PE players await DACH carve-outs uptick

The aggregate volume of private equity-backed carve-outs in the DACH region fell to its lowest figure for several years in H1 2020, according to Unquote Data. This period saw four carve-out deals with an aggregate value of almost €110.2m.

The drop in value when compared with previous half-yearly figures is largely a result of uncertainty brought about by the coronavirus pandemic in the region from February 2020 onwards, which saw a number of higher-value processes put on hold while corporates addressed urgent capital structure and liquidity issues.

While H1 2020's figures for carve-outs are comparable to previous half-yearly figures in terms of deal volume, the fact that no carve-outs valued at more than €50m were recorded in the period is significant. Carve-out deals that did take place during H1 2020 included BPE's acquisition of Dätwyler Group's Germany-based civil engineering business Dätwyler Sealing Technologies Deutschland (DST) in April 2020.

"My impression is that we saw fewer corporate carve-outs during March to June [because] companies handled their own problems and had no time to look at strategic decisions," says Simon Schulz, a partner at Aequita. However, he anticipates that this is likely to change in the near future: "Now they are more settled and are focusing more and more on strategic transactions again."

A number of sponsors were expecting that insolvency filing obligations might trigger carve-outs in the DACH region, once the German federal government's suspension of the obligation for companies to file for insolvency came to an end. The suspension was announced in March 2020 and was due to come to an end on 30 September 2020, but the suspension has been extended until the end of 2020.

In addition, Germany's Kurzarbeit scheme has been extended for another year, as announced by the federal government on 26 August 2020, meaning that many corporates that have been able to postpone significant liquidity challenges by cutting down the hours worked by employees will continue to have the option of the government backing their wage payments.

The extension of certain state support programmes will not be a silver bullet for corporates, however. Andi Klein, an investment advisory professional at Triton and head of the firm's smaller mid-cap strategy, notes that government support programmes and the effects of lockdown could actually make it more difficult to market businesses. "There will be more in-depth price discussions regarding the normal underlying earnings levels. If businesses have used Kurzarbeit, how should you look at that? Especially if you have businesses that have underperformed for a good many years – how much of that is due to the underperformance per se, and how much is due to Covid-19?"

Picking up pace
Nevertheless, Michael Cziesla, a partner in McDermott Will & Emery's private equity team, says the market is already seeing a shift: "What we are seeing right now is that the lockdown drained a lot of the equity of many Mittelstand companies – the large-cap ones are in a better position. If there is a second wave and a lockdown, partially or fully, many companies will be in difficult situations, and they are preparing for various scenarios: some are preparing for partial sales and carve-outs to ensure there is enough liquidity. They want to do this strategically and earlier to improve their equity position, rather than waiting until there is a crisis."

Carve-outs always present specific operational needs and challenges that GPs must address, and some of these processes will be complicated by the coronavirus pandemic. Klein highlights a problem unique to the current crisis: "Management teams have to operate in a volatile economic environment, where you have to manage Kurzarbeit, capex cuts and some permanent layoffs, adapting to non-physical meetings and sales. On top of that, the issue of how to carve themselves out with the help of the acquirer is a serious undertaking. People will look at how the deals are being prepared, and what the management capacity and experience is. In a more stable economic environment, this would have been easier to manage."

Difficulties in securing financing for deals have been widespread across Europe during the pandemic. For non-distressed carve-out situations, which can still be leveraged, questions of company financials can be challenging for lenders. Says Klein: "Generally, leveraging banks apply caution when it comes to carve-out financials, since there is always a risk of underestimating the needs of a business. And in a volatile economy, that could be subject to further weakness – people will talk about creative structures. Unavailability of leverage could be replaced by a vendor note."

Resilience is key
Certain business models and sectors are likely to be prioritised by both GPs and lenders when making decisions about risk level. "Business services will see good backing from lenders, unless you cater to an industry that is in distress," says Klein. "There is also a lot of carve-out appetite for consumer and healthcare. We have seen debt funds get more defensive in harder economic environments, with a run for more stable businesses. I would think they would continue to focus on that. For businesses that are more exposed to cycles, they are likely to be extra cautious. But the competition for the better assets will be very fierce and that may impact margins and documentation."

The Q4 carve-out pipeline is currently set to include a number of chemicals businesses. According to Unquote sister publication Mergermarket, the sale of Solvay's strontium carbonate, barium and sodium percarbonate units is underway, as well as Steag's Power Minerals division. Mergermarket reported in July 2020 that teasers had been circulated by Solvay's adviser Lazard, while indicative bids for Steag's business unit are expected at the beginning of October. In July 2020, Lonza, advised by Bank of America and UBS, announced its intention to begin the sale of its speciality ingredients unit in H2 2020, while Lanxess is in preparatory stages of selling its leather chemicals division.

Klein expects the market to present a range of assets in the coming months, comprising both distressed and more stable businesses. "We will see a mix of well- and under-performing units. The top performing units will be sold by sellers with cash needs or who are in distress. The more difficult businesses will probably be sold by corporates that have unsuccessfully tried to turn the businesses around themselves for a while and now need to divest."

Oliver Würtenberger, a partner at Accursia Capital, anticipates that corporate decision-making and processes could advance quickly: "Covid-19 has pushed certain developments at a much faster pace: it has pushed the fast forward button to two or three years ahead on developments that companies might have already anticipated. So processes might jump forward with a new sense of urgency."

Click here to view a pipeline of live, expected and pulled DACH sale processes on Mergermarket.

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• Topics
• DACH
• Investments
• Unquote Data
• coronavirus
• Carve-out