Germany's private equity train losing steam

Regularly vying with France for a second-place ranking for both deal volume and value behind the UK, Germany appears to be somewhat running out of steam.

It is against this backdrop that Warburg Pincus announced the closure of its Frankfurt office in July. The retreat back to the UK – its "centre of expertise" – ends the global investor's operations in the region after almost a decade.

The retreat could be due to the more favourable tax regime on UK shores. "I think taxation issues for private equity are better in the UK than Germany," says Wilken von Hodenberg, BVK board spokesperson and supervisory board member for Deutsche Beteiligungs AG (DBAG). Private equity management fees are subject to Germany's 19% rate of VAT and, although Germany provides a 40% tax exemption on carried interest, the remaining 60% is met by a 45% rate of tax. Compare this to the UK, where management fees are untaxed and carried interest is treated as capital gains, and the country's 28% tax rate is an inevitable pull.

GPs are not alone in their disappointment; LPs too feel Germany has gone off the rails this year. Limited dealflow has frustrated investors looking to take advantage of Europe's economic power house. According to the Indicator of Economic Sentiment for Germany, a monthly study of attitudes carried out by the Centre for European Economic Research (ZEW) in Mannheim, morale has plummeted to its lowest level in more than 18 months. This comes as no surprise considering the official assessment for the future economic situation has markedly – and dramatically – declined. ZEW links this decline to the ongoing geopolitical tensions in eastern Europe, which have contributed to uncertain sales prospects.

At 80 transactions, Germany's deal volume in H1 2014 is significantly lower than previous half-year results. According to unquote" data, it has been almost a decade since deal volume was lower. Moreover, the last time German private equity firms conducted fewer than 100 deals was in the second half of 2010.

Sizing up the competition
"It's not that the asset class is not willing to pay decent prices – the financing side is in place; banks are willing to lend; interests rates are low so borrowing costs are cheap. Businesses are in good shape, but there's competition," explains von Hodenberg. "Industrial buyers are sitting on cash and are quite intentionally looking for add-on opportunities. There are lots of family offices, which act like private equity but without a formal fund structure. The cake will be divided and it may be that there are fewer deals for private equity. But these things fluctuate."

Indeed, fluctuation seems to be the norm in Germany of late. While deal volume may have declined in the first half of the year, value showed a slight uptick on the previous half's results. Germany topped the board for large and mega-buyouts in the most recent unquote" Private Equity Barometer – published in association with SL Capital Partners – with six of the top 10 pan-European transactions in Q2 2014 involving German companies.

Despite the strength of the large buyout segment, another blow came with the latest German GDP figures, which shrank by 0.2% between April and June. Nevertheless, Von Hodenberg remains upbeat: "A small setback is nothing to worry about. If it continues for a number of quarters then you have to reassess the situation."

Whether the decline continues remains to be seen, but are these the nascent signs that Germany is heading for the wrong side of the tracks? It is unlikely that a poor first half will derail the economic engine entirely considering its strong momentum, but the country will need to up its game to counteract negative investor sentiment and steam ahead.

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