Deutsche Beteiligungs – Five things investors need to know

As businesses increasingly opt to stay private for longer, and the number of listed companies has not expanded in recent years, private equity has become a compelling addition to listed equity exposure, as it provides access to actively managed, attractive companies not accessible through public markets. Institutional investors have already recognised the opportunity in private equity, and have steadily increased their exposure to the asset class over the last decade and at higher average target allocations (they now often allocate between 5% and 15% of their portfolios to private equity investments).

However, investments as limited partners or co-investors in top private equity funds are normally reserved for institutional investors and accredited high-net-worth individuals, and are subject to high minimum ticket sizes (often several million US dollars or more), and are therefore beyond the reach of the average retail investor. These investments are also relatively illiquid, as they are locked until a fund completes its fund-raising investment realisation cycle (which may take around 10 years). Fortunately, a range of listed private equity companies provide investors with a convenient route to gain exposure to private equity portfolios managed by experienced general partners. Deutsche Beteiligungs (DBAG) is one of these.

#1 DBAG operates a unique business model as investor and asset manager focused on the private equity (PE) mid-market in the DACH region (Germany in particular) and neighbouring countries
DBAG is a private equity investment and fund management company (with total AUM of c €2.6bn at end-March 2023), focused on the PE mid-market, looking for businesses with an enterprise value between €50m and €250m. It often acquires companies that were not previously owned by PE (they are frequently owned by the founder or the founder’s family) and represent low-hanging fruit in terms of value creation (frequently available at lower entry multiples than large/mega buyouts). The company has been the go-to partner for German families looking for buyers of their businesses. In this context, we note that the German PE market is characterised by quite a high share of primary transactions (ie when the seller is not a financial investor) and has doubled over the last decade (growing at 7% pa), mainly driven by a rising number of family successions.

#2 DBAG recently made several successful realisations despite tough PE exit markets
Despite recent muted global M&A volumes (weighing on exit activity across PE markets), DBAG has completed several successful exits in late 2022 and early 2023. These include Cloudflight (sold at a multiple of invested capital, MOIC of more than 4.0x), Pmflex (MOIC of over 2.0x after a short holding period from September 2020) and BTV Multimedia (agreed in February 2023 at a MOIC of c 3.0x). DBAG also agreed to sell Heytex, the last remaining investment of DBAG Fund V, where management highlights that it was able to close the transaction successfully despite the company’s sensitivity to gas prices. The realisation proceeds represent cash inflow in the high double-digit-million euros, according to DBAG’s management, and have therefore significantly boosted DBAG’s liquidity and provided a good base for further growth (DBAG reported net cash inflow from its investment activity of €73.4m in H123 on the back of the disposal proceeds).

#3 DBAG’s portfolio composition has changed a lot over the years, with an increasing share of ‘growth sectors’
Historically, DBAG’s portfolio largely reflected the German industrial mid-market, with industrial businesses making up 80% of its portfolio in FY15. Since then, DBAG has consistently increased its exposure to other sectors like broadband & telecommunications, IT services and software, and healthcare. These represented 46% of the portfolio at end-March 2023 and have provided a cushion against the macroeconomic headwinds which have been affecting DBAG’s industrial portfolio since 2019.

#4 Outlook for the German economy is looking brighter
While the macroeconomic outlook remains uncertain, it has improved somewhat for Germany compared to late 2022, as the risk of a gas shortage has diminished, energy prices have softened and policy support for households and companies has been implemented. Moreover, supply chain bottlenecks have started to ease as China’s economy has reopened. A rebound in Germany’s economic activity could prove supportive of DBAG’s industrial and industrial services portfolio. The European Commission expects Germany’s GDP to increase by 0.2% this year, highlighting the fact that its industry has proved resilient to elevated production costs, and equipment investment is set to recover as full order books support manufacturing and exports. That said, we note the weak March factory orders in Germany, suggesting that the road ahead may not be entirely smooth.

#5 Management remains confident in the liquidity position across its portfolio
Unlike VC funds, PE funds like DBAG invest mostly in more mature businesses which are profitable over the cycle. That said, we note that average leverage (calculated as net debt to EBITDA) across DBAG’s portfolio has increased in recent years, with 64% of its portfolio exhibiting a net debt to last 12-month EBITDA ratio of more than 4.0x at end-March 2023 versus 27% in March 2021 (although the share of holdings with leverage above 3.0x declined from 77% at end-March 2022 to 72% at end-March 2023). The degree of leverage depends significantly on the individual business model of a portfolio company: resilient, non-cyclical business models with stable cash flows and structural growth typically allow for a higher degree of leverage compared to cyclical/industrial business models. As such, the change in DBAG’s portfolio, with a rising share of IT services & software, likely explains some of the change in overall portfolio leverage. Part of the increase in average leverage across the portfolio is likely also due to higher working capital funding requirements and the recent pressure on margins experienced by some industrial holdings caused by cost inflation, supply chain disruptions and project delays, coupled with deteriorating economic conditions last year. Furthermore, management highlighted recently that it does not expect liquidity injections into its portfolio in the current economic cycle meaningfully to exceed the c €15m it provided in 2020 amid the COVID-19 outbreak.