Deutsche Beteiligungs — Valuations hit by macro headwinds

DBAG reported a €35.8m net loss in H122 ending March 2022 (H121: €73.1m net profit), due to a downward revision of its portfolio value amid deteriorating macroeconomic conditions and declining public market valuations. Meanwhile, the fund services segment continues to generate stable income, broadly in line with management expectations.

The private equity investments segment generated a €41.5m loss (H121: €64.7m profit), which stemmed from a €61m decline in portfolio valuations (down 11% vs end-September 2021) with segment costs remaining broadly flat, while gains on disposals amounted to €13.9m in H122.

The impact of change in multiples amounted to a negative €96m (reducing portfolio value by 17% vs end-September 2021) amid deteriorating global equity markets (see Exhibit 2). This particularly weighed on the valuations of DBAG’s IT services and software holdings (which make up a third of DBAG’s growth portfolio) as US-based tech indices1 declined on average by 10% in the first three months of 2022. Consequently, DBAG’s growth portfolio is currently valued at 2.0x cost vs 2.6x at end-December 2021. We note that 16% of the portfolio represents companies acquired less than 12 months before the reporting date and is valued at acquisition cost, including both industrial (Dantherm, Itelyum) and tech companies (in-tech, freiheit.com). Additionally, DBAG’s portfolio valuations do not reflect further price declines in the public equity markets seen post end-March 2022.

DBAG’s core portfolio of industrial companies (largely based in Germany) was affected by input cost inflation (including growth in energy prices) and supply chain bottlenecks triggered by the Russian invasion of Ukraine, Western sanctions on Russia and lockdowns in China as part of zero-COVID policy. As a result, the German government's council of economic advisers currently expects real GDP growth in Germany of 1.8% (vs 4.6% forecast earlier) and sees a risk of recession if supply chains and energy security continue to deteriorate. This was reflected in German equity valuations, with the DAX Index decreasing by 9% (and its industrial sub-index falling by 11%) in the first three months of 2022. DBAG’s industrial portfolio is currently valued at 0.9x acquisition cost (unchanged versus end-December 2021).

The changes in earnings of the portfolio companies increased the valuation of the portfolio by €23m, mostly due to positive effects from add-on acquisitions closed during the period. On completion of an add-on acquisition, its budgeted results for the current year are added to the acquiring (platform) company’s budget. As these bolt-on acquisitions are often carried out at a lower valuation multiple than the ratio at which the platform company is valued by DBAG (which is also applied to all completed add-ons), these transactions are normally value-accretive immediately. According to management, such uplifts had a meaningful positive effect on DBAG’s NAV in H122.

The above effect offset the negative earnings contributions from higher-risk discounts applied to 11 of DBAG’s portfolio companies which are unlikely to reach their budgeted results amid the above-mentioned macro headwinds.

Finally, DBAG posted an €11m valuation uplift from a change in debt as 12 companies raised €49m in debt (mostly to finance their M&A growth), while 12 other companies used their surpluses to repay €60m of debt.

The fund services segment recorded a minor increase in fees earned (€21.9m in H122 versus €21.8m in H121), which is in line with management expectations. DBAG funds charge fees predominantly on committed capital, and new investments have only a minor impact on the fee calculation basis. The expenses of the segment increased 27% y-o-y to €16.1m, which in turn led to a 37% decrease in the segment’s profit (€5.8m). This was driven by DBAG’s recent team expansion, higher consultancy expenses and a c €2m one-off expense on benefits paid in relation to terminating the employment of former CFO Susanne Zeidler, which was split between DBAG’s private equity investments and fund services segments on a pro-rata basis. According to DBAG’s announcement in January 2022, during discussions regarding the long-term strategic direction of DBAG's business model, the supervisory board and Ms Zeidler agreed that she would resign from her position.

DBAG’s financial resources decreased during H122 to €64m (from €112.8m at end-September 2021) and, including the €107m undrawn credit line, DBAG had €171m available for investment (FY21: €220m). The liquidity position in relation to unfunded commitments improved during the period, as commitments decreased by €83m following capital calls for new investments. As a result, the ‘funding gap’ (difference between commitments and available liquidity) narrowed to €20m from €54m. In addition, a further €7.7m cash is available at subsidiary level.

DBAG has announced its updated guidance, which takes into account portfolio and macroeconomic developments in H122, as well as planned disposals. DBAG now expects a net loss of €15–25m in FY22, which (given the €33.5m loss in H122) implies an H222 net profit of €8.5–18.5m. The fund services segment is expected to generate an FY22 profit of €14–16m (up from €11–12m previously), implying €8–10m in the second half of the year. This is a 40–75% increase over H122 in the absence of one-off expenses and significantly lower variable performance-linked remuneration costs expected by DBAG. The above translates into net income in the private equity investments segment of €0–8m in H222, meaning that DBAG’s valuation uplifts and other gains/income should at least cover the segment’s ongoing costs. We highlight the fact that DBAG normally designs its guidance based on stable valuation multiples compared to the last reporting date (end-March 2022 in this case), hence it does not capture the subsequent continued sell-off in public markets.

At end-March 2022, DBAG’s portfolio consisted of 36 platform companies, which mostly follow a buy-and-build strategy. The portfolio is split between ‘growth sectors’ (broadband telecoms, healthcare and IT; 45% of the portfolio) and ‘core sectors’ (industrial services, industrials and industrial technology; 44%) with the remaining 10% exposure labelled as ‘other’. The sector split remained broadly stable over the last year, despite new investments and disposals, as well as carrying value fluctuations over the period. The platform companies often use external debt to finance acquisitions (15 add-ons in H122 and 17 in FY21), and overall the portfolio is quite leveraged, with 60% of portfolio value allocated to companies with a net debt to EBITDA ratio of more than 4.0x. However, we note that part of the high average leverage is attributable to companies from ‘growth’ sectors, which have more predictable earnings and can thus take on more debt. During H122, the share of the portfolio with leverage of 3.0x EBITDA or more increased to 77% from 63%, which was predominantly a result of new debt incurred to finance add-on acquisitions. Nevertheless, the change was amplified by reduced earnings expectations in some portfolio companies.

In the first half of FY22, DBAG was quite active as it invested €92m alongside its managed funds and from its own balance sheet. This represents more than twice the amount invested a year earlier (€37.5m) and compares to €57m invested on average annually over the last 10 years. DBAG funds have completed four new investments: freiheit.com, Dantherm, in-tech and Itelyum (described in our last note) with DBAG providing €82m in total. Additionally, its portfolio companies announced a further 18 add-on acquisitions (15 of which completed in the period) – predominantly using their own resources and external debt, with DBAG providing €10m in total.

Furthermore, three investments have been agreed that are yet to be completed. In March 2022, DBAG Fund VII agreed a management buyout (MBO) of akquinet – a company in the IT services & software sector, which implements ERP systems and customises the development of software solutions. DBAG has agreed to invest up to €4.7m alongside its fund. DBAG Fund VII is now closing its investment period, with akquinet being its final MBO (although some further minor investments can be made to support the growth of portfolio companies). In H122, DBAG received the deferred management fee from DBAG Fund VII to the amount of €28m. DBAG will also invest alongside DBAG Fund VIII in MTW Holding. The transaction will mark the seventh MBO by DBAG Fund VIII (since the beginning of its investment phase in mid-2020) and DBAG’s third investment in Italy. MTW Holding comprises three companies (Metalworks, Mengoni & Nassini and FGF) that design and manufacture accessories for luxury fashion brands (eg belt buckles, fastening systems, logos and jewellery). The fund will acquire a majority position (62%) and the former sponsor (Bravo Capital Partners) and company management will remain minority shareholders. DBAG will invest up to €13m in the transaction. The third transaction announced is a long-term investment in the newly established datahub, an acquisition made solely from DBAG’s balance sheet. DBAG will invest up to €25m to acquire two data centres, which were formerly part of the akquinet group (to be acquired by DBAG Fund VII as above). On closure of the announced transactions, DBAG investments so far in FY22 will reach €135m, up 128% y-o-y and 76% more than the annual average over the last five years.

During H122, DBAG made two partial exits totalling €25.5m in last carrying value – 4% of the end-FY21 portfolio value. DBAG has sold part of its shares in Telio (communication systems for correctional facilities), as well as unlocked value in von Poll Immobilien (real estate agency), which completed refinancing.

DBAG clearly underperforms its peers over both the long and short term. We understand that its high exposure to industrials (compared to peers) has weighed on its performance both in the period leading to the outbreak of COVID-19, as well as in the current economic slowdown – as it experiences headwinds from demand changes, high materials costs and supply chain disruptions. Nevertheless, the underperformance is potentially overstated, as only three out of six peers presented in Exhibit 4 (HgCapital, Princess, 3i) have their portfolios valued as at end-March 2022, ie reflecting the recent deterioration in market conditions to the same degree as DBAG. The most recent performance figures available for ICG and Oakley are as at end-January 2022 and end-December 2021, respectively; and while abrdn Private Equity Opportunities already reported its end-March 2022 NAV, it is based predominantly on end-December 2021 portfolio valuations.

DBAG trades at a narrower discount compared to the group, which in our view is attributable to its fund services segment, which is not reflected in the NAV, while generating a recurring income. Among peers, 3i has a similar business model which is also reflected in its narrowest discount in the group. DBAG also pays one of the highest dividends among peers, with the current dividend yield at a healthy 5.6%.

DBAG’s NAV (defined as equity value) is almost entirely attributable to its PE investments portfolio, and the valuation of the fund services segment represents only a small fraction of NAV. Having said that, DBAG manages third-party assets of c €2.5bn (end-March 2022) and generates considerable fees. DBAG’s shares regularly trade at a premium to NAV (five-year average of 19%), which we believe is due to the market-implied value of the fund services segment (Exhibit 5). Given the recent strong decrease in DBAG’s share price (22% over the first three months of 2022) it currently trades at an unusual 15% discount to NAV, still narrower than peers despite NAV underperformance.

We estimate the market-implied value of both DBAG segments in two scenarios: 1) the implied value of private equity investments, assuming fund services are valued in line with peers; and 2) the implied value of the fund services segment, assuming the private equity investments are valued in line with peers. As peers to DBAG’s fund services segment, we use a group2 of listed asset managers with exposure to alternative unlisted assets, such as real assets, PE or infrastructure (as described in detail in our August 2021 note). In the case of private equity investments, we use the peer group as presented in Exhibit 4 above, excluding 3i.

Given high visibility in terms of income generation in the asset management business, valuation multiples in the sector were less volatile in recent months compared to the greater uncertainty about the value of underlying companies in PE portfolios. Having said that, assuming the fund services segment is valued in line with peers (17.4x earnings multiple), the implied value of private equity investments is at €235m, ie 63% below its NAV, while peers trade at a 26% discount. On one hand, DBAG’s wider discount may be justified by NAV underperformance and exposure to German industrials. On the other hand, a 63% discount seems relatively wide, especially given that DBAG’s portfolio value is already reflecting developments in the first quarter of 2022, unlike some peers. Assuming that PE investments are valued in line with peers (which is less likely than the first scenario in our view), the value of the fund services segment is €74m, a 4.9x earnings multiple versus the 17.4x peer average.