Deutsche Beteiligungs — Market sentiment weighing on portfolio value

DBAG reported a €21.4m net loss for Q119 compared to net income of €10.1m a year earlier. The main reason behind this was the negative impact of lower capital market valuations that are used as a reference to value DBAG’s private equity investment portfolio. This has translated into a negative impact of €47.8m on the company’s accounting profits and portfolio value. Equity per share decreased to €28.05 at end-December 2018 from €29.50 at end-September 2018, the latter value being restated from the previous €29.76 due to accounting adjustments relating to the recognition of irrecoverable interest receivable and income from advising funds, in accordance with IAS 8. This represents a 0.9% y-o-y decrease (after accounting for the €1.40 dividend paid in Q218) and a 4.9% decline vs Q418. After adjusting for the unpaid dividend of €1.45 per share, the equity per share reduction vs end-September 2018 stands at 5.1%.

During Q119, the fair value of DBAG’s private equity investment portfolio diminished by €8.1m (or 2.3%) to €340.6m (see Exhibit 2). The reduction was largely driven by the above-mentioned market multiples revision, with 69% of DBAG’s portfolio valued using the multiples method at end-December 2018 (vs 63% at end-September 2018), 17% valued at cost. This was largely offset by portfolio additions of €40.2m, including initial investments in FLS, Kraft & Bauer and Sero and follow-on funding rounds in duagon, Frimo, netzkontor, BTV and Telio. The portfolio value was assisted by a positive €30.9m effect arising from increased earnings prospects for portfolio companies in the current year versus 2018, with the effect of the roll-over from 2018 to 2019 accounting for part of the negative effect from lower valuation multiples. Disposals had a €24.3m negative impact on portfolio value and were mostly attributable to the sale of CleanPart. The negotiated sale price was already reflected in DBAG’s portfolio value at end-September 2018.

The Fund Investment Services division reported fee income of €7.6m (up 6.6% y-o-y), which included €0.4m of transaction-related fees from DBAG ECF II. On an annualised basis, fees as a percentage of average assets under management in the period stood at 1.68% compared with 1.59% in Q118. The segment’s earnings before tax reached €1.5m (vs. €0.7m in Q118), with the increase in net expenses associated with higher personnel costs more than offset by the lack of a €0.9m negative non-recurring effect recognised in Q118. The latter related to an adjustment for remuneration that DBAG had received for the work performed by members of the investment team on supervisory bodies of DBAG Fund V portfolio companies.

DBAG finalised three new investments alongside DBAG Fund VII and DBAG ECF II in Q119, with another transaction in the radiology area agreed upon after the reporting date where DBAG Fund VII is involved. As a result, the latter fund has already allocated 56% of its investment commitments in six MBO transactions. During the quarter, DBAG took investment decisions amounting to €56m and invested c €40m (including follow-on investments); see below for more detailed elaboration on the deals. DBAG has also completed the sale of CleanPart to Mitsubishi Chemicals Corporation as agreed in Q418, receiving €19.0m and realising a quite attractive 2.4x money multiple after a 3.5-year holding period. This compares with DBAG’s historical averages of 2.7x and 4.8 years, respectively. After the reporting date, DBAG ECF sold its minority stake in PSS to the majority shareholder. However, this will not have a material impact on Q219 numbers, given that the sale proceeds are yet to be determined, based on the prospective development of the company.

In November 2018, DBAG deployed €13m in exchange for a 19% stake in Kraft & Bauer (K&B) and together with DBAG Fund VII (which deployed a further €46m) acquired a majority stake of 84% in the company. Kraft & Bauer’s estimated FY18 revenue came in at €26m (c +24% y-o-y), implying an equity/sales multiple of 2.7x. The company was acquired from Invision, a Swiss investment company, which became a majority shareholder in 2013 as part of a succession process. DBAG acquired its stake through an MBO alongside the Bauer family and current Managing Director Frank Foddi.

K&B is a supplier of automated fire extinguishing systems for around 800 types of machine tools. These systems need to be inspected and maintained regularly and hence K&B derives c 30% of its revenues from services. It employs 80 employees in its headquarters in Germany, as well as its production site in Switzerland and 13 service locations in Germany, Switzerland and Italy. The company is targeting international expansion beyond the DACH region and Italy, as well as an increase in revenue generation from services.

In November 2018, the company and DBAG Fund VII jointly acquired a 100% stake in Sero for €50.9m, with DBAG alone investing €11.4m in exchange for a 22.4% stake. With a revenue of €87m in 2018 (c +10% y-o-y), this implies an equity/sales multiple of 0.6x. The business was acquired from the Schröder family, with the company’s founder Armin Schröder leaving the management.

Sero is a development partner and manufacturing service provider for electronic components, with a particular focus on the automotive sector, which makes up 80% of the company’s revenue. Sero’s products are also used in various metrology equipment and microphones. The ever-increasing number of electronic components used in the production of automobiles has helped Sero to post an 18% revenue CAGR since 2015. Although the industry currently suffers from the uncertainty linked to the Worldwide Harmonised Light Vehicle Test Procedure (WLTP) roll out, it is expected to remain Sero’s main growth driver, with autonomous driving being the next big step for the industry. Prospective priorities for the company include capacity expansion and international expansion (particularly into North America and China).

DBAG invested in FLS in October 2018, acquiring in total a 39.3% stake alongside DBAG ECF II. DBAG itself provided €9.5m (for a 16.3% stake) and the fund contributed a further €13.7m. With an estimated €10m in revenues in 2018 (c +11% y-o-y) the deal valuation implies a 5.8x equity/sales multiple. The company was acquired through an MBO alongside its founder Thomas Brechtel and current management.

FLS provides real-time route optimisation software and operates a SaaS (software-as-a-service) model. It has developed a proprietary algorithm, PowerOpt, that it implements across a wide variety of businesses, for clients including Allianz, Royal Mail and Sky. The real-time solutions optimisation enables its clients to significantly improve travel costs, lead times or productivity of field employees.

After the reporting date, a radiology practice was acquired as an addition to the Ranova network, in which DBAG’s investment has yet to close. The transaction (ie acquisition and merger of several radiology practices) was initially agreed in March 2017, when DBAG committed to invest €15m for an 11% stake (translating into a 56% combined stake with DBAG Fund VII) in a newly formed group, which at that time delivered c €54m in revenues annually. With the new investment the group revenues should total c €77m annually.

Also after the reporting date, Unser Heimatbäcker filed for insolvency. However, this will not affect Q219 results as DBAG recorded a further impairment in Q119 (which reduced earnings by €1.6m). DBAG ECF also sold its minority stake in PSS in January 2019 and the negotiated price was reflected in the fair value of the portfolio as at end-December 2018.

Follow-on investments totalling c €6m (Edison estimate) were made in portfolio companies including duagon, Frimo, netzkontor and Telio, with funding provided for the acquisition of major competitor Anedis Management by BTV Multimedia (DBAG contributed €2.2m to the transaction).

As discussed in our previous update notes, DBAG’s reported NAV is exclusively attributable to the value of its private equity investment portfolio and does not account for the fair value of its fund services business, which currently represents third-party assets under management of c €1.4bn and generates considerable recurring fee income. In contrast, DBAG’s market value reflects the value of both its fund services business and its private equity investments. Consequently, there is an inherent premium when comparing DBAG’s share price with its reported NAV, which disguises any underlying premium or discount that the market may be applying to the value of DBAG’s private equity investment portfolio. We believe that this is the primary reason why the company’s shares have traded at a premium to NAV for nearly all of the last three years (currently at 23.7%), as illustrated in Exhibit 3.

DBAG’s reported NAV as at end-December 2018 stood at €422.0m, which represents a decline of €21.8m (or by 4.9%) versus end-September 2018 (and a 5.5% decrease from end-December 2017). As already discussed, this was largely the result of lower earnings multiples of listed peers that are used to value portfolio companies, following the recent market sell-off. This compares with DBAG’s current market capitalisation of €514.2m. If we assume that the market is valuing the company’s private equity business in line with its last reported NAV, this implies a value attached to the fund services business at around €83.0m. Based on the LTM earnings before tax of the latter segment, this translates into an earnings multiple of 12.2x. However, in this context it is important to note that 17% of DBAG’s current portfolio is valued at acquisition cost and will be moved to the multiples method basis 12 months after the acquisition date. Alternatively, if we assume that the private equity investments business is valued at a discount to NAV in line with the current discount of the LPX Europe index (16.9%), the multiple for the fund services business goes up to 22.8x. Please note that we have not adjusted the multiple for the transaction-based fees earned by DBAG over the last 12 months.

We have compared DBAG with other listed private equity investment companies with a prime focus on Europe in Exhibit 4. However, we acknowledge that DBAG is the only company in the group that targets mid-sized companies in the German-speaking countries. Moreover, unlike all the peers except 3i in the UK, DBAG also manages third-party funds. As discussed earlier, we see the value of DBAG’s fund service business as the main reason that its shares trade at a premium to its reported NAV. This is in contrast to its peers that do not manage third-party funds, some of which are trading at a wide discount to NAV. DBAG’s 4.2% dividend yield is among the highest in the peer group (average of 3.6%).

DBAG’s NAV total return in sterling terms marginally underperformed the peer group average over three and five years to 31 December 2018, ranking fourth and third out of eight, respectively. The company’s one-year NAV TR performance was broadly flat, compared with average peer performance at 9.6%. However, the company was slightly ahead of peers over the last 10 years, posting a total return of 145.2% vs peer average at 133.8%. Despite the marked relative weakness over one year, DBAG’s share price return is only modestly below the peer group average over three years and is ahead of peers over five years.