Disposal adds to strong Q116 performance

DBAG reported first-quarter FY16 net income of €30.8m compared with €13.2m in Q115. The strong results benefited from valuation gains across the carried portfolio; DBAG noted that one source of positive surprise was a particularly cautious budget at one of the more recently acquired investments. The divestment of Spheros and a further realisation contributed c €10m. The majority of portfolio companies are budgeting revenue growth and higher earnings in 2016 and this was the main driver of valuation gains. Lower debt levels also had a positive effect on valuations while declining market valuation multiples tempered gains.

As illustrated in Exhibit 2, NAV per share gained €2.25 in the quarter, equating to a 10.6% increase after adjusting for the €1.00 FY15 dividend, with provisions for performance-linked profit sharing only a minor offset to valuation gains and fee income covering a large part of operating expenses.

As in FY15 the investment business contributed the majority of net income in Q116 (see Exhibit 3). The increase in the investment business income compared with Q115 reflects strong valuation gains while the increase in expenses (net of other operating income) reflects the inclusion of a considerable gain in the value of temporarily-held shares in Q115. Lower fee income and higher costs brought the fund services business to just below break-even. Compared with Q115, fee income was lower due to DBG Fonds I no longer generating fees and a decline in fees from DBAG Fund V, largely due to the refinancing of an investment and repayment of acquisition costs. Fund services costs were higher due to expansion of the investment team during FY15 as well as the level of investment activity during the quarter.

The elevated pace of investment activity in FY15 continued in the first quarter of FY16 with €21m committed to two new investments; an MBO investment of up to €12.8m in Telio Group and an expansion capital investment of up to €7.9m in mageba.

The sale of Spheros Group to Valeo was agreed during the quarter, representing the first divestment of a portfolio company since October 2014. DBAG notes that Valeo saw Spheros as a strategic acquisition, helping to secure a cost multiple of more than 2.0x and providing an example of the quality of investment it aspires to make. This transaction will realise a €15m to €18m gain, making a contribution of around €4m to net income in Q116. Spheros will remain in DBAG’s portfolio until anti-trust approval for the transaction is received, expected by the end of FY16. A further realisation was agreed by DBG Eastern Europe II international buyout fund comprising the sale of one of its three remaining investments, which contributed around €6m to net income in Q116. Completion of this transaction is expected by June 2016.

Founded in Hamburg in 1998 with subsidiaries in France, Belgium and the Netherlands, Telio Group is a leading European provider and operator of communications and media systems in prisons. Telephones and related systems are installed to create a controlled environment allowing inmates to make calls to approved numbers from communal areas or directly from their cells. Telio’s product range includes devices providing other modes of communication, such as TVs, DVD players, radios and PCs with restricted internet access. Telio employs a staff of about 100 and expects to report revenues of close to €30m for 2015. DBAG is taking an 18.8% stake in Telio Group, investing up to €12.8m alongside a c €50m investment by DBAG Fund VI.

Telio’s growth is being driven by an increasing focus on supporting prisoners’ rehabilitation after their release. Studies have shown that regular contact with family and friends outside of prison can contribute significantly to this goal and inmate access to telephones and other communication devices has been expanded in recent years. Device-based learning in preparation for life after prison is seen as an additional growth opportunity. DBAG management intends to apply the experience gained with the two other telecommunication companies in its portfolio and support Telio’s expansion into new markets.

A Swiss family business, mageba is a leading global provider of structural bearings, expansion joints and other products and services for the infrastructure and building sectors. Structural bearings ensure the controlled transfer of forces between a bridge’s superstructure and its substructure; expansion joints absorb the longitudinal movements in bridges that occur through temperature variations and traffic load. Growth is being driven by many countries increasing infrastructure expenditure at a faster rate than overall economic growth, rehabilitating existing structures as well as building new transport infrastructure. The company expects to report 2015 revenues equivalent to around €90m. Subsequent to the investment and a capital increase, DBAG and DBAG ECF will hold a 40% interest with DBAG investing up to €7.9m for a 19.8% interest.

One of the business areas to be expanded with the support of DBAG is seismic protection where an opportunity is seen due to many countries budgeting additional funding for projects in this area. mageba provides structural dampers for these applications that not only dissipate seismic forces resulting from earthquakes, but also absorb noise and vibration. The additional equity capital provided should enable mageba to take advantage of growth opportunities in its existing markets and DBAG also intends to back the company in its further internationalisation.

Although there was a high level of investment activity in Q116, none of the four main investment and realisation transactions highlighted above were completed during the quarter. As a result, no related cash drawdowns were made or distributions received in the period and DBAG’s financial resources increased from €58.3m at 30 September 2015 to €61.7m at 31 December 2015, primarily due to the recapitalisation of the investment in Schülerhilfe in October 2015. DBAG received €8.8m from this transaction, equating to 90% of its original €9.8m investment in October 2013.

At 31 December 2015, DBAG had total undrawn capital commitments of €97m relating to the DBAG ECF and DBAG Fund VI parallel funds that have investment 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 further realisations to add to financial resources. Financial resources are expected to decline in Q216 with the mageba transaction having completed in early February 2016 and the Telio deal expected to complete before the end of March 2016. However, the divestment of Spheros Group will add to financial resources in the current financial year as will a prospective distribution from DBG Eastern Europe II following completion of its sale transaction.

In January 2016, DBAG put in place a five-year €50m credit facility to provide additional flexibility to manage short-term timing differences in cash inflows and outflows. This does not represent a change to DBAG’s long-term financing strategy and management has confirmed that there is no intention to introduce any permanent leverage into the capital structure. Securing this facility should enable DBAG to maintain a more efficient balance sheet as excess cash will not need to be held to cover potential shortfalls, which could arise due to the unpredictable timing of both acquisitions and sale transactions. Added to DBAG’s €61.7m financial resources, the facility increases total available funds to €111.7m, which compares with outstanding commitments of €97m.

Concerns over a slowdown in global economic growth and the risk of a hard-landing in China have contributed to increased market volatility and a marked recent decline in stock market valuations. This has partly been reflected in the lower valuation multiples applied at end-December 2015, but could have a further negative effect on the valuation of DBAG’s portfolio. The majority of DBAG’s portfolio companies are budgeting higher revenues and earnings in 2016, indicating that the slowing global economy has not materially affected their growth plans. However, DBAG management applies a discount to these figures in valuing portfolio companies to reflect its assessment of the level of uncertainty over budgets being achieved, which may reduce the potential for downward revisions to valuations if earnings disappointments materialise. DBAG management report that the current market environment has not affected its deal pipeline and the investment team continues to work intensively on both prospective new investments and exit transactions.

Following the Q116 results, DBAG management has confirmed its FY16 guidance of exceeding FY15 comparable net income of €25.2m by more than 20% excluding any contribution from divestments. This suggests that net income of at least €40m is expected for FY16 including the €10m from realisations recorded in the first quarter. The disposal of Spheros will crystallise a €15m to €18m capital gain raising the prospect of an increase in the FY16 surplus dividend.

We see DBAG’s fund services business as the explanation for its shares trading at a premium to NAV, which contrasts with the discount at which the shares of its listed private equity peers trade (DBAG shares currently stand at a 10% premium vs a 24% discount for the LPX Europe index). DBAG’s NAV does not incorporate any value for the stream of recurring fee income generated from its management of co-invested funds, but DBAG’s market valuation does reflect additional value that can be attributed to the fund services business.

As illustrated in Exhibit 4, since the end of its financial year to October 2014, when DBAG provided increased disclosure on the performance of its fund services business, DBAG shares have traded fairly consistently at a premium to NAV. The recent decline in premium reflects a combination of the shares weakening along with the wider market and the strong uplift in reported NAV at end December 2015.

Exhibit 5 shows a comparison of DBAG with a selected peer group of listed private equity investment companies. DBAG is differentiated from peers by its regional and sector focus as well as its fund services business.

DBAG’s NAV total return in sterling terms to 31 December 2015 is ahead of the peer group average over one, three and five years and substantially ahead over 10 years. This outperformance reflects the strength of underlying euro-denominated returns given the context of euro weakness against sterling weighing on DBAG’s sterling-denominated returns over one, three and five years (the euro weakened by 5.9%, 10.9% and 16.6% over these periods), which has been unhelpful to DBAG when comparing with UK and global peers. Helped by the shares moving to a premium to NAV, DBAG has seen an even stronger share price total return performance, which is also ahead of the peer group average over one, three, five and 10 years.