Deutsche Beteiligungs — Solid exits in FY23, expanding into private debt

DBAG operates a unique business model as an investor and asset manager focused on the PE mid-market in the DACH region (Germany in particular) and neighbouring countries. It operates two complementary business lines, PE investments and fund investment services, built around DBAG-managed PE funds (DBAG funds), through which DBAG invests alongside third-party investors. It had c €2.5bn in assets under management and advisory at end-September, of which c €1.9bn was from third-party investors. Investing through the DBAG-managed funds creates a substantially larger capital base, and hence a broader range of investment opportunities, for DBAG’s own balance sheet investments. The strategy also provides some assurance to third-party investors in the funds that the manager’s interests are aligned with their own.

The pre-tax profit of the fund services segment more than covered the operating expenses of DBAG’s PE investments segment (they stood at €14.0m and €12.8m in FY23, respectively), see Exhibit 1. DBAG’s management guides to FY24 funds services profit of €9–13m, somewhat below FY23 given that DBAG Funds VI and VII are in their disinvestment phase. It then guides to a pick-up to c €11–16m by FY26 upon the launch of the new buyout fund (DBAG Fund VIII’s successor), which is likely in 2025.

DBAG invests in companies with proven business models, rather than early-stage businesses or companies requiring restructuring/distressed assets. The companies are often characterised by leading market positions, entrepreneurial management and capacity for innovation, with the prospect of a long-term future for their products. Importantly, DBAG focuses on the PE mid-market, which we believe offers several potential advantages, especially in the current environment (see our comment above for details). The partnership with ELF Capital allows DBAG to further expand its deal origination and investor network.

Historically, DBAG’s portfolio largely reflected the German industrial mid-market, with industrial businesses making up c 80% of its portfolio in FY15. Since then, DBAG has consistently increased its exposure to other sectors like IT services and software (22% of end-September 2023 portfolio value), broadband & telecommunications (11%), and healthcare (9%). These provided a cushion against the macroeconomic headwinds that have been affecting DBAG’s industrial portfolio since 2019. The share of these so-called ‘growth’ sectors declined slightly in FY23 from 45% in FY22, which reflects the re-rating of the industrial portfolio, as well as successful disposals of ‘growth’ businesses.

The recent Avrio Energie, TBD and NOKERA acquisitions (as well as some earlier investments, eg Itelyum, which specialises in recycling of complex industrial waste) illustrate DBAG’s shift within its industrials portfolio (including industrial technology and services) away from the German traditional capital goods sectors (eg automotive, which has been facing headwinds in recent years) towards energy transition/sustainability plays, which often have a more defensive profile (eg TBD). We note that among DBAG’s top 15 holdings (making up c 70% of portfolio value at end-September 2023), there are only two companies with significant exposure to the automotive sector (Karl Eugen Fischer and Oechsler). Some of the other industrial holdings in the top 15 bucket are Cartonplast (a provider of a pool system for the rental of reusable plastic layer pads), Congatec (an industrial technology company focused on high-performance embedded computer products), Dantherm (a provider of heating, cooling, drying, ventilation and air cleaning technology) and Duagon (a provider of network components for data communication in railway vehicles).

DBAG may be considered one of the preferred PE partners for private company owners, especially families and founders, across Germany and neighbouring countries (eg Italy). This is underpinned by DBAG’s deep understanding of the mid-market in the DACH region and the industries it invests in. It is illustrated by the fact that 58% of all DBAG’s management buyout (MBO) investments in 2013–22 were businesses acquired from families and founders, compared to 53% for all German mid-market MBOs, see Exhibits 3 and 4.

DBAG is managed internally and has an investment team consisting of 33, including 21 senior members who have an average PE experience of 17 years. The alignment of the team’s interests with DBAG and fund investors is supported by co-investments made alongside the DBAG funds by senior members at c 1–2% of capital raised (the volume of these co-investments stood at €17.3m at end-September 2023). They are entitled to a share in profit (carried interest) at 20% of proceeds from sales over the investors’ preferred return of 8% pa. Members of the investment team also receive a variable remuneration based on the success of DBAG’s long-term investments. The investment team is supported by an extensive external network of 84 experienced industrial partners and senior advisors (as at May 2023).

DBAG’s team is actively engaged in the development of its portfolio companies, both organically and through targeted M&A. In the last eight years, DBAG carried out 101 bolt-on acquisitions across its portfolio, of which 10 were in FY23 (with another two agreed during the last financial year). DBAG’s buy-and-build strategy and expertise is illustrated for instance by its investment in Cloudflight, a full-service provider for industrial digital transformation. The partial sale of the company was agreed in November 2022 (DBAG retained a minority stake) after a holding period of around three years, with DBAG achieving a multiple on invested capital (MOIC) above 4x. DBAG invested in the company alongside DBAG Fund VII in June 2019 by creating Cloudflight from software specialist Catalysts and IT research and consultancy firm Crisp Research. Since then, the platform company performed six add-on acquisitions and was able to grow its revenues from €59m in 2019 to €80m in 2021.

DBAG’s structuring options range from traditional MBOs of majority stakes (with an equity investment of €40–220m), through smaller buyouts (with an initial ticket size of €10–40m), long-term investments executed entirely from DBAG’s own balance sheet, up to private debt investments (see Exhibit 5). Management expects more investment opportunities to arise in equity minority positions in companies seeking reliable long-term financing. DBAG executes these investments primarily through its own balance sheet, though some investments of the DBAG Expansion Capital Fund (ECF) may also be structured as minority investments.

In September 2023, DBAG announced its entry into the private debt segment via a strategic partnership with ELF Capital, a manager of credit funds that was spun off from ESO Capital’s German direct lending platform. DBAG will acquire a majority stake in ELF Capital Group, with a gradual increase to 100% over the next five years. The group includes ELF Capital Advisory, a private debt asset manager with c €200m of assets under management at present in two credit funds. Its flagship fund focuses on straight, senior-secured private debt (targeting a return of c 7–8% pa), while its Credit Solutions Fund has a more flexible mandate covering highly structured investments, including hybrid capital/structured equity investments, with an expected return of 14–16% pa.

DBAG’s management highlighted that the present value of its initial investment in ELF Capital amounts to €12.2m, while the purchase price of the entire 100% stake depends on the ELF Capital Group’s further business development. Moreover, DBAG plans to co-invest c €100m in ELF Capital funds as a limited partner (LP), which will be a similar approach to its co-investments alongside DBAG funds. This compares with DBAG’s total co-investment commitments to DBAG funds of €244.0m at end-September 2023 and DBAG’s end-September 2023 NAV of €669.4m. The partnership allows DBAG to expand the financial solutions offered to German SMEs and gain exposure to an attractive, fast-growing private debt asset class via co-investments and fee income. It is worth noting that DBAG does not plan to tap into ELF Capital’s debt funding for its PE transactions.

DBAG posted a strong NAV total return (TR) of 18.1% in FY23, allowing it to more than recoup the FY22 NAV TR loss and post a five-year return of 8.6% pa, compared to 1.7% pa for SDAX, the German small-cap index (see exhibit on page 1). Meanwhile, DBAG’s share price rebounded from the end-September 2022 trough by a strong c 50% to end-September 2023, though it has given up some of the gains lately. The recent share price weakness may have been due to (1) the change to DBAG’s dividend policy announced on 20 November (see below for details) and (2) DBAG’s deletion from the MSCI Global Small Cap indexes as part of index constituent changes as of end-November 2023. As a result, DBAG’s shares now trade at a 23.4% discount to NAV, while they normally traded at a premium pre-2022 (see Exhibit 7). We believe that DBAG’s share price accounts for both the value of DBAG’s PE investment business (reflected in its reported NAV) and the value of the fund services business (not included in DBAG’s reported NAV).

DBAG’s FY23 performance was assisted by a €121.0m positive impact from an increase in comparable multiples used to value the portfolio (including the revaluation of R+S based on the agreed disposal price), see Exhibit 8. This was further supported by €63.0m of net disposal gains, mostly related to the partial exits from Cloudflight and GMM Pfaudler, as well as full disposals of BTV Multimedia and Pmflex. The operating performance of the portfolio had a net €20.1m negative effect, as the positive contribution from earnings (mostly in IT services and software, broadband telecommunication and industrial services) was offset by an increase in debt, mainly to fund add-on acquisitions. The share of DBAG’s portfolio companies with a net debt to EBITDA multiple of 3.0x or more increased to 74% at end-September 2023 (54% with net debt to EBITDA of 4.0x or more) from 69% at end-September 2022. The pre-tax profit of DBAG’s PE investments segment reached €96.8m in FY23 (vs a €111.3m loss in FY22).

German economic activity remains muted, with a 0.1% sequential decline in real GDP in Q323, mostly driven by a 0.3% q-o-q fall in consumer spending. Both the German Ifo Business Climate Index and the ZEW Indicator of Economic Sentiment remain subdued. Current GDP forecasts for 2023 issued by the European Commission, the German government and the International Monetary Fund (IMF) suggest a 0.3–0.5% decline. The IMF expects GDP to grow moderately by 0.8% in 2024, which we believe may be supported by a turn in the interest rate cycle, with the market currently pricing in six 25bp rate cuts by the European Central Bank for 2024. The German consumer price index (CPI) eased substantially in November to 3.2% (vs 3.8% in October), the lowest level since August 2021. That said, this includes some base effects, most notably the contribution from lower energy prices, while food prices continued to increase by 5.5% y-o-y. Nevertheless, the annual core inflation rate also moderated to 3.8% in November. The IMF now expects the German 2023 CPI to be 4.1%, followed by 2.8% in 2024. Lower inflation, coupled with interest rate cuts and nominal wage growth, may have a positive impact on consumer spending in the near term.

Global M&A activity remains subdued, with the Q323 value at a 10-year low, affected by macro headwinds, a disconnect between buyers’ and sellers’ expectations and the lower debt availability, especially in the syndicated loans market. While European new loan issuance picked up in Q323 to €7.4bn, the highest level since Russia’s invasion of Ukraine, this was mostly driven by loan refinancings rather than accretive M&A activity, according to the Quarterly Liquid Loan Market Commentary from Partners Group.

That said, PitchBook noted in its Q323 European PE breakdown report that there remains some appetite for dealmaking, with deal value down only 2.8% y-o-y and still being above pre-2020 levels. Importantly, market activity shifted away from megadeals and towards smaller transactions in the €100–500m range (often add-ons to larger PE holdings), which accounted for 56.8% of all deals in 9M23. This is important in the context of DBAG, given its focus on the PE mid-market with a target enterprise value of €50–250m.

Moreover, European PE exit activity improved from the lows of late 2022 and Q123, with an exit value of €97.0bn in Q323 (vs €60.0bn in Q322 and €100.1bn in Q321), according to PitchBook. However, this was driven by several mega-exits of over €1.0bn, for instance the Arm IPO. Therefore, a broad-based recovery in exit activity is yet to come. PE fundraising remained robust with €86.0bn in 9M23 vs €76.1bn in 2022 and €118.6bn in 2021 (PitchBook data), which bodes well for an activity rebound as the market cycle turns. In Germany alone, PE deal activity reached €55.7bn in 9M23 versus €93.5bn in 2022 and €84.3bn in 2021, while exits stood at €20.7bn in 9M23 versus €33.5bn in 2022 and €56.8bn in 2021, according to PitchBook (see Exhibits 9 and 10).

The lacklustre activity in the syndicated loan market allowed private debt providers to gain market share in the global credit markets. For instance, private debt funds financed 55% of all MBO transactions in Germany in 2022, according to Houlihan Lokey MidCapMonitor. Compared to traditional bank lending, private debt offers more flexible debt structures and often a shorter financing process. At the same time, private debt is normally more expensive than bank lending, and floating-rate structures benefited private debt investors amid the monetary policy normalisation. Private debt strategies continue to attract significant inflows from institutional investors, with H123 global fundraising of US$94.9bn vs €91.4bn in H122, with a direct lending share of 32.0% and mezzanine 27.9%, according to PitchBook. The growing interest in private debt is illustrated by the expectation of Ares Management (a global alternative asset manager) that the global private credit market will double to US$3trn in five years.

Since 1997 (when it structured its first MBO), DBAG has financed 68 MBOs and made 19 minority growth financing investments. Out of this, 41 MBOs and 16 growth financings were realised in full or mostly, with the full and partial exits generating a healthy MOIC of 2.7x and 2.9x, respectively. In Appendices 1 and 2, we present DBAG’s fully realised MBOs and growth financings.

Furthermore, the company announced in July 2023 that it agreed its first exit from its long-term investment portfolio with the sale of R+S, a provider of technical building services. DBAG decided to realise the investment after a relatively short holding period of around two years, encouraged by the attractive price offered by a strategic investor (NOKERA), translating into an internal rate of return of over 40% since March 2021. Part of the R+S exit proceeds was reinvested in a minority stake in the private company NOKERA, which is a producer of buildings in serial and sustainable construction and positions itself as the largest technology-enabled platform for serial timber production.

Including unrealised investments, DBAG increased the value of equity invested since 1995 by 1.9x (MBOs) and 2.7x (growth financings), with its current portfolio held at 1.1x cost on average (including 1.2x for holdings in industrial sectors and 1.3x in growth sectors). The lower unrealised MOIC comes from the fact that PE portfolios are a blend of different investment vintages, and each successful disposal (in line with a target return) normally reduces the average unrealised MOIC of the portfolio (DBAG has a balanced portfolio by vintage, see Exhibit 12). In the case of DBAG, an additional factor weighing on the unrealised MOIC (and the long-term NAV TR performance) was the demanding macro environment for some of its industrial holdings. Consequently, the ratio of fair value to acquisition cost at end-September 2023 for vintages of more than five years (1.19x) is only marginally higher than for vintages up to two years (1.16x), according to our calculations. That said, over the last year, DBAG was one of the top performers within this group, see Exhibit 13.

DBAG continues to trade at a discount to last reported NAV (currently 23.4%, see Exhibit 7), while historically it traded at a premium to NAV (the average premium over the five years to end-2021 is c 18%). We believe this was due to the share price reflecting the additional value of DBAG’s fund services business, which manages c €1.9bn of third-party capital and whose value is not directly captured within its reported NAV.

We believe it is instructive to examine the market-implied valuation of both DBAG segments in two scenarios: (1) using the implied value of PE investments, assuming fund services are valued in line with peers; and (2) using the implied value of the fund services segment, assuming that PE investments are valued in line with peers. For peers for DBAG’s fund services segment, we use a group of listed asset managers with exposure to alternative unlisted assets, such as real assets or PE (as described in detail in our August 2021 note): Blackstone, EQT, Partners Group, Intermediate Capital, Tikehau Capital and Cohen & Steers. In the case of PE investments, we use the peer group shown in Exhibit 13, excluding 3i.

Assuming the fund services segment is valued in line with peers (ie at a 16.8x FY24e earnings multiple) and using DBAG’s current market capitalisation, the implied value of DBAG’s PE investments would be €327m (ie 51% below its end-September 2023 NAV), while DBAG’s peers currently trade at an average c 29% discount. While some of this difference could potentially be explained by the subdued outlook for the German economy, DBAG’s discount may still be considered wide given its portfolio changes in terms of sector exposure in recent years, as discussed above.

On the other hand, if we assume that the PE investments were valued in line with peers (at a 29% discount to NAV), then DBAG’s current market capitalisation would imply a 3.6x FY24e earnings multiple for DBAG’s fund services segment. This seems to be a quite low multiple, especially given management’s expectations of an increase in fund services pre-tax profit to €11–16m by FY26, as discussed above.

DBAG made €63.6m of investments from its balance sheet in FY23 compared to €176.8m in FY22 and €59.2m in FY21 (see Exhibit 15). This includes €28.8m spent on three new investments completed in the period:  AOE Group (an agile software provider), Avrio Energy (a biogas platform) and TBD (a critical infrastructure service provider). On top of this, DBAG agreed a new MBO of ProMik (a provider of programming and testing solutions for the electronics manufacturing industry) and a long-term investment in NOKERA (reinvesting part of the R+S proceeds). The balance of the amount invested in FY23 was spent on financing add-on acquisitions (€13.6m) and investments in existing portfolio companies (€21.2m).

Despite recent muted global M&A volumes (weighing on exit activity across PE markets), DBAG completed several successful exits in late 2022 and 2023. As discussed above, these include full disposals of Heytex and Pmflex, as well as partial disposals of Cloudflight and PMM Pfaudler. The resulting €48.7m net cash inflow from investment activity allowed DBAG to pay down its two revolving credit lines of €106.7m in aggregate. These are now fully at DBAG’s disposal for drawdown, together with its €20.0m cash position at end-September 2023.

The above €126.7m liquid resources covered 52% of DBAG’s outstanding commitments to its funds at end-September 2023, which we consider a safe level given the latest end of the investment period of DBAG Fund VIII (to which DBAG has €106.9m outstanding commitments) is December 2026. After including the €100m expected commitments to ELF Capital funds, the coverage ratio stands at 37%. DBAG’s liquidity will be further assisted by the R+S realisation proceeds once the deal is completed. While the disposal price was not disclosed, we note that DBAG booked an uplift to the previous carrying value of €14m on the back of the deal in Q323 and that it invested €18m in total into R+S. DBAG’s management expects to cover the shortfall between current liquidity and future commitments through further realisations from its current portfolio.

According to DBAG’s dividend policy updated in November 2023, the company aims to pay out a stable dividend with a minimum payment of €1.00 per share, which is also management’s payout recommendation for FY23. This represents a reduction from DBAG’s earlier mid-term dividend target for 2023–2025 of €1.60 per share. We believe that DBAG’s more cautious approach to dividend payments may be partly due to the financing required for the above-mentioned ELF Capital acquisition and the associated fund commitments. That said, it is above the €0.80 per share payment made based on FY22 results and still represents an attractive dividend yield of c 3.7%.

Moreover, we note that DBAG shifted from a pure dividend policy to a broader distribution policy, as management highlighted that it would consider buybacks on a more regular basis. We note that at the current discount to NAV, share buybacks would be NAV accretive. Management has not shared any details in the terms of the size of a potential share repurchase programme yet.

DBAG has been a signatory of the United Nations Principles for Responsible Investment from December 2021 and embedded sustainability aspects in its corporate governance and investment process, highlighting that this improves the alignment of shareholders’ and fund investors’ targets with DBAG’s objectives. At the same time, management highlights it must make a balanced assessment in its investment decisions between what is valued by society and what is economically advisable. To monitor and manage the ESG performance at DBAG and portfolio companies, it started to collect a set of general and business model specific ESG key performance indicators (KPIs) in FY21. These address key sustainability topics identified by management, including greenhouse gas emissions, occupational health and safety, employee satisfaction, gender parity and compliance. DBAG has integrated these ESG-based KPIs (covering a multi-year horizon) into the budget plans of its portfolio companies starting in FY23.

Moreover, DBAG enhanced its target system through the addition of ESG-related goals at the holding level from FY23. These include CO2 footprint (scope 1–3, with scope 3 comprising business travel and commuting); employee satisfaction, as measured by the arithmetic mean of all values provided by its employees in a survey conducted using the TeamEcho software; and payments from compliance breaches. For FY23, management aimed at a reduction of DBAG’s CO2 footprint to 2.4 tonnes per full-time equivalent from 2.5 tonnes in FY22 (with an FY25 ambition of 2.2 tonnes). Its actual carbon emission per employee rose to 2.9 tonnes in FY23, mainly due to an increase in transaction activity which led to more business trips than initially assumed. DBAG now targets a carbon footprint per employee of 2.8 tonnes in FY24. DBAG was able to improve the average employee satisfaction score to 65% in FY23 versus initially planned 63% and 62% in FY22 (in line with the 65% target by FY25). The proportion of women within DBAG’s investment advisory team is 17%, with improvement targeted for the coming years. Finally, DBAG emphasises zero tolerance for any form of corruption and other unethical business practices, and therefore wants to avoid any payments from compliance breaches (which it was able to achieve in FY23). We also note that at the beginning of FY23, DBAG supported a local reforestation campaign launched for the Hesse state forest. Moreover, it decided to support a carbon reduction project in Italy.

At end-September 2023, DBAG’s share capital consisted of 18.8m ordinary shares of no par value. DBAG shares are predominantly owned by private investors (43.2%) and family offices (36.2%).