Strong economy belies faltering buyout market in Germany

Germany, Europe's powerhouse economy, has been remarkably resilient in the face of southern European problems. The largest economy in Europe and a major world manufacturer and exporter is so successful, it is today seen as a lifeline for heavily indebted nations such as Greece and Spain.

Indeed, it has played no small part in holding the eurozone together for over a year of troubles, but these problems are starting to take their toll.

For the private equity industry, this means shrinking debt availability and a drying up of deal opportunities. The eurozone's biggest economies, Germany and France, have both seen private equity activity tumble in 2012 after several years of growth in the wake of the financial crisis of 2008/09.

The first three quarters of this year have clocked up just 26 buyouts in Germany, compared to 76 in 2011 and 55 in 2010 (full-year figures). At the current rate of investment activity, there is a real threat that German buyout volumes could fall below the 2009 trough.

Values are down too, with €4.25bn transacted in the first nine months of this year compared to €6.98bn across the whole of last year. EQT's acquisition of BSN Medical accounted for more than a third of this year's value.

The figures paint a grim picture; perhaps surprising, considering Germany's general economic strength and wealth of mid-market businesses, which one might assume would translate into a resilient private equity market.

"There are two major factors affecting the German buyout market right now," says Dr Hanno Schmidt-Gothan, managing director of Perusa Partners.
"Firstly we've got a lack of financing, which we're seeing elsewhere in Europe because of all the problems banks have been having. However, in Germany we've also got inflated prices to deal with."

The relative strength of the German economy has meant that businesses are still very profitable, and vendors have high price expectations when selling their businesses. Combined with a lack of finance availability, many buyout investors are finding it difficult, if not impossible, to secure deals at a price that makes sense from an investment perspective.

Preiswert
High pricing is not unusual at present. For the last few years, GPs across Europe have complained that, while the economic situation has been dire, many vendors have refused to cut their prices and EBITDA multiples have remained stubbornly high. This trend, while showing some signs of abating recently according to research by Argos Soditic, is also being driven by the growing presence of corporates in the deal room.

Having hoarded cash for the past few years, many corporates are now cash-rich and seeking out acquisition opportunities to help them grow, as their existing markets are often stagnant. As corporates come to dominate auctions, private equity bidders are squeezed out. "We are seeing far fewer financial investors in the deal room these days," says Schmidt-Gothan.

However, high price expectations are starting to fade, according to André Mangin, managing partner at Deutsche Beteiligungs AG (pictured): "What we've seen in the automotive industry is a lowering of price expectations as export markets in southern Europe have declined, and Asia is not providing as much growth as might have been expected. High prices have been a feature of the first half of this year but should become less of an issue," he says.

Don't bank on it
Tough leverage conditions have been a feature of the buyout market since the financial crisis erupted in 2008, and continue to weigh on the German market. Adding to a general aversion to risk among banks, new regulations such as Basel III are likely to further limit the ability of banks to lend and will curtail any recovery in the buyout market.

Furthermore, there is a growing threat of national regulation on the banking sector. In September, former federal finance minister Peer Steinbrück called for a ban on bank lending to private equity funds, raising concerns from the BVK.
However, despite difficult financing conditions, today GPs may have more options available to them than in the past. Alternative non-bank lenders are becoming increasingly common in the market.

"We're seeing more of these kinds of lenders, and it's something we're watching carefully, but at the moment it's an expensive way of financing deals. I think in the future we will see these players gain ground," says Mangin.

While these kinds of lenders might provide more options, there remain concerns about their suitability. "We get a lot of calls from people offering alternative forms of financing, but when you sit down with them, it often turns out to not really be economically viable," Schmidt-Gothan explains.

Mangin is also concerned providers might not fully appreciate how to do business in Germany. "Some are trying to enter the market without understanding the dos and don'ts of German business."

Heading for the exit
The picture appears gloomy, but there are reasons for optimism. The increased presence of corporate buyers is providing good exit opportunities for funds that, in many cases, have been sitting on portfolio companies for some time.

"We expect the market to remain stable and the economy will continue to be difficult, but we don't mind those scenarios," explains Mangin. "Challenging conditions means we can still arrange financing due to our long-standing bank relationships."

Schmidt-Gothan agrees that the market offers a lot of opportunities.
"There are potential deals on the horizon and we're seeing good dealflow.
Lots of companies in Germany offer the potential to be built into pan-European leaders in their fields. Also, when you sit down and talk to vendors, you can arrange flexibility in financing that is needed to get deals done."

German buyout activity is expected to remain subdued for the remainder of
2012 and will almost certainly come in below 2011 levels. However, challenging times create opportunities and private equity funds should be well placed to take advantage of these.

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