Deutsche Beteiligungs — Strong firepower for new acquisitions

DBAG reported net income of €131.2m in the first nine months of FY21 (9M21) ending June 2021 (versus a €24.6m loss in 9M20, see Exhibit 1), driven mainly by strong revaluations in the PE segment, which posted a €118.0m pre-tax profit (versus a loss of €31.2m in 9M20).

The result of the PE investments segment in 9M21 was primarily assisted by improved earnings expectations in portfolio companies (€113.4m, see Exhibit 2), especially in the broadband/telecom sector (including the impact from several bolt-on acquisitions completed by one of the platform investments), IT services/software companies and one company within the ‘other’ sectors bucket. Having said that, manufacturing businesses and related service providers (including automotive suppliers) also had a positive contribution. This, however, has been partially offset by supply bottlenecks, raw materials cost inflation and higher freight rates.

A further €35.1m positive effect came from the change in valuation multiples, including €26.0m attributable to the uplift upon the disposal of the blikk radiology group agreed in Q321. The remaining upward revaluations came mostly from broadband/telecom and IT services/software businesses, partially offset by write-downs of DBAG’s holdings in automotive suppliers. Change in debt had a €28.1m negative impact, mostly associated with the financing of bolt-on acquisitions. We note that the share of companies with a net debt to EBITDA ratio above 3.0x fell to 45% at end-June 2021 from 72% at end-September 2020 on the back of improved earnings (see Exhibit 5). Finally, the company recognised a €19.8m net result of disposals, which includes: 1) a €4.2m gain on the sale of Rheinhold & Mahla (RM); 2) a €13.5m gain on the disposal of DNS:Net; and 3) the result on the disposal of DBAG’s stake in the remaining externally managed foreign buyout fund.

DBAG values its portfolio at 1.34x cost at end-June 2021 (versus 1.3x at end-March 2021, 1.2x at end-December 2020 and 1.1x at end-September 2020), with its industrial portfolio still valued slightly below acquisition cost (at 0.9x), reflecting the COVID-19 impact and structural changes in the automotive sector. At the same time, its five broadband/telecom holdings are on average valued at a healthy 3.7x cost.

The fund services segment reported a €13.9m pre-tax profit in 9M21 (significantly up from €6.6m in 9M20), with income up to €32.5m from €21.3m in 9M20, mostly on the back of fees from DBAG Fund VIII, whose investment phase started in August 2020 (€13.9m fees in 9M21) as well as capital calls from the top-up funds of both DBAG Fund VII and VIII. We note that the main funds collect fees based on committed capital, while fees from their respective top-up funds are based on capital invested. The above was partially offset by the decline in fees from DBAG Fund VII to €10.8m from €13.1m last year, as these are now calculated based on invested rather than committed capital. Net expenses for the segment increased to €18.6m from €14.8m in 9M21, primarily due to higher provisions for variable remuneration, as well as team expansion.

DBAG reports net asset value (NAV) attributable solely to its private equity investments, which amounted to €622.7m at end-June 2021 (€33.12 per share), translating into a 20.3% total return. In our analysis, in order to capture the performance of the whole group, we use DBAG’s equity value as NAV which stood at €643.3m at end-June 2021 (€423.5m at end-September 2020), translating into €34.21 per share, according to our calculations. The NAV per share total return was 24.5% in 9M21 after accounting for the dilutive effect of the €100m share issue (compared to LPX Europe NAV at 19.8%). The main value driver was the change in value of portfolio holdings, adding €114.2m (including accrued income) to the NAV, which excludes gains on disposals and revaluations to the agreed price of the disposals not closed yet (a further €44.5m). While the ongoing costs (net of other operating income) increased significantly to €32.0m, we note that these include fund services segment costs that are offset by generated fee income (the segment’s pre-tax margin increased to 43% from 31% in 9M20). We calculate the annualised net expense ratio at a minor 0.3% of DBAG’s average assets under management (AUM) (compared to 0.1% in FY20).

On the back of the uplift from the agreed blikk exit, as well as positive revaluations of portfolio companies as at 30 June 2021, DBAG’s management raised its FY21 guidance (previously reiterated in May 2021). It currently expects net income in the PE investments segment in the range of €125–140m (vs €65–75m previously), which would translate into an NAV (as reported by DBAG) of €620–690m (after accounting for the recent c €100m capital raise), implying a c 0–11% increase compared to the end-June 2021 level. DBAG’s management generally assumes stable market multiples of listed peers, which are the reference point for valuing a major part of DBAG’s portfolio (76% based on last available data as at end-September 2020). Hence, the expected NAV increase stems from operational developments of DBAG’s portfolio companies, as well as some contribution from changing the valuation method of companies acquired in Q420 (as newly acquired businesses are normally valued at cost during the initial 12 months). Earnings from the fund services segment are now forecast in a €16–17m range (€15–16m previously) compared to €13.9m already booked during the first nine months of FY21. The management is currently updating its mid-term ambition to 2024 (last updated in November 2020), which should be released together with the FY21 annual report in December.

On 9 July 2021, DBAG announced the sale of blikk, which marks the third disposal from DBAG’s ‘growth’ portfolio and the first exit done by DBAG Fund VII. DBAG achieved a multiple of invested capital (MOIC) of 2.1x, which is attractive given the relatively short holding period as the business was acquired in May 2019 (the transaction was agreed in March 2017, but closure was delayed due to a prolonged regulatory approval process). As mentioned above, the sale was carried out at a c €26.0m uplift to carrying value as at end-June 2021 and is expected to close in Q421.

Blikk is a group of radiology and nuclear medical service centres, which DBAG developed by initially acquiring two radiology practices (from a group of 18 physicians) and subsequently adding new centres through bolt-on acquisitions, growing the business to €95m of revenues and 732 employees in 2020. Over the holding period, DBAG invested €18.7m in the entity (for an 11% stake), and DBAG Fund VII provided a further €87.0m (holding together with DBAG a 61.7% stake). We note that in January 2021, the nephrology division of the blikk group (managed by operasan) was spun off and will be developed as a separate healthcare platform investment. DBAG Fund VII acquired a 71% stake in operasan, of which 13% is attributable to DBAG, which invested €3.2m.

Blikk is being acquired by the EQT Infrastructure V fund, which agreed to purchase stakes held both by DBAG and its MBO fund, as well as the stake held by blikk’s management. DBAG will reinvest part of the proceeds and will hold an up to 15% stake (of which up to 3% will be attributable to DBAG, which will pay a low-single digit million-euro amount). We consider the deal another indication of the interest of foreign institutional investors (including infrastructure funds) in the German PE market supporting DBAG’s exit activity. Earlier this year, DBAG sold its stake in broadband telecom business DNS:Net to 3i Infrastructure at a very healthy 5.8x MOIC (the transaction was closed in June 2021 and is described in detail in our previous update note).

DBAG agreed to sell Telio Management in June 2021 after an over five-year holding period (initial investment in April 2016) at a 1.8x MOIC, which is somewhat below DBAG’s long-term historical average multiple on buyout investments of c 2.7x (though still representing an 80% gross return). The exit valuation is in line with Telio’s last prior carrying value, hence DBAG has not recognised any uplift on the deal.

Telio specialises in developing, installing and operating communications and media systems for correctional facilities (currently covering 700 facilities in 21 countries). DBAG and DBAG Fund VI invested €74.5m for an 83% stake in the company (of which €14.3m and 15.3% were attributable to DBAG, respectively). Telio’s +22% revenue CAGR since DBAG’s initial investment to €83.0m in 2020 was supported by both organic growth and acquisitions (two of which involved additional funding from DBAG). The company is being sold to Charterhouse Capital Partners, a UK-based PE investor focusing on European mid-market opportunities. DBAG and DBAG Fund VI will reinvest part of the disposal proceeds into a c 13% stake in Telio (of which 2.5% will be attributable to DBAG).

DBAG’s recently adopted strategy assumes c €120m new investments per annum in the current and subsequent two years. So far, the company has invested €58.2m in the first nine months of FY21 (ending September 2021), which includes in particular the acquisitions of congatec, operasan and R+S Group (which combined represent a c €43m investment), with the rest likely being add-ons to existing platform investments. In Q321, DBAG completed the acquisition of R+S and the merger of DING and Vitronet (discussed in detail in our previous update note). The merger did not involve any additional DBAG funding. We note that no major further investments were agreed in Q321 (except for the re-investments in minority stakes in blikk and Telio). However, DBAG’s management underlines the continued solid number of new investment opportunities the company is pursuing (see Exhibit 4). We acknowledge that PE deals require a certain amount of time to be completed and the timing of deal closure may at times be difficult to predict.

DBAG continues to have ample dry powder for new investments, which stood at €205.5m at end-June 2021 (covering c 75% of its co-investment commitments alongside DBAG funds), according to the management. This includes €159.3m of financial resources (26% of DBAG’s NAV) and the €46.2m undrawn part of the credit facility. DBAG also has €7.9m of cash held at the level of its investment entity subsidiaries. On top of this, the company will receive the proceeds from the sale of blikk and Telio (net of the reinvestment amount, which has not been confirmed yet) and a €24.8m deferred advisory fee to DBAG Fund VII accrued until end-June 2021 (DBAG communicated earlier that its intention is to collect the fee from the proceeds of the first exit of the fund, which will be blikk). DBAG plans to repay the drawn part of its credit facility (€60.5m) upon receipt of these proceeds.

As at end-June 2021, DBAG’s portfolio is valued at €541.6m and consists of 32 companies. The exposure to German industrials is gradually decreasing, yet it still accounts for 39% of portfolio value (-7pp y-o-y). DBAG’s new investment activity is focused on new ‘growth sectors’ – broadband/telecommunications, IT and healthcare – which already comprise 43% of the portfolio (+5pp y-o-y, supported by their performance).

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 €2.6bn (end-June 2021) and generates considerable fees. We believe the fact that DBAG’s shares regularly trade at a premium to NAV is due to the market-implied value of the fund services segment (Exhibit 7). DBAG shares currently trade at a 10.8% premium, significantly below the five-year average of 18.6%.

Assuming that the market assigns no discount to the reported carrying value of DBAG’s PE investments (in line with LPX Europe index, which now trades broadly at par with NAV), the current market-implied premium translates into €69.4m of value attributed to the fund services segment, which in turn translates into a 6.6x earnings multiple of the segment. On the other hand, DBAG’s direct peers (see Exhibit 9) excluding 3i and Eurazeo (which similarly to DBAG manage third-party assets) trade at a median discount of c 12.3%, which would imply a value for DBAG’s fund services business of €148.6m and an earnings multiple of 9.0x.

We have decided to compare the above implied value of DBAG’s fund services business with listed asset managers with exposure to alternative unlisted assets, such as real assets, PE or infrastructure. We have selected companies that focus predominantly on closed-end (or similar) structures as we believe that one of the differentiating factors in the asset management industry is the ease of capital outflow potentially decreasing prospective fee income. Having said that, companies listed in Exhibit 8 fulfil this requirement to varying degrees, with the highest share of AUM managed through open-end funds of 46% (Cohen & Steers). We also underline that the group includes some players with significantly higher AUM than DBAG (eg Blackstone or Partners Group). Moreover, some of the managers invest their own capital, with the highest share reported by Intermediate Capital (c 13% of AUM).

Keeping the above in mind, we estimate that based on the 9.0x earnings multiple, the fund services segment is valued at a 69% discount to the average FY21e P/E multiple of the above-mentioned listed alternative asset managers of c 29.1x (based on Refinitiv consensus, see Exhibit 8). This suggests that DBAG’s current market valuation may be relatively undemanding.

Here, it is worth keeping in mind that DBAG’s mid-term ambition to FY23 assumes a lower income from fund services of €10–11m (which at the mid-point implies an earnings multiple at 14.1x and a still wide c 51% discount to the average FY21e P/E multiple of the peer group). However, we understand that it does not account for any new MBO fund, while DBAG has historically launched a new fund every three to four years (the most recent was launched last year). At the same time, the management ambitions factors in the decline in fee income from earlier funds (most notably DBAG Fund VI and DBAG Fund VII).

In Exhibit 9 we present DBAG’s peers focused on PE investments. We underline that only 3i combines both DBAG’s business models of managing its own portfolio and external capital, which explains its prevailing premium to NAV. DBAG’s NAV return falls behind the peer group average across one to 10 years, which stems from lower returns directly before the COVID-19 outbreak (affected by the slowdown in the German manufacturing sector), as well as a slightly below average return in the last year. The peers trade at discounts of 7–21% to their NAV, except for 3i, GIMV and HgCapital Trust (the latter has a tech-heavy portfolio that is likely more appealing to investors). DBAG’s dividend yield falls slightly behind the average, but we need to note that only DBAG, Eurazeo and GIMV pay their dividend once a year and their last 12 months’ yield is still fully affected by the lower pay-out associated with the COVID-19 uncertainty.