Deutsche Beteiligungs — Recession in Germany unfolding

DBAG operates an integrated business model with two complementary business lines, PE investments and fund investment services, built around DBAG-managed PE funds (DBAG funds), through which DBAG invests alongside third-party investors. Investing through the DBAG-managed funds creates a substantially larger capital base, and hence a broader range of investment opportunities, for DBAG’s own balance sheet investments. The strategy also provides some assurance to third-party investors in the funds that the manager’s interests are aligned with their own.

DBAG invests in well-established companies with proven business models, rather than early-stage businesses or companies requiring restructuring. The companies are often characterised by leading market positions, entrepreneurial management and capacity for innovation, with the prospect of a long-term future for their products.

DBAG expects more investment opportunities to arise in equity minority positions in companies seeking reliable long-term financing. DBAG executes these investments through the DBAG Expansion Capital Fund (ECF), as well as through its own balance sheet. DBAG does not intend to invest in distressed assets as they remain outside of its core strategy.

As well as participating in competitive sale processes, DBAG’s extensive network enables it to originate proprietary deal flow. DBAG’s investment process consists of three phases:

DBAG’s buy-and-build strategy and expertise is illustrated by its investment in Cloudflight. The partial sale of the company was agreed in November 2022 (DBAG will retain a minority stake) after a holding period of around three years, with DBAG achieving a MOIC above 4x. DBAG invested in the company alongside DBAG Fund VII in June 2019 by creating Cloudflight from software specialist Catalysts and IT research and consultancy firm Crisp Research. Since then, the platform company performed six add-on acquisitions and was able to grow its revenues from €59m in 2019 to €80m in 2021.

DBAG has embedded sustainability aspects in its corporate governance and investment process, highlighting that this improves the alignment of shareholders’ and fund investors’ targets with DBAG’s objectives. At the same time, management highlights it must make a balanced assessment in its investment decisions between what is valued by society and what is economically advisable. DBAG documented the importance of ESG aspects in its business by signing the United Nations Principles for Responsible Investment (UN PRI) in September 2021 (it will issue its first UN PRI report in spring 2023).

To monitor and manage the ESG performance at DBAG and portfolio companies, it started to collect a set of general and business model specific ESG key performance indicators (KPIs) in FY21. These address key sustainability topics identified by management, including greenhouse gas emissions, occupational health and safety, employee satisfaction, gender parity and compliance. DBAG plans to integrate these ESG-based KPIs (covering a multi-year horizon) into the budget plans of its portfolio companies for FY23.

Moreover, DBAG recently enhanced its target system through the addition of ESG-related goals at the holding level from FY23. These include: CO2 footprint (scope 1–3, with scope 3 comprising business travel and commuting); employee satisfaction, as measured by the arithmetic mean of all values provided by its employees in a survey conducted using the TeamEcho software; and payments from compliance breaches. For FY23, management aims at a reduction of DBAG’s CO2 footprint to 2.4 tonnes per full-time equivalent from 2.5 tonnes in FY22 (with an FY25 ambition of 2.2 tonnes, see Exhibit 12). It also wants to improve employee satisfaction to 63% in FY23 from 62% in FY22 (aiming for 65% by FY25). The share of women within DBAG’s investment advisory team is currently at 14%, with further improvement targeted for the coming years. Finally, DBAG puts emphasis on zero tolerance for any form of corruption and other unethical business practices, and therefore wants to avoid any payments from compliance breaches. We also note that DBAG recently decided to support a local reforestation campaign launched for the Hesse state forest.

At end-September 2022, DBAG’s portfolio consisted of 39 companies with a total gross value of €567.3m (down 0.5% y-o-y). Around 50% of DBAG’s portfolio value was allocated to industries of its core expertise historically, that is industry/industrial technology and industrial services.

The recent new investments (see below), coupled with changes in carrying values of portfolio holdings, translated into a share of ‘growth’ sectors at c 45% of DBAG’s portfolio at end-September 2022, of which 21% is in IT services and software, 13% in broadband telecommunications and 11% in healthcare. This is broadly in line with the 46% at end-September 2021, as the increase in IT services and software and healthcare exposure offset the decline in the carrying value of broadband telecommunications companies (see Performance section for details). We believe that DBAG’s recent investments and current portfolio allocation to the software and services space illustrate DBAG’s intention to benefit from the digitalisation wave unfolding globally. According to a press release published by the research unit of German development bank KfW from October 2021, Germany needs to double, or even triple, its IT expenditure to reach a level as a percentage of GDP closer to other advanced economies.

DBAG exhibited a high level of investment activity in FY22, investing €176.8m in total (25% of opening NAV) compared to an FY17–21 average of €76.5m (18% of opening NAV, see exhibit on the front page). This includes four MBOs announced and completed in FY22, three of which (akquinet, freiheit.com and in-tech) are from the IT software and services sector. Akquinet specialises in the implementation of ERP systems (SAP and Microsoft) and the customised development of software solutions, with expertise across the health and social welfare sectors, as well as mechanical and plant engineering, the public sector and logistics. It also provides IT outsourcing services for both small and large businesses. Freiheit.com specialises in the implementation of complex digital transformation projects for large and mid-sized companies, including for example Daimler, METRO andr Tchibo. In-tech offers technological and process consulting, engineering services and software development, with c 90% of sales derived from development services for the automotive and automotive supply industries. The fourth buyout was the investment in MTW Holding, an Italy-based designer and producer of high-quality metal accessories for luxury fashion brands, such as belt buckles, clasps or fittings for handbags, shoes and clothing, as well as jewellery and emblems. DBAG also completed two MBOs agreed in the previous financial year: Dantherm (a provider of heating, cooling, drying, ventilation and air cleaning technology) and Itelyum (specialising in the recycling of complex industrial waste). Importantly, four of the companies acquired in the calendar year 2022 were bought from families/founders, illustrating in our view DBAG’s distinct advantage in terms of deal sourcing.

DBAG also completed two new long-term investments: Green Datahub (consisting of two data centres) and vhf (a developer and producer of CNC milling machines and tools for the dental, industrial and sign making sectors). DBAG’s portfolio companies remained active in terms of add-on acquisitions with 28 transactions carried out across DBAG’s portfolio in FY22 (of which 26 completed and two are agreed but yet to be closed).

DBAG generated a moderate €30.6m in realisation proceeds stemming from two partial disposals (Telio, GMM Pfaudler) and one refinancing (von Poll Immobilien). DBAG also sold Sjølund (a producer of bent aluminium and steel components acquired in January 2018) for a negligible amount in FY22. After the reporting date, in November 2022 DBAG agreed to sell Cloudflight (a full-service provider for industrial digital transformation) to Partners Group (which acted on behalf of its clients) – see details above.

DBAG’s liquidity has worsened over FY22 to €84.8m of available liquid resources (of which €19.2m in cash and €65.7m in the undrawn part of its credit facility) from €219.5m at end-FY21 (€112.8m in cash and liquid securities, and fully undrawn credit facility of €106.7m). DBAG will receive c €45m proceeds from the recently agreed disposal of Cloudflight (expected to be closed within four months from deal announcement), although part of it will be reinvested in a c 3% stake in the company (out of up to 15% in total to be provided jointly by DBAG and DBAG Fund VII); the transaction should meaningfully improve the company’s liquidity.

We expect DBAG’s exit activity in the coming months to be rather limited. Firstly, it has a relatively young portfolio, of which 39% by fair value was acquired less than two years ago (and 31% was acquired two to five years ago). Secondly, DBAG’s industrial portfolio (despite being quite mature) continues to be affected by macro headwinds and is held at 1.1x acquisition costs on average, below DBAG’s target returns. This means DBAG is less likely to sell any of the industrial holdings soon, unless it accepts a below-average return to free up capital for new, more compelling investments. For instance, DBAG could decide to sell one of the assets held beyond the usual investment horizon in older DBAG fund vintages (eg DBAG Fund V now holds only one investment acquired in 2012). Finally, deal activity across the global PE market slowed significantly in recent months, mostly due to an uncertain macroeconomic outlook (which makes the pricing of new deals more difficult), as well as lower debt availability (see the ‘Market outlook’ section for details). Having said that, as DBAG’s portfolio is diversified (39 companies), it may still be able to exit some of its holdings in the coming quarters.

DBAG’s net operating expenses (€40.2m in FY22) are more than covered (or at least largely covered) by its fund services income (€43.2m in FY22). Consequently, DBAG can spend the above-mentioned liquid resources on (1) new investments, (2) follow-on investments in existing holdings (to fund add-ons or to support companies in distress) and (3) dividend payments. DBAG’s outstanding commitments to invest alongside its funds stood at €199.3m at end-September 2022 and its mid-term planning from November 2022 assumes new investments (both alongside DBAG funds and in long-term investments entirely from DBAG’s balance sheet) of €96m pa on average in FY23–25 (vs €114m for 2022–24 based on November 2021 planning). Consequently, DBAG’s liquid resources covered 43% of its outstanding commitments at end-September 2022, or 36% if we include DBAG’s commitments to DBAG ECF IV as of the fund’s first close (see Exhibit 6).

We note that DBAG’s outstanding commitments will be drawn gradually over several years, given that they are mostly related to DBAG Fund VIII (DBAG’s only buyout fund still in investment phase, which ends in 2026) and DBAG ECF IV. Moreover, given the strong investment activity in FY22 and the recent decline in new investment opportunities (see above), DBAG’s capital calls from its funds to finance new buyouts could slow down in the coming months. Beside new MBOs and long-term investments, the pace of DBAG’s capital deployment will be also determined by its support for companies with liquidity challenges (management does not expect liquidity injections in the current economic cycle to meaningfully exceed the c €15m it provided in 2020 amid the COVID-19 outbreak), as well as DBAG’s funding of add-ons across the portfolio (as a broad reference point, DBAG provided €11m to its portfolio companies in FY22).

The above considerations, coupled with the capital markets environment and the aim to maintain a sustainable dividend payout ratio, resulted in a board recommendation of a dividend of €0.80 per share for FY22 (or c €15m), compared with €1.60 per share in FY21. However, management, in its FY22 results commentary, stated a medium-term FY23–25 target dividend of €1.60 per share.

DBAG reported a net loss of €97.6m in FY22 (ended September 2022), broadly in line with the preliminary figures published on 20 October. Its loss from private equity investments of €111.3m largely reflects negative revaluation effects (see below for details), partially offset by a reduction in accrual for carried interest (€28.3m). This translated into a decline in net asset value per share of c 13% in total return terms in FY22. This compares to a total return of SDAX (the German small-cap index) of -36%, though we note that DBAG (similar to other listed PE companies) does not consider public equity indices as a formal benchmark and that its assessment of private equity valuations are not exclusively determined by the changes in listed peer multiples.

Meanwhile, its fund services segment delivered a €15.4m profit, in line with management guidance of €14–16m. This implies a c 15% y-o-y decrease, which reflects one-off expenses associated with the departure of DBAG’s CFO (€2.0m), as well as team expansion (DBAG’s headcount increased to 89 from 77 a year ago) and higher consultancy expenses. Income from fund services increased slightly by 2.0% y-o-y to €44.3m as increasing fees from DBAG Funds VII and VIII were offset by lower fees from DBAG Fund VI and DBAG ECF (as expected), as new investments of top-up funds increase the fee-earning assets, while funds in the divestment phase reduce their assets under management (AUM) through disposals.

DBAG’s five-year and 10-year NAV total return (TR) to end-September 2022 stood at 6.0% and 12.1% pa, respectively (vs SDAX’s -2.4% and 9.1% pa, respectively). Apart from the FY22 loss (largely driven by the derating of broadband telecom holdings, see below), this also reflects the impact on its industrial holdings from the economic slowdown both in the period leading to the outbreak of COVID-19 and during the pandemic (see below for details).

We note the particularly significant decline in the value of broadband/telecom investments (coming from a combination of lower multiples, as well as weaker earnings in some cases), with this sector contributing €77.7m to the €98.9m negative net income of the PE investments segment. As a result, their share of the total portfolio value fell from 30% at end-FY21 to 13% at end-FY22 (despite only one partial exit from Telio carried out within this sector in FY22). Alongside new investments (recognised initially at acquisition cost), this was one of the main drivers behind the decline in average multiple of acquisition cost from 2.80x at end-FY21 to 1.33x at end-FY22. Meanwhile, DBAG’s industrial sectors have been revalued upwards, with the average multiple increasing from 0.9x at end-FY21 to 1.1x at end-FY22.

Overall, the €144.4m downward revaluation of DBAG’s total portfolio in FY22 (from €545.3m) was primarily driven by lower peer multiples across sectors (€150.8m impact). Most of DBAG’s portfolio is valued using the multiples method (29 out of 39 equity investments), normally based on forecast EBITDA and debt for FY22 (though in some cases based on earnings likely to be generated over the long term). Following DBAG’s strong new investment activity in FY22, eight holdings (making up 25.6% of portfolio value) are recognised at acquisition cost, and the total portfolio value increased by 1.5% to €553.3m.

Against the deteriorating macroeconomic conditions and near-term outlook, earnings growth made a positive contribution to DBAG’s portfolio value of €80.7m in FY22, especially in the industry/industrial technology and IT services & software sectors. This was driven by the recognition of higher earnings likely to be generated over the long term, as well as add-ons (which are valued at the platform’s multiple immediately after acquisition).

Having said that, the positive earnings effect in FY22 was almost fully offset by the increase in debt at the portfolio companies’ level (€78.6m), of which 45% was to finance add-ons. At end-September 2022, 58% of DBAG’s portfolio value was attributable to companies with a net debt to EBITDA of more than 4.0x, which represents a significant increase from the 17% at end-September 2021. A further 11% had a ratio of 3.0–4.0x, versus 47% at end-September 2021, suggesting that some portfolio holdings moved from this bucket to the >4.0x group. In this context, we note the recent increase in three-month Euribor from c -0.5% in March 2022 to c 2.1% currently. While some of the holdings with a higher leverage are likely companies from the more resilient ‘growth’ sectors (especially those that performed more add-ons recently), part of the increase in average leverage across the portfolio is likely also due to higher working capital funding requirements and a pressure on margins experienced by some industrial holdings caused by cost inflation, supply chain disruptions and project delays coupled with deteriorating economic conditions. DBAG disclosed that the top five companies in terms of exposure to supply chain issues represented 16% of DBAG’s portfolio value at end-September 2022.

DBAG’s management expects supply chain issues to ease somewhat, though it expects that its manufacturing companies will remain negatively affected in 2023. Management also admitted that, while some portfolio companies have been quite successful in passing on cost inflation to customers, others have been slower to do so than DBAG originally expected. Still, management believes that measures introduced so far across the portfolio should assist DBAG’s overall portfolio performance, which is reflected in its FY23 NAV guidance (published alongside annual results) of €605–675m and pre-tax profit forecast of the PE investments segment of €60–70m. When adjusted for the €0.80 dividend per share (as per management’s proposal), this implies an NAV TR of 7–19% in FY23. We note that management guidance is based on end-September 2022 valuation multiplies and that the public equity markets have rebounded since then (the SDAX is up c 12% so far in the final quarter of the current calendar year).

DBAG’s management expects fund services earnings to reach €13–15m in FY23 (ie somewhat below or in line with FY22). Its FY25 ambition assumes €9–11m, though we note that this is because DBAG assumed that the investment phase of a new buyout fund (DBAG Fund VIII’s successor) will start at some point during FY25, while expenses associated with setting up and running the fund would be incurred from the beginning of the financial year. However, the exact date for launching a fund is obviously difficult to predict a few years in advance.

DBAG distributes dividends once a year, with a stable or rising (whenever possible) DPS policy. The dividend per share increased steadily over FY16–21 (except for the COVID-19 year) and remained stable in FY22. However, in light of the reduced liquidity (see above) following the high level of investment activity throughout FY22, as well as fewer than expected exits from the industrial portfolio (amid macroeconomic headwinds), DBAG’s management board has proposed an €0.80 payment for FY22. DBAG plans to resume its dividend policy next year, targeting a payout of no less than €1.60 per share in the midterm (FY23–25). We understand that in the near term, this will be dependent on a normalisation of the exit environment and DBAG’s investment pace.

DBAG’s NAV basically reflects its PE investments portfolio. Having said that, DBAG manages fee-generating third-party assets of c €1.9bn (AUM including DBAG’s investment portfolio at end-September 2022 was €2.5bn). DBAG’s shares historically normally trade at a premium to NAV (five-year average of 10%), which we believe reflects the market-implied value of the fund services segment (Exhibit 14). Given the recent strong decrease in DBAG’s share price (32% since end-2021, reflecting a broader trend in the listed PE space) it currently trades at an unusual 17% discount to NAV, still narrower than most peers despite the NAV underperformance.

We estimate the market-implied value of both DBAG segments in two scenarios: (1) using the implied value of PE investments, assuming fund services are valued in line with peers (12.9x FY23 P/E multiple); and (2) using the implied value of the fund services segment, assuming the PE 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 or PE (as described in detail in our August 2021 note). In the case of PE investments, we use the peer group as presented in Exhibit 15 below, excluding 3i (which also manages third-party capital and generates fee income).

Given the higher visibility in terms of income generation in the asset management business, valuation multiples in the sector were less volatile in recent months than the market valuations of listed private equity investment companies. Assuming the fund services segment is valued in line with peers (ie at a 12.9x FY23e earnings multiple), the implied value of PE investments is €301m (ie 48% below its end-September NAV), while DBAG’s peers currently trade at a 31% discount (see Exhibit 16, excluding 3i).

The wider discount may be at least partially justified by DBAG’s high exposure to the German industrials sector, which has been experiencing market headwinds for a prolonged time, even before the pandemic. It now faces significant challenges related to a weakening macroeconomic outlook (see above). We believe that this is an important factor behind DBAG’s NAV underperformance versus its peers. As at end-September 2022, 50% of DBAG’s portfolio is still allocated to industry/industrial technology and industrial services sectors (overall, companies from DBAG’s ‘core’ sectors are currently valued at 1.1x acquisition cost). Improving M&A activity, earnings prospects and investor sentiment could trigger a narrowing of the discount.

DBAG’s dividend yield based on payments in the last 12 months stands at 6.3% and is the highest among peers. Having said that, DBAG decided to recommend a lower DPS to be paid from FY22 profits (see above) to secure liquidity in the current environment, which now implies a 3.1% yield, which is in line with peers. However, we note that some peers may decide to take a similar approach, as illustrated by Princess Private Equity recently suspending its second interim dividend from FY22 profits (see our note and podcast for details). DBAG intends to return to €1.6 DPS in the medium term (2023–25).

Deutsche Beteiligungs is a Germany based and listed PE investment and fund management company founded in 1965. It invests in mid-sized companies in German-speaking countries (the DACH region) and selected other European regions (eg Northern Italy), focusing on growth-driven profitable businesses valued at €50–250m. DBAG also initiates and manages closed-end PE funds (generating stable recurring fee income) with current third-party capital under management of €1.9bn. The DBAG funds carry out MBO transactions to acquire a majority equity stake for €40–220m, with DBAG acting as a co-investor. DBAG also makes long-term investments funded exclusively from its own balance sheet where the company normally targets a ticket size of €15–35m with a holding period of seven years and longer (compared to up to five years in MBOs). Here, DBAG focuses either on providing growth financing to family-owned businesses in exchange for a minority stake or on acquiring majority stakes in companies with performance-driven equity requirements, including corporate spin-offs. DBAG also manages funds focused on growth financing (Expansion Capital Funds, ECFs). The DBAG ECF funds I, II and III have completed their investment period and currently manage a minor part of DBAG’s AUM. After the reporting date, DBAG successfully launched DBAG ECF IV, accepting €72m commitments from investors at its first close. DBAG entered into a co-investment agreement with the fund amounting to 49% of total commitments, but no more than €100m. The company has been a ‘partner of choice’ for a number of German private businesses, in particular those owned by founders and their family members, as illustrated by the share of businesses sold by this group to DBAG and included in its total MBO volume in 2012–21 at 57% compared to 46% for the broader German mid-market MBOs segment.

DBAG is managed internally and has an investment team consisting of 37 employees (up from 28 a year earlier) including 14 senior members who have been with DBAG for 18 years on average. The alignment of the team’s interests with DBAG and fund investors is supported by co-investments made alongside the DBAG funds by senior members (currently 21 individuals) at c 1–2% of capital raised (the volume of these co-investments stood at €24.6m at end-September 2022). They are entitled to a share in profit (carried interest) at 20% of proceeds from sales over the investors’ preferred return of 8% pa. Members of the investment team also receive a variable remuneration based on the success of DBAG’s long-term investments. The investment team is supported by an extensive external network of 82 experienced industrial partners and senior advisors.

DBAG is a self-managed entity and therefore does not incur any expenses related to external fees and charges. While the operating expenses translate into c 1.4% of the AUM (FY20–22 average), they are fully covered by the fee income collected from the managed funds (fees include management, transaction and incentive fees). As a result, the net expense ratio is actually a profit and amounted to 0.2% of AUM on average in FY20–22.

As at end-September 2022 DBAG’s share capital consisted of 18.8m ordinary shares of no par value. DBAG shares are predominantly owned by family offices (38%) and individual shareholders (36%).