth funds) 2011 2012 2013 2014 2015 2016 2017 2018

Source: European Data Commission/BVK, as of February 2019

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More borders aren’t good for PE

The surge of nationalist populism has had an impact on German private equity’s cross-border investment activity in recent years.

Succession deals, an “everlasting story” In 2017, the remit of the German Foreign Trade and Payments Ordinance, known in Germany, remain attractive, says Simon. as AVW, was expanded to focus on “critical infrastructures” that may pose a threat “Culturally, German families would like to to national security if acquired by foreign interests. Sectors covered include health, preserve their wealth and keep their money telecoms and finance. invested in a company [rather] than being In addition, an amendment to the German Foreign Trade Regulation, which invested in the stock market.” came into force on 29 December 2018, expands the oversight of the German The market is now filled with young Ministry for Economic Affairs and Energy. The new rule lowers the foreign companies founded by serial entrepreneurs, investment threshold screening from 25 percent to 10 percent for some who won’t necessarily sell a majority but transactions and even blocks purchases of stakes in German companies by want to co-develop their business with a non-Europeans. private equity firm and list it at a later stage, As a result of such measures and other protectionist policies, Chinese direct Simon adds. investment in Europe has fallen to €17.3 billion in 2018 from €37.2 billion in Family-owned businesses have consist- 2016, according to the Mercator Institute for China Studies. Germany’s advanced ently accounted for about 10 percent of the manufacturing capabilities were the biggest attraction for Chinese investors with German buyout market, which corresponds automotive and industrial equipment accounting for more than 6 percent of total to 30-50 transactions per year with enter- Chinese investment since 2000. prise values ranging between €50 million Andreas Simon says: “When you speak to M&A advisors, they are quite cautious and €250 million, Grede says. That propor- on engaging and involving Chinese investors on the buy-side because there has been tion has increased to 20 percent in the last a change in the regulatory framework where Berlin can have a say.” two years. A lack of clear, predictable rules around Chinese investment into Germany makes Much of that increase is accounted for it tough to engage with Chinese bidders. by companies founded 30 years ago with “When it comes to transaction certainty – which plays a role when it comes younger business models, such as software to exits – GPs have to think twice before engaging in a deal with a Chinese party and IT services. because it will be subject to regulation. That’s the new environment we are facing,” “It seems to me that the owners of these Simon adds. first-gen companies have a different view – In addition, helping portfolio companies set up subsidiaries in China means also they don’t have a dynastic view. They are thinking hard about whether that could derail a future sale to a US buyer, given the 55 years old, thinking about their personal ongoing US-China trade tensions. life. They want to enjoy life and don’t want

Share of total investment volume by sector (%) ...... and by investment phase

0 5 10 15 20 25 30 35 Venture capital ICT Business products and services 14% Consumer Biotech Energy Chemicals and materials

Construction Financial Buyouts Transportation Growth/ Turnaround Others (includes 70% agriculture, real estate, etc) 16%

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“The most successful GPs invest more in infrastructure, invest more in functional capabilities, such as operational teams, digital teams or financing teams. This also means investing in infrastructure as it pertains to industry expertise”

PHILIPP PATSCHKOWSKI Neuberger Berman

to stay in the office until they are 75,” says data, while those at the large end of the Grede. market – companies with revenues of be- “That explains why the proportion of tween €100 million and €500 million a year family-owned businesses in private equity – made up only 5 percent of the total share is increasing.” and are often acquired by large pan-Euro- Simon, who is also co-head of industry pean firms. and technology at Capvis, says what’s in- Two of the largest deals last year were teresting is the technology available with EQT Partners’ €2.2 billion acquisition limited cost that has the ability to reshape of SUSE Linux and Cinven’s €1.7 billion industries. takeover of Generali Lebensversicherung, “You can consider it a threat for estab- according to EY’s German Private Equity lished businesses but also as an opportunity Deal Survey 2018HY2. because new business models are emerging, Grede points out, however, that tap- founded by a relatively young generation ping opportunities in Mittelstand or small who have a different approach,” he says. and medium enterprises isn’t new and can Capvis portfolio company B2B market- be quite challenging. place ‘Wer liefert was’ recently acquired “It’s all about cultural differences. For gebraucht.de, a Berlin-based start-up that a German entrepreneur who has taken develops software and infrastructure for over a business founded by his father or the consumer sector. great-grandfather, his company is part of Close to 80 percent of PE-backed com- his life and the family. That explains why panies in 2018 had an annual turnover of a large number of Mittelstand companies do less than €10 million, according to BVK not come to market.” n

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