Continuing high level of investment activity

DBAG reported FY15 net income of €27.0m, which exceeded management’s guidance range of €20-25m. NAV per share increased 10% to €22.16 in the truncated 11-month financial year to 30 September 2015 (see Exhibit 2), after adjusting for payment of the FY14 total dividend of €2.00 per share. In contrast to FY14 when the sale of a major investment was the primary contributor, FY15 returns were driven by valuation gains across the carried portfolio.

There was a strong underlying €49.9m (+33%) valuation gain for the carried portfolio. Valuation gains for the financial year were driven primarily by earnings improvement (€39.3m) at the portfolio companies, while increased valuation multiples (€11.6m), reflecting market performance, also had a positive effect. These gains were partly offset by a €23.5m provision for performance-linked profit sharing relating to DBAG Fund V. The recent strong performance of DBAG Fund V investments led to the expectation that the 8% pa hurdle rate triggering performance-linked payments to the investment team will be met and thus the requirement to make the provision, which relates to the cumulative performance of the fund since its launch in 2007.

As shown in Exhibit 3, similar to FY14 the investment business contributed the majority of net income in FY15. The investment business saw an improved margin due to the strong valuation gains (net of the profit-sharing provision) in DBAG’s carried portfolio and lower costs while a combination of lower fee income and higher costs reduced the fund services business margin. Compared with FY14, fee income was lower primarily due to a reduction in fees from the DBAG Expansion Capital Fund (ECF), as well as DBAG Fund IV no longer generating fees, having moved beyond its contractual life. A lower than expected level of investment by DBAG ECF, reflecting market conditions including vendor preference for longer-term funding, led to the size and terms of the fund being modified. The investment phase has been prolonged until May 2017 and the size of the fund has been reduced from €142m to €112m. Starting in May 2016, investors will make fresh commitments and thus the fund’s term will restart every two years. Since January 2015, fees charged during the investment period have been based on invested capital and, from June 2017, there will be one-off fees for new investments. Fund services costs increased due to expansion of the investment team and the high level of investment activity during the year.

DBAG achieved a strong pace of investment activity throughout FY15 with total new investment for the 11-month financial year reaching €71.4m, ahead of the target €50m pa run rate, and compares with the €20.6m average for the prior 10 years. Seven new companies were added to the portfolio in FY15 (see Exhibit 4), comprising five MBO and two expansion capital investments all in DBAG’s core manufacturing and industrial services sectors, increasing the number of holdings to 24.

The elevated pace of investment activity has continued into FY16 with two companies added to the portfolio during the first quarter. These comprised an MBO investment in Telio Group, a developer, installer and operator of communications and media systems in prisons, and an expansion capital investment in mageba, a Switzerland-based provider of structural bearings, expansion joints and other services for the infrastructure and building sectors. The sale of the investment in Spheros Group was announced in Q116, representing the first portfolio disposal since October 2014, with the proceeds equivalent to more than double DBAG’s €13.5m original investment in March 2012.

Despite a modest decline in FY15, the stability and predictability of fee income from its fund services business together with its growth over the last 10 years has justified an increase in the base dividend from €0.40 to €0.50 per share. Additionally, although no major portfolio investments were realised during the financial year, retained profit of €67.1m from profitable realisations in prior years has allowed a surplus dividend of €0.50 to be proposed. Subject to shareholder approval at the Annual Meeting, the FY15 total dividend of €1.00 per share will be paid on 26 February 2016. While the total dividend is lower than in FY14 (see Exhibit 1), based on the current share price, it represents a healthy 3.7% yield with the base dividend providing a 1.9% yield. For FY16, the base dividend is expected to remain at the increased level of €0.50 and a capital gain of between €15m and €18m from the divestment of Spheros Group equating to €1.10 to €1.32 per share provides scope for an increase in the surplus dividend.

For the current and two following financial years, DBAG management expects NAV to grow by an average of more than 10% pa with a significantly higher net result of investment activity and net income from the investment business in each year than reported for FY15. As well as aiming to maintain a strong pace of investment over this three-year period, management sees a positive environment for divestments and strong demand for well-managed companies with leading market positions. Management anticipates increased returns over the three-year timeframe due to the increase in size of the invested portfolio during the last financial year providing a broader platform for creating value as well as its prospective maturing profile. Fee income from fund services is expected to be slightly lower in FY16 as there will be no fees from DBG Fonds I following its liquidation in FY15. Fee income will reduce further as divestments are made although, with the DBAG Fund VI scheduled to reach the end of its investment period in February 2018, there is the prospect of a new fund subsequently being raised with an associated increase in fee income.

The high level of investment activity in FY15 resulted in a substantial reduction in DBAG’s cash position, improving the overall capital structure and reducing potential cash-drag on performance. DBAG’s financial resources declined from €140.8m at 31 October 2014 to €58.3m at 30 September 2015. At 30 September 2015, DBAG had total undrawn capital commitments of €105m relating to the DBAG ECF and DBAG Fund VI parallel funds that have investments periods ending in May 2017 and February 2018. Given the implied c €50m pa investment run rate and fee income largely covering operating expenses, DBAG appears adequately funded for the next 12 months with the potential for realisations to add to current financial resources. The divestment of Spheros Group will add to financial resources in the current financial year and the recently secured €50m credit facility provides additional flexibility to manage short-term timing differences in cash inflows and outflows.

Recent investment activity and the sale of the major investment in Homag in 2014 has lowered the average maturity of DBAG’s portfolio, with investments younger than five years increasing from 43% of the portfolio at 31 October 2013 to 77% of the portfolio at 30 September. However, as shown in Exhibit 5, investments held for more than two years represent two-thirds of the portfolio value, with investments held for longer than five years comprising four portfolio companies equating to 20% of portfolio value and two international buyout funds representing 2%. While the overall immaturity of the portfolio suggests that the rate of divestments may remain below the long-term average in the near term (given the typical four- to seven-year holding period), due to the valuation gains seen by the more mature investments, there is scope for divestments to provide a meaningful source of additional funding as well as capital gains over the next two years.

As shown in Exhibit 7, DBAG’s NAV total return has substantially outperformed that of the LPX Europe index over 10 years while performance has been similar to the index over one, three and five years. Over 10 years DBAG’s share price total return has substantially outperformed both private equity (LPX Europe and LPX Direct) indices as well as the DAX 30 index. Over shorter time periods, DBAG’s share price total return relative to listed equity indices has been helped by the shares moving to a significant premium to NAV in 2015. Exhibit 8 illustrates the steady outperformance of the LPX Europe NAV index that DBAG achieved from 2006 to 2009, while performance has kept pace with the index over the last five years.

We see the recurring fee income generated from DBAG’s management of co-invested funds as the explanation for its shares trading at a significant premium to NAV. Based on DBAG’s €365m market valuation and assuming reported NAV of €303m reflects the valuation of its investment business, the €62m residual value can be attributed to its fund services business. This represents a 12x multiple of the €5.1m average pre-tax income for the fund services business in FY14 and FY15. Taking DBAG’s reported €1,075m assets under management (AUM), deducting €58m financial resources and adding DBAG’s €105m outstanding commitments gives €1,122m fee-generating AUM for the fund services business. The €62m valuation equates to 5.5% of fee-generating AUM.

A similar analysis of 3i, DBAG’s most direct peer, based on a £4,319m market valuation and £3,851m reported NAV (30 September 2015), implies a £468m value attributable to the fund management business. This equates to 3.5% of 3i’s €13,469m AUM with the lower percentage compared with DBAG potentially reflecting a lower fee margin on AUM (c 94bp vs over 200bp), which in turn contributes to a higher implied multiple of average underlying profit for FY14 and FY15 for 3i. Other factors such as expected NAV progression and growth in AUM will influence 3i’s and DBAG’s market valuations, but this analysis provides an alternative perspective from the share price comparison with NAV that can be applied to the wider peer group.

As illustrated in Exhibit 9, DBAG’s shares have consistently traded at a premium to NAV since November 2014. Although it has widened from a low of 12% in October 2015, the current 21% premium is below its 12-month average (28% premium). 3i in the UK has a similar business model and its shares are trading at a comparable premium to NAV (see Exhibit 11).

As illustrated in Exhibit 10, DBAG shares have traded at a premium share price to NAV (P/NAV) rating compared with the LPX Europe index throughout the last five years. Since the end of its financial year to October 2014, DBAG has provided increased disclosure on the performance of its fund services business and has subsequently seen the shares trade at a greater average premium to the P/NAV of the LPX Europe index.

Exhibit 11 shows a comparison of DBAG with a selected peer group of listed private equity investment companies. DBAG is differentiated from listed private equity peers by its regional and sector focus on the German Mittelstand as well as its fund services business.

DBAG’s NAV total return in euro terms to 30 September 2015 is below the peer group average over one, three and five years but substantially ahead over 10 years. The weakness of the euro against sterling over the last year has been unhelpful to DBAG when comparing with UK and global peers. DBAG’s share price total return has been helped by the shares moving to a significant premium to NAV over the last 12 months and this has contributed to DBAG ranking in the top three within the peer group over one year on this measure.