The German Private Equity Market: Analytical Essay

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1. Introduction

Private equity (PE) is a fundamental pillar of the financial system. Governments in the European Union (EU) are eager to keep private investments fluid and buoyant. This is critical especially in the era where global economic growth appears to come to a halt. In today’s world, new companies tend to remain private for long and many existing public companies tend to go private, in most cases, attracted by the ability to effect transformational change away from the onus of quarterly earnings. Given this reach of PE firms, it is important to understand how the industry functions, its drivers and dynamics.

Historically, the German private equity market has struggled to perform at par with its European peers like UK and France. However, over the last 5 years the German buyout deal value as percentage of GDP has increased from 0.64% to 0.77%, a jump of 19%. This is still small when compared to UK, France or even Finland but definitely an improvement for a country where PE is looked upon as “locusts”, a term coined by Franz Muentefering (Social Democratic Party leader) in 2005. However, the recent growth demands that the industry is looked upon from a critical eye to ascertain its growth and impact on the industry.

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The below study is an attempt to analyze the German PE market by looking at recent trends and statistics via academic research but more importantly by publications of eminent consulting and research companies like BCG, PwC, E&Y, KPMG, etc. This gives our study a much-needed practical lens.

2. Private equity business model

PEs are companies that aim to take a controlling stake in businesses (referred to also as Portfolio companies). In many instances, PEs tend to aim a complete takeover so that they can easily push through transformation and operational improvements in the portfolio companies. If PEs acquire a company listed on the stock exchange, post the transaction, the company is taken off the stock exchange. The profit is earned by two sources. The PE has control over the revenue and income of the portfolio company during the entire duration of the holding period and in addition they aim to make profit upon resale of the business upon exit. PEs tend to operate multiple close-ended funds which are the primary source of their money. The private equity companies receive a fee for fund management, and they also participate in profits once a break-even point is reached. The remaining profit flows back to the fund investors as shown in Figure1. ,

Figure 1. Main stages of the investment process and key parties involved Source: Söffge, 2015

3. Private equity firms: Creating value

Which mergers and acquisitions (M&As) succeed and which don’t and to what extent is a core fundamental topic of all corporate finance research. Private equity professionals, strategy consultants and related M&A parties aim to maximize the value they create both pre and post M&A. Millions of dollars are spent on value-enhancing pre-sales and on post-merger integration (PMI). The same is true for Private equity transactions. Organizational culture, conflict of interest, poor execution, etc. could all be the factors leading to a poor post M&A performance. There is quantitative and qualitative research done on this topic and below is an extended theoretical model proposed by Berg and Gottschalg (2005) for value creation (Figure 2).

Figure 2. Value generation in buyouts with primary and secondary levers Source: Hannus, 2015

Multiple researchers like Achleitner et al. (2010) taking a sample of European PE deals have found that one-third of the value created results from the use of leverage, 45% from operating improvements and close to 20% from multiple expansion, i.e., the change in transaction multiple from entry to exit. They also present an important piece of research that finds abnormal performance in PE deals, compared with publicly listed peer companies from the same industry. The results show that abnormal performance is largely influenced by increases in sales and in operating margin during the holding period of the portfolio company. They also note leverage as an important driver of value creation. Lerner et al. (2011) use the patenting behavior of PE-owned firms as a proxy for how focused they are on long-term investments, supporting the notion that PE investors help portfolio companies by strengthening their focus on those activities that add most value. This is also supported by multiple research from corporate players like BCG (Figure 3).

Figure 3. Operational improvement is the value creation strategy of choice Source: Brigl, Jansen, Schwetzler, Hammer, & Hinrichs, 2016

4. German private equity market

Germany is one of the key European markets. The country is financially stable and is widely regarded as the powerhouse of Europe. It is quite natural that the country is one of the most attractive destinations for private equity investments. German businesses spend a considerable amount of their share of revenue on research and development (R&D) and technology development and thus domestic companies are known widely for their innovation, efficiency and quality of goods and services.

Figure 4. Top countries by PE deal value, 2015 Source: Heberlein, 2017

Germany is the 2nd largest PE market behind UK on both volume and value basis (Figure 4). Globally, the German PE industry ranks 5th largest. However, when factoring in the GDP and large size of the German population, ratio of PE per GDP basis is quite low. One very commonly known reason for this low PE activity is the aversion of the German SMEs (small & medium-sized enterprises), commonly known as “Mittelstand” to PEs. , For years, GPs (General Partners) have sought to “crack” the Mittelstand, waiting for a change in attitudes towards the selling to financial sponsors of family-owned businesses, which have often been passed down multiple generations. This perseverance of funds is bearing fruit which is evident in the robust volume and value of the German PE market in the last years. This growth is widely expected to continue to remain strong. According to a PwC global family business survey 2018, 83% of family-owned businesses are said to be open for investment in private equity firms. In comparison, the number in 2013 was 61% and in 2011 only 18%. The image of private equity has thus completed a full transformation within the last 6 years and further reinforces hopes being high (Table 1).

Table 1: Openness to PE by German “Mittelstand”

2011 2013 2017

% of family- owned German business open for PE investment




Source: Wills & Englisch, 2018

For PE funds, Germany provides a strong investment opportunity in Europe. The country has largely been resilient to market volatility, growth rates have been steady and even raising capital is easy. In a PwC survey, a clear majority of 71% of respondents view Germany favorably in comparison with other countries as a location for private equity investment and 62% of PE companies intend to invest in the country in the next five years. One of the major benefits of investing in the country is the engineering and technological expertise of its companies, which ensures strong export demand for products manufactured in the country. This allows even small companies to benefit from high growth in Asia and other markets where German SMEs export to and offers natural currency hedging and sustains demand amid sluggish growth in Europe.

4.1. German private equity market: Statistics

The German PE market has evolved considerably since the crisis in 2009. The Global financial crisis meant that PE deals almost dried up in that period. Only 111 PE deals were completed in 2009 whereas this number even fell to 103 deals in 2010 (Figure 5). Since then the market has been in recovery mode and in 2016 PE activity in Germany was at its peak with over 190 deals executed whereas in 2017 a record number of 210 deals were executed. Although in number of deals 2017 was much better than in 2016 but on a value basis 2016 was much higher. These trends indicate that the German market is fully out of crisis and is on a growth mode with strong investor confidence.

Figure 5: PE deals development during and after the financial crisis Source: Kron, Taudte, & Hackober, 2017

The German Private Equity and Venture Capital Association – BVK is the face and voice of the private equity industry in Germany. The objective of the association is to promote the industry and take a stand on policy in cooperation with the PE players, government and media. In figure 6 is a PE Barometer the association publishes on a quarterly basis. As seen in the figure, it is apparent that the industry underwent a huge drop during the financial crisis (`08-`10) but since then has rebounded and is looking northwards.

Figure 6: German PE Barometer, 3. Quartal 2018 Source: Metzger, 2018

4.2. German private equity market: Sector focus

Given the historic importance of industrial and chemicals in Germany, it is not surprising that the PE deal focus in the last 7-8 years has been on industrials and chemicals (Figure 7). However, over last 2 years sectors like technology, media and telecom (TMT) have gained ground (Figure 8). Over last years, especially, during the European financial crisis consumer sentiment was cautionary leading to a decrease in share of deals into consumer and retail industry. Technology seems to be a pure winner. The role of technology especially in the context of Industry 4.0 will be discussed in subsequent sections.

Figure 7. DACH Buyout volume, split by industry, 2012-2015 Source: Roberts & Naydenova, 2018

Figure 8. DACH Buyout volume, split by industry, 2016-2017 Source: Roberts & Naydenova, 2018

4.3. German private equity market: Increasing global interest

Traditionally, PE funds located in Germany had been able to make inroads into the German SME buyout market. However, there has been an increasing number for foreign and international PE funds which have successfully entered the DACH markets and made their marks. In 2014-2015, almost 59% of all PE transactions were led by Germany-based PE players. This declined to 49% in 2016. During this period, an increasing number of PE players from France/Benelux, UK and US expanded their coverage of the German market (Figure 9). Other than US, this trend can also be looked as “Europeanization” of the PE market. Financial investors from these countries and from other European countries in Scandinavia and Switzerland accounted for 38% of all takeovers and 53% of employees in the companies taken over.

Figure 9. Development of PE investments according to the origin country of investors Source: Kunz, Taudte, & Hackober, 2018

In addition, there has been an additional “Internationalization” via exits. Looking at successful PE exits within 2016, the share of international owners in the companies rose to over 70% and the degree of internationalization was much higher than last years. It is noticeable that financial investors from France/Benelux were able to more than double their shares in the transactions and in the employees. The European share grew to half of all company acquisitions (excluding Germany), while the American share fell to 6%. The share of sales to Asia – especially China – remained stable at 12% within 2016.

5. German private equity industry: Key strengths

Below are some of the key strengths of the PE industry in Germany:

  1. Stability in the buyout market: Low-interest rates have increased the interest of financial investors to such an extent that even strategic investors are giving strong competition to financial and institutional investors. At the same time, the increased purchase prices for companies do not seem to have significantly increased the willingness of company owners to sell. The overall buyouts market has increased by a meagre 3% over the last year.
  2. Fund-based business models dominate: There are multiple sources of generating capital for financial investors. The source dictates the risk profile and the time horizon of the investments. In the last 4 years, around 66% of all takeovers have been made by fund-based companies where the capital is fixed for at least 10 years. This type of fund backed deals have skyrocketed over last 2 years. In 2016, almost 70% of all takeovers were by fund-backed PE companies. By contrast, other financing routes namely industrial holdings, direct investments and public equity investments play a minority role.23
  3. Successful exits: The resale of companies by financial investors picked up again in 2016. Compared to the previous year, the number of exits rose by more than a third to 182 and the number of employees in the sold companies by around 22% to 102,000 (Figure 10). This significant increase was made possible by the attractive terms of sale. The low interest rate environment and the low supply of companies caused their purchase prices to rise.23 There has been only a slight decrease in successful exists in 2017 but on the positive side the € value of exits is far more than 2016. Some notable exits of 2017 were CVC selling Ista for €4.5B, Wendel selling labels division of Constantia Flexibles at €1.15B and so on. Figure 10. DACH exit trends 2012-2017 Source: Roberts & Naydenova, 2018
  4. Extension of holding period: The period in which a private equity company owns a company has increased by nine months in the 2016 exits compared with the previous year’s exits. The average holding period in 2016 was six years and two months; 70% of all companies sold had been owned by the same financial investor for between three and eight years. The longer holding periods may have been due to the more difficult conditions for re-investing the capital and more complex restructuring strategies of the financial investors.

6. German private equity industry: Key risks & issues

The story of German PE industry is positive but not without caution. The industry is still in nascent stage and lacks some key fundamentals. Below is a listing of few imminent risks being faced by industry today:

  1. Trade war: One of the largest risks looming on the global financial markets is a full-blown trade war caused by protectionist policies of US and the retaliatory sanctions by China, India and the European Union. A similar geopolitical risk is being caused by Brexit negotiations. UK is 3rd largest global PE market and thus any political risk very rapidly engulfs the PE world. These potential geopolitical risks cause an insecurity among investors that force them to increase focus on contingency planning and could create some hesitancy in the deal-making pace.
  2. Underdeveloped German market: Despite the growth and dynamic German market, the private equity market in the country is underdeveloped. On a GDP basis, the PE market is way below counterparts in UK and France. In the field of smaller and low to medium value PE deals, there is quite a dearth of interested companies. Secondly, the expectation of PE players is many times unreasonable. The growth expectations and yield estimates are unrealistic which makes exit difficult. There is also a lack of qualified and experienced fund managers along with an issue with raising enough fund in a timely manner.

7. Key private equity players active in Germany

Players in DACH have increasingly become international. Many PE firms in UK, France, China and US have raised funds to invest in DACH markets giving strong competition to Germany based PE funds. Figure 11 illustrates key players in DACH as per raised capital in 2008-2017. As are apparent, key players like Partners and Triton have raised substantially more capital than others giving them an edge when it comes to larger deals.

Figure 11. Key players in DACH as per raised capital in 2008-2017 Source: Morgan & Geen, 2018 and own analysis

Unquote, which is a key PE focused research company, tracks 33 funds which are currently fund raising or about to come to market with a cumulative capital of €14B. Largest of these is Triton followed by Capvis, Deutsche Private Equity and Bregal Unternehmerkapital. This does indicate that the PE industry in Germany will see some key deals in next years.

8. Increasing role of technology and digitalization

Increasingly PE companies have started to realize the importance and usefulness of digital and analytical tools. They have started to invest heavily in new software for portfolio analytics and management, digital platforms to better communicate with investors and automation tools for mundane and routine tasks. This was demonstrated well within the E&Ys latest PE survey. Putting aside investment in technology solutions, managers are improving operational efficiencies by increasingly relying on outsourcing of administrative and tactical tasks.

Digitalization has been on the forefront of any industrial conference and gathering recently. There is quite a lot of interest in what could digitalization do for investors and especially PEs. Rapidly developing digital business models in automotive, industrial automation and mobility are going to transform these industries. As these verticals evolve, they might mean more opportunities for PE companies to look for distressed conventional businesses and transform them. This trend is supported by the 2018 Global Divestment Study, wherein 87% of global companies have stated that they are considering a divestiture, up from 43% in the 2017 study.

In terms of outsourcing certain operating functions, 88%, 82%, and 71% of investors agree that tax compliance, treasury, and fund accounting, respectively, are areas they feel comfortable moving to third parties. For fund managers, this is a great opportunity to focus more on their core activities and reduce the time needed on admin tasks that distract them from creating value for their investors. Other areas where fund managers rely on third parties are in valuation of assets, due diligence processes and risk management services. More and more, outsourcing is endorsed by investors as a sustainable means to improve operational efficiency

The fourth industrial revolution is in full swing and Germany is an epicenter of growth in this area whether it is factory of the future or industrial automation with robots. The federal government has also recognized the potential of digitalization and Industry 4.0 within the German industry context and is supporting the industry with funds, subsidies and grants. PE firms make excellent partners in this journey as such businesses present high growth potential in a short to medium term time period along with a competitive edge business model usually in form of a patented technology. PE firms are coming out and harnessing this trend and strength within the German SME companies. There are already many examples of successful collaboration but figure 12 shows some of the key ones highlighted in the publication of German Private Equity Association.

Figure 12. PE true partners in taking Industry 4.0 in Germany to new heights Source: Hinrichs, 2015


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