DBAG: Value enhancement potential also in secondary buy-outs

31. July 2018

Frank­furt am Main — The current indus­try survey conduc­ted by Deut­sche Betei­li­gungs AG (DBAG) on the subject of secon­dary buyouts produ­ced the follo­wing result: a) Secon­dary buyouts are attrac­tive despite lower expec­ted returns, b) there is a strong focus on buy-and-build stra­te­gies and internationalization.

The deve­lo­p­ment of new custo­mer groups and busi­ness areas as well as the inter­na­tio­na­liza­tion of the busi­ness are the most promi­sing value levers for private equity compa­nies when they acquire a medium-sized company as a second finan­cial inves­tor. Howe­ver, even in times of stron­gly deve­lo­ped know­ledge of various value enhance­ment stra­te­gies, the return poten­tial of so-called secon­dary and tertiary buy-outs is lower than when a finan­cial inves­tor invests in a company for the first time. This is shown by the 6th Midmar­ket Private Equity Moni­tor, for which FINANCE maga­zine surveys invest­ment mana­gers of around 50 private equity houses opera­ting in Germany every six months on behalf of Deut­sche Betei­li­gungs AG (DBAG) on trends in the German midmar­ket segment.

Nearly four out of five experts (79 percent) said in the latest survey that secon­dary and tertiary buyouts in the midmar­ket promise lower returns than prima­ries — compa­nies that have not previously been owned by another private equity firm. Nevert­hel­ess, such tran­sac­tions are expe­ri­en­cing an upswing: last year, in more than half of the buyouts in the German SME sector (19 out of 35 tran­sac­tions), finan­cial inves­tors were active on both sides, i.e. as sellers and as buyers; this is a new record.

In view of the fact that more and more capi­tal from insti­tu­tio­nal inves­tors is looking for invest­ment oppor­tu­ni­ties, thus incre­asing compe­ti­tion for invest­ment oppor­tu­ni­ties, the high propor­tion of secon­da­ries is hardly surpri­sing. “Such tran­sac­tions have long been estab­lished and are also accepted by the inves­tors in our funds,” says Tors­ten Grede (photo), Spokes­man of the Board of Manage­ment of Deut­sche Betei­li­gungs AG; “they are a sign of the incre­asing matu­rity of the German private equity market and defi­ni­tely offer advan­ta­ges,” Grede conti­nues. “Tran­sac­tions between finan­cial inves­tors are often easier to struc­ture because both part­ners know the market prac­ti­ces. Manage­ment has alre­ady proven its entre­pre­neu­rial exper­tise and has gained expe­ri­ence with corpo­rate gover­nance, which a private equity part­ner brings to the table.”

85 percent of those now surveyed said that prior to a Secon­dary, opera­tio­nal control had alre­ady been impro­ved in the company through KPI-based report­ing. 64 percent observe that working capi­tal has been redu­ced. Costs in procu­re­ment are also alre­ady being redu­ced in the Primary, accor­ding to the majority.

Nevert­hel­ess, there remain suffi­ci­ent start­ing points for the second or even the third finan­cial inves­tor to deve­lop the compa­nies further. Stra­te­gies that used to be common, such as finan­cial engi­nee­ring or split­ting up compa­nies, have long since ceased to play a decisive role anyway. “An incre­asing number of private equity firms have a stron­ger focus on more complex value crea­tion stra­te­gies,” said DBAG board spokes­man Grede.

Three quar­ters see the grea­test poten­tial for value enhance­ment in SME follow-up invest­ments in expan­sion into new custo­mer groups and busi­ness areas. 67 percent also cite the inter­na­tio­na­liza­tion of the busi­ness as a value lever that is parti­cu­larly well suited to secon­da­ries. In addi­tion, 48 percent said they often still needed to inte­grate add-on acqui­si­ti­ons made under the aegis of the first private equity partner.

A look at the recur­ring ques­ti­ons shows that the vast majo­rity of houses in middle-market private equity also gene­rally rely on buy-and-build stra­te­gies. At 79 percent, this conti­nues to be by far the most highly rated value enhance­ment method — regard­less of whether it is an initial or follow-on invest­ment. Private equity inves­tors bene­fit from the fact that there are still many highly frag­men­ted markets, espe­ci­ally in the midmar­ket, in which strong market leaders with high profi­ta­bi­lity can be estab­lished through acqui­si­ti­ons in a rela­tively short time. When acqui­si­ti­ons of smal­ler compa­nies are made at lower valua­tions, the price of the entire tran­sac­tion can be redu­ced in this way: “This is also a response to the price deve­lo­p­ment we have seen in recent years,” comm­ents CEO Grede, “and is repre­sen­ta­tive of the private equity industry’s ability to adapt to chan­ging market conditions.”

The longi­tu­di­nal data of the survey also show that, irre­spec­tive of the tran­sac­tion type, inter­na­tio­na­liza­tion (curr­ently by 52 percent of respond­ents) and the stra­te­gic expan­sion of addi­tio­nal busi­nesses and services (46 percent) conti­nue to be conside­red attrac­tive, even among compa­nies that have alre­ady been in the hands of an invest­ment company.

Nevert­hel­ess, prima­ries conti­nue to offer the most start­ing points for initia­ting stra­te­gic further deve­lo­p­ment and reali­zing value enhance­ment poten­tial. “Those who can close as many such tran­sac­tions as possi­ble will have an advan­tage over their compe­ti­tors,” says board spokes­man Grede. DBAG has struc­tu­red five buyouts in the past twelve months. Four of them were Prima-ries, in which the respec­tive company foun­ders were the sale­s­peo­ple. The fifth new invest­ment concer­ned a company that had previously been in the hands of other finan­cial investors.

About Deut­sche Betei­li­gungs AG
Deut­sche Betei­li­gungs AG, a listed company, initia­tes closed-end private equity funds and invests along­side DBAG funds in well-posi­­tio­­ned medium-sized compa­nies with deve­lo­p­ment poten­tial. DBAG focu­ses on indus­trial sectors in which German SMEs are parti­cu­larly strong by inter­na­tio­nal stan­dards. With this expe­ri­ence, know-how and equity, it streng­thens the port­fo­lio compa­nies in imple­men­ting a long-term, value-enhan­cing corpo­rate stra­tegy. The entre­pre­neu­rial invest­ment approach makes DBAG a sought-after invest­ment part­ner in the German-spea­king region. The capi­tal mana­ged and advi­sed by the DBAG Group amounts to appro­xi­m­ately 1.8 billion euros.

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