Frankfurt When the top managers of billionaire private equity funds gather in Berlin this week for the Super-Return Conference, some will wonder whether the world’s most important meeting place for the industry is still rightly named. A whole range of stress factors is putting pressure on the business model of financial investors.
The long phase of low interest rates ensured that the investment companies were able to buy medium-sized companies and parts of large corporations with cheap credit. After a few years, the financial investors passed on the investments at a higher price or listed them on the stock exchange.
But after the historic turnaround in interest rates, takeover financing has become expensive and rare, new funds are getting less money than before and portfolio companies have to cut costs rather than focus on growth during the recession.
“Financial investors are under pressure from many sides, this is a new situation for many investment managers,” says Christian Kames, Managing Director at the investment bank Lazard.
Large deals are stuck or cannot be implemented
It is becoming more difficult for private equity funds to obtain the necessary credit for mega deals – but sometimes large transactions are also dependent on strategic considerations. According to information from financial circles, a few days ago Lufthansa selected the financial investors CVC and Advent for the final bidding round for its maintenance subsidiary Lufthansa Technik, which is worth six to seven billion euros. It is still unclear when exactly the offers will be due, according to the current schedule sometime in July, according to the financial circles. Discussions are currently taking place as to what say the investors should have in Lufthansa Technik.
Skeptics doubt whether Lufthansa still needs the sale given the booming business and will go through with it. In the largest private equity deal that is being prepared in Germany, the sale of the Bahn Logistics subsidiary Schenker, the management recently dampened hopes that the deal would be completed quickly. According to the management, there is still no fixed start date for the sales process for the around 15 billion euro company.
Another billion dollar deal failed a few days ago. The German Football League (DFL) wanted to sell a 12.5 percent stake to a financial investor, but did not find the necessary majority among the Bundesliga clubs.
At the moment it does not appear that the economy for large deals by financial investors will improve over the course of the year. “In view of the economic challenges, we see that companies that are put up for sale are often withdrawn from the market, mostly because the market exploration has not produced satisfactory results or a decision is made to take further measures, not least in the form of acquisitions, to further increase the value of the company before selling it,” says Thomas Neubaum from the law firm Allen & Overy. “With deals up to one billion euros, you see a steady flow of transactions, above this mark it becomes more difficult. Currently, there shouldn’t be more than ten deals in the billions in the pipeline in Germany, which is significantly fewer than before,” adds Lazard banker Kames.
According to figures from Dealogic, there were only 990 deals worth 214 billion euros involving financial investors worldwide in the year to date by the end of May, compared to 1,477 transactions worth 654 billion euros in the same period in 2022.
Collecting capital is becoming much more difficult
Before the corona pandemic and the Ukraine war, private equity funds were getting bigger and bigger, but for many investment managers these days are over for the time being. Because of the rise in interest rates, institutional investors can once again switch to bonds from governments or top companies as investment alternatives, which are less risky and these asset classes are also very liquid, while the capital in private equity funds is tied up for ten years or more.
In the past six to eight months, it has become much more difficult for financial investors to collect fresh money, says Ralph von Selzam, private equity banker at BNP Parisbas. “Many expect that given the rise in interest rates, it will be more difficult for private equity to achieve the promised returns,” warns the expert.
More meetings are needed to secure capital for new funds, with large funds generally having an easier time than small ones. “For most private equity investors, fundraising is the main topic right now,” agrees Christian Keller, co-head of Houlihan Lokey’s European Financial Sponsors Group. Investors would have to think carefully about when to enter the market. This also has a major impact on their deal activity.
No investor wants to take the risk of being below the initial valuation when starting their fundraising with the last company they acquired. “Therefore, many are currently keeping their hands off companies that are highly interesting in the long term, but could perhaps suffer from a cyclical weakness in the short term,” says Keller. “Fundraising is getting harder, the new funds are getting smaller and launching is taking longer,” summarizes Lazard banker Kames.
Contested middle class
In contrast to the mega deals, there is still movement among medium-sized companies, and a steady stream of transactions can be expected in the coming months. According to financial sources, the manufacturer of laboratory power supplies, EA Elektro-Automatik, is for sale. The financial investor Bregal could achieve a valuation of well over 700 million euros for the company with an operating result of over 60 million.
According to financial sources, the 400 to 500 million euro IT service provider Avenga has been put up for sale by its owners Oaktree and Cornerstone. The financial investor OEP wants to separate from the test tube company DWK Duran. In view of the rather restrained response, however, it is currently unclear whether the sales process will continue.
According to financial circles, three large manufacturers from the packaging industry in German-speaking countries could soon change hands. The companies mentioned declined to comment or were initially unavailable.
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In the medium-sized sector, however, financial investors compete with buyers from industry and service providers. Valuations are also stagnating or falling here, too. The average purchase prices for European SMEs fell to 9.7 times operating profit (Ebitda) in the first quarter of 2023, in the previous quarter they had fallen below the 10.0 mark for the first time since 2020, reports the investment company Argos Wityu.
For the financial investors, the principle of hope now applies: “The deal pipeline for the second half of the year is still rather thin, but we expect increasing activity and an attractive deal pipeline for 2024. We also see an increasing interest in working with Private Equity,” says Martin Suter, co-head of investment banking at Rothschild & Co in German-speaking countries. The partnership approach is also in the foreground for the financial investor CVC. “We want to develop companies together with founders and families and make them the best in their industries,” says Daniel Pindur, Managing Partner at CVC. After several years, the financial investor parted ways with a joint venture with the industrial gases manufacturer Messer in a very lucrative deal this week.
The industry is reinventing itself
Despite all the problems, the private equity industry probably has the strength to survive this crisis as well. After all, the investment funds coped with similar adversities even after the financial crisis of 2008/2009 and continued to grow.
Structural changes to the business could help: “Alternative deal structures such as minority shareholdings, partnership deals and also continuation vehicles have become established over the past few years and we expect this trend to continue,” says Rothschild’s Suter. With continuation funds being a relatively new phenomenon in the industry, private equity funds can hold on to a successful company longer and not have to divest themselves after three, four or six years.
However, the model has also been criticized because it keeps attractive companies away from the sales process. Financial investors argue, however, that this eliminates the pressure of having to sell portfolio companies at any price and in times of crisis.
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2023-06-05 01:00:43
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