Guidance beat assisted by a successful exit

In FY19, DBAG reported a net profit of €45.9m, which is clearly ahead of the guidance given by management in July 2019 (which was for net profit to be down by more than 40% vs the €48m reference point, but at least positive). In line with its strategy of stable or rising dividend, DBAG declared an increase in dividend per share to €1.50 (from €1.45 in the prior year), which translates into a dividend yield of c 4%. The solid bottom line was largely assisted by the €39.7m uplift booked on the successful exit from inexio (see more detailed commentary later in the note), which was completed after reporting date and was recorded as an unrealised gain at end-September 2019. Moreover, DBAG reported a €13.3m net gain on realised disposals (vs €4.6m in FY18, see Exhibit 3), largely related to the Novopress and Infiana exits.

Excluding the unrealised gains on agreed transactions, the valuation impact from the change in market multiples used to value DBAG’s holdings would have been -€22.7m due to a decline in the market valuations of peers in Q419. We understand this was particularly true for DBAG’s core industrial segments, which were affected by headwinds from the economic slowdown and ongoing US-China trade war, as well as sector-specific challenges (such as weak order intake in the automotive sector, higher commodity prices or slow capacity additions in the German wind energy sector).

We note that at present, 71% of DBAG’s portfolio is valued based on the multiples method, while 7% is still valued at cost. On average, portfolio holdings are valued at 1.4x initial cost (including 1.1x for core sectors and 1.7x for focus sectors), which compares with DBAG’s average historical realized exit multiple of 2.7x for MBOs and 3.3x for growth financings.

The fund services segment delivered fee income of €28.2m. This was down 5% y-o-y due to: 1) DBAG Fund V entering a phase with no fees charged; 2) disposals/deconsolidation within the DBAG Fund VI portfolio; and 3) lower transaction-based fees in DBAG ECF (see Exhibit 4). Together with the set-up costs associated with the new MBO fund (DBAG Fund VIII), this has translated into a segment result of €3.0m (vs €5.6m last year). However, the recent fund launch should drive up fees considerably in FY20 and beyond (see below for details).

During FY19, DBAG’s NAV increased 9.1% in total return (TR) terms to €30.59 per share. This is within the range guided at the end of FY18 at 8.8–11.7% and also clearly ahead of DBAG’s average cost of capital of 5.7%. Please note that we refer to the balance sheet value of equity, rather than DBAG’s reported NAV, which excludes assets and liabilities other than those directly related to the portfolio.

The main contributor to NAV accretion was value changes within the portfolio (+€5.06 per share), especially those stemming from agreed and realized transactions (+€3.52), while fees collected from DBAG funds contributed €1.79 (compared to €1.90 in FY18). Other expense and income was up to €3.49 vs €2.57 in FY18, with the increase partially being the result of an actuarial change in the discount rate applied to the balance sheet value of pension obligations, which lowered DBAG’s NAV by €6.5m (or €0.43 per share).

With the announcement of FY19 results, DBAG introduced new key performance indicators (KPIs), which will also be the reference point for communicating management guidance going forward. The former KPIs (consolidated net income and return on equity) are being replaced by NAV growth and income earned in the fund services segment, while shareholder returns (the third KPI) remain unchanged. According to management, the new approach will provide better visibility on performance in each of DBAG’s two operating segments.

For FY20, DBAG’s management provides cautious guidance amid subdued economic conditions in the German industrials sector. At the same time, however, it anticipates healthy development of the fund services business on the launch of DBAG Fund VIII as described below. The detailed guidance is stated as follows:

On the longer perspective, DBAG aims to increase NAV by more than 20% between FY20 and FY22 and expects the result in the fund services segment to be over 10% ahead of FY20, with group net income in FY22 targeted to be more than 40% higher.

In December 2019, DBAG initiated its new buyout fund, which had already gathered €1.05bn of capital commitments close to the targeted fund size of €1.1bn (with remaining commitments expected by the company in early 2020). Total commitments will come from both external investors (€845m) and DBAG itself (€255m). Similar to DBAG Fund VII, the new fund consists of a main fund (€910m) and a top-up fund (€190m) with the latter providing flexibility to pursue larger transactions. The fund has a four- to six-year investment horizon and will target equity investments of €40–100m, which translate into total enterprise values between €75m and €250m.

DBAG Fund VIII, with a volume of €1.1bn, is similar in size to its predecessor (DBAG Fund VII: €1.01bn). This gives the investment team flexibility in selecting the companies for the fund’s portfolio and takes into account the number of companies available in the relevant market segment. In addition, DBAG's investors benefit from lower fees on the capital under management due to the ongoing trend towards a shorter investment phase compared to the market. The limited fund growth is thus put into perspective because DBAG launches its new funds at shorter intervals (DBAG Fund VI: 2013, DBAG Fund VII: 2016, DBAG Fund VIII: 2020). At the same time, DBAG has slightly increased its contribution with 23% of total commitments compared to the 19–20% range for DBAG Funds V–VII. We believe DBAG Fund VIII may complete its first investments in the second quarter of 2020 at the earliest, given that its predecessor (DBAG Fund VII) still has some dry powder left.

DBAG will charge a management fee on committed capital in the main fund at 2% pa (in line with DBAG Fund VII), while the management fee in the top-up fund will be charged on capital invested at 1.75% (higher than the 1.0% charged in the case of DBAG Fund VII). Consequently, we estimate that this should translate into annualised incremental fees for DBAG of €18.2m (excluding the top-up fund) and up to €21.5m pa (in the case of full utilisation of the top-up fund). This compares with total fees received by DBAG in FY19 of €28.2m (from the buyout funds V–VII as well as DBAG ECF).

The initiation of the fund has been accompanied by an adjustment to DBAG’s investment strategy. Management announced that it does not intend to launch any further ECF funds focused on growth financings and recently also small MBOs. In the current (second) investment period of DBAG ECF, 68% of the €97m commitments have already been allocated (of which DBAG contributed 41%). From now on, smaller MBO deals will be executed by the buyout funds (including in particular DBAG Fund VIII), while longer-term investments in minority stakes in owner-managed, mid-market enterprises will be conducted exclusively from DBAG’s own balance sheet.

DBAG ended FY19 with €69.4m in financial resources, which included €43.9m in cash and €25.5m in liquid, short-term securities. Its €50m credit line remained undrawn, bringing available resources to €119.4m, covering 92% of capital commitments towards already launched DBAG funds (mainly DBAG Fund VII). After accounting for post-reporting date events, ie €35.6m investments (Cartonplast and STG) and c €44m proceeds from the inexio disposal, the available resources amount to c €128m. After accounting for the commitments to DBAG Fund VIII (€255m), this covers one-third of its overall commitments. However, given the four- to six-year investment horizon of the new fund, with some time required for initial ramp-up, as well as management expectations that DBAG will invest a total of c €90m annually over the next three years, its commitments seem to be well covered at this stage.

Until 2013, DBAG’s main competencies and portfolio composition were centred around four core sectors: industrial components, mechanical and plant engineering, automotive suppliers and industrial services. Subsequently, however, the company has made a strategic decision to pursue opportunities in selected new areas (which it now refers to as ‘focus sectors’), including broadband/telecommunications, IT services/software and healthcare. In recent years, the importance of these sectors has gradually increased as they now represent 39% of DBAG’s portfolio (as at end-September 2019, before the inexio exit). Simultaneously, the portfolio allocation to DBAG’s core sectors declined from 94% in FY13 to 44% in FY19. This move seems to be paying off, demonstrated by the solid contribution to NAV total return from the new sectors and the recent successful disposal of DBAG’s investment in inexio.

The share of focus sectors may increase further, given that DBAG sees a more limited set of attractive investment opportunities in its core sectors at present amid the recession in the German industrial sector. At the same time, we note that the latter means that the positive impact of optimisation processes in DBAG’s core sectors may start to become visible later than initially expected. It also means that holding periods might extend by an additional one to two years vs the long-term average of 4.9 years.

Companies from DBAG’s core and focus buckets displayed varying dynamics in FY19. In the core sectors, 13 companies which were included in DBAG’s portfolio throughout the whole financial year reported muted aggregate revenue and EBITDA growth of 4.7% and 0.2%, respectively. Meanwhile, four holdings from the focus sectors (DNS:NET, vitronet, BTV Multimedia and netzkontor nord) reported significantly higher revenue and EBITDA growth at 31.6% and 29.8% y-o-y, respectively, although this was largely fuelled by acquisitions (with organic growth of single-digit levels). The M&A activity may have contributed to the higher leverage of the companies from focus sectors, with average net debt to EBITDA at 4.5x for these compared to core sector companies at 2.4x. On the other hand, broadband telecommunications companies normally exhibit more stable earnings compared to the industrial sector and thus can service a higher debt load.

In FY19 (ending September 2019), DBAG continued its portfolio diversification. It completed five new investments, while its portfolio companies concluded six acquisitions. In total, the company deployed €78.4m (vs the record-high level of €85.1m in FY18). This included c €57m invested in new holdings and c €21m invested in the further development of DBAG’s portfolio companies, according to our calculations. New investments were made in both focus sectors (€33m – blikk, FLS, Cloudflight) and core sectors (€24m – Kraft & Bauer, SERO). A further two investments – Cartonplast (€26.0m) and STG Group (€9.6m) – were concluded (in November) after the end September reporting date. For a detailed discussion of transactions completed and announced during the year, see our previous notes. As at end-November 2019 (post the inexio disposal), DBAG’s portfolio consists of 28 holdings.

In November 2019, DBAG co-invested €9.6m alongside DBAG ECF, acquiring a 36% stake in STG Group. The total investment volume (including investment by DBAG ECF) reached €23.3m, which translates into a DBAG-controlled stake of 88%. The transaction marked the seventh MBO of the DBAG ECF fund, which provides growth financing to companies and recently expanded its strategy to include majority positions. With this investment, DBAG ECF’s allocation of committed capital reached 68%.

STG Group constructs, operates and maintains municipal fibre optic networks in the fibre-to-the-home (FTTH) infrastructure. Approximately 20,000 households are connected to STG’s network operated in the Ruhr area in Germany. In 2018, the company generated c €16m revenues. We note that it is DBAG’s sixth investment focused on broadband business. DBAG considers the company a potential platform for a buy-and-build strategy. The business should benefit from the current low market penetration, as only 7% of German households have access to fibre optic networks (one-third of the EU average).

During FY19, DBAG exited five investments which delivered c €64m in cash proceeds. DBAG Fund VI sold its investments in Cleanpart and Infiana at money multiples of 2.4x and 2.2x, respectively after holding periods of 3.5 and 4.8 years (vs DBAG’s historical MBO average of 2.7x and 4.9 years, respectively). The fund has also fully written off its investment in Unser Heimatbäcker, which filed for insolvency in December 2018. DBAG ECF sold its investments in Novopress and PSS, at respective money multiples of 15.7x and 0.5x. We note that PSS was the fund’s smallest investment (€2.3m at cost). See our earlier notes for details on transactions announced prior to Q419.

Post the reporting date, DBAG completed the disposal of its stake in inexio, generating €44m in cash proceeds (which represents an exit multiple of 7.5x) and booking an uplift of €39.7m. DBAG initially invested €3.2m in the company in May 2013 alongside DBAG ECF. Over time, DBAG increased its stake and participated in the capital raise as part of the MBO executed by Warburg Pincus in 2016. Consequently, DBAG’s equity investment increased to €7.5m (representing a 6.9% stake). inexio is a provider of fibre optic broadband to rural parts of southern Germany, which expanded organically as well as through M&A in recent years. It has grown its annual revenues to €78m from €28m at the time of DBAG’s investment. It constitutes the first exit from DBAG’s focus portfolio.

DBAG’s reported NAV is exclusively attributable to the value of its private equity investment portfolio and does not account for the fair value of its fund services business, which at end-FY19 represented third-party assets under management of c €1.4bn and generates considerable recurring fee income. We note that on DBAG Fund VIII’s launch, the total AUM should increase to c €2.5bn from €1.7m at end-FY19. In FY19, the segment generated €28.2m in fees, translating into a pre-tax profit of €3.0m. Consequently, there is an inherent premium when comparing DBAG’s share price with its reported NAV, which disguises any underlying premium or discount that the market may be applying to the value of DBAG’s private equity investment portfolio. We believe this is the primary reason that the company’s shares have traded at a premium to NAV over the last three years, as illustrated in Exhibit 9. Over the last year, DBAG’s shares traded at a premium of around 10–30%, which currently stands at 26% after a rebound from a multi-year low of 4.3% in August 2019 (which we believe was triggered by the profitable disposal of inexio).

DBAG’s reported equity (which we treat as an equivalent of NAV, as discussed above) at end-September 2019 stood at €460.2m, which compares to the current market capitalisation of €576.2m. We estimate the price tag on the fund services segment implied by DBAG’s market capitalisation using two scenarios. If we assume that the private equity investments business is valued at a discount to NAV in line with the current discount of the LPX Europe index (9.9%), the value of the fund services business amounts to €165.5m and translates into an earnings multiple of 54.6x (LTM basis). This compares to our last estimate from September, when the LPX discount amounted to 11.2%, implying a multiple of 24.9x. Alternatively, if we assume the market is valuing the company’s private equity business in line with its last reported NAV, this implies a value attached to the fund services business of around €119.8m (21% of the market cap), implying an LTM earnings multiple of 39.5x. This compares to our previous calculations at the time of the Q319 results of an 11.1x earnings multiple based on similar assumptions.

While these multiples may seem high, we believe the market is already discounting the higher fee income from the upcoming launch of DBAG Fund VIII (as discussed earlier in the note). Moreover, we believe that significant uplift on the recent disposal of inexio was a share price development catalyst. Finally, we note that in each of the last five financial years, DBAG recognised positive net disposal gains (including gains on agreed but yet to be finalised exits). These represented up to c 20% of DBAG’s beginning NAV, suggesting its portfolio valuation may be considered quite conservative.

We have compared DBAG with other listed private equity investment companies with a prime focus on Europe in Exhibit 10. However, we acknowledge that DBAG is the only company in the group that targets mid-sized companies in German-speaking countries. Moreover, unlike all the peers except 3i in the UK, DBAG also manages third-party funds. As discussed earlier, we see the value of DBAG’s fund service business as the main reason that its shares trade at a premium to its reported NAV. This contrasts with the peers that do not manage third-party funds, some of which are trading at a wide discount to NAV. DBAG’s c 4% dividend yield is among the highest in the peer group (the average is 3.2%).

DBAG’s 8.2% NAV total return in sterling terms (9.1% in euro terms) over one year to end-September 2019 lagged that of the peer group. We believe the main contributor to performance was DBAG’s relatively high exposure to the German industrial market, which experiences more intense headwinds from the slowing economy and trade war threats than other sectors. In the longer term, performance is more aligned with the peer group, although lower than the average.