Rich pickings Prices high, investors grumpy in German private equity

Lots of cash and low interest rates are making mergers and acquisitions attractive, but heady demand is making assets expensive.
A metaphor: So many rings, so few fingers.

Business is good for financial investors, especially in the United States. The deal volume in January was 25 percent higher than at the start of 2017 - and that doesn't even include investment company Blackstone's latest megadeal. Although 2017 was record-setting in Germany too, it led to high prices that dampened activity – and the mood – in the final quarter, when the German Private Equity Barometer fell to 66.1 points, four points below the record set in the third quarter.

The persistently high entry points for young technology companies tempered sentiment for the first half of 2018. But higher takeout prices for corporate units and small- and mid-sized companies are also cause for consternation. Ulrike Hinrichs, member of the management board of the BVK financial investor association, believes that an outstanding year has come to an end for the German investment market. The association collaborates with the state KfW bank to prepare the barometer for exclusive publication in Handelsblatt. The experts remain optimistic for 2018, although the "ambitious valuations" are likely to continue.

"There is undoubtedly a lot of money in the private equity market and valuations are high," said Markus Brennecke, head of German operations at Swedish investor EQT, adding that there is fierce competition in the private equity market. In addition to the growing number of investment funds, strategic buyers are also looking for opportunities. "And those institutional investors that have gained experience with private equity, such as Canadian pension funds, are now investing directly," Mr. Brennecke added.

The German market for equity capital was dominated by superlatives in 2017. The business climate for the sale of investments and initial public offerings has never been better. Collecting new funds is also a cinch with professional investors routinely offering well-known investment funds more money than requested. After exactly 10 years, the market has surpassed the record levels of the pre-crisis year 2007.

01 p29 Highs and lows-01

High entry prices and high buyer dissatisfaction are the result. Those who have misjudged their holdings will have a problem in an economic downturn, said Mr. Brennecke. The outlook for the investment market in 2018 is also good – but there is a risk of overheating if the influx of funds continues. In contrast to the US, climbing European interest rates aren’t yet likely, meaning investors will continue to look for opportunities elsewhere, keeping cash flowing and prices high.

Even though companies are more open to accepting outside investors rather than bank loans or lines of credit, there’s still an overhang of private equity cash. Financial investors will continue to compete for the best deals, forcing investment managers to face continued high initial valuations.

In the German market, transactions in medium-sized businesses are particularly competitive. In the segment between €50 million and €250 million, the deal volume in 2017 climbed to €4.4 billion – the highest figure in the last 15 years, according to Deutsche Beteiligungs (DBAG), a listed financial investor. The stiffer competition for a steady number of companies is also contributing to higher prices. Many companies are now overpriced, according to DBAG management spokesman Torsten Grede. Fortunately, the industry has realized that family-owned companies have far fewer reservations about financial investors. "I don't expect a bonanza for traditional companies, but if only 1 percent of entrepreneurs think about private equity, that's enough for us," said Mr. Grede.

According to DBAG, a total of 35 larger medium-sized companies were taken over by financial investors throughout Germany in 2017. The last time there were this many such deals was in 2007. Mr. Grede believes market activity will remain high in the current year. In view of rising prices, he said, it remains a challenge for companies to increase their value – for example, by expanding their product lines or through expansion abroad.

Peter Köhler is a Handelsblatt editor in Frankfurt, reporting on banks, private equity firms, venture capital and corporate funding. To contact the author: [email protected]