Deutsche Beteiligungs — Steady progress in the first quarter of FY18

DBAG reported net income of €11.4m and a NAV return of 2.7% for the first quarter of FY18, with valuation gains mainly driven by an improvement in earnings expectations for the portfolio companies in 2018 versus 2017. A decline in the market earnings multiples used to value portfolio companies (largely a result of moving from 2017 EV/EBITDA multiples to 2018 EV/EBITDA multiples) held back valuation gains during the quarter. Both business lines reported positive pre-tax income; private equity investments contributed €10.8m and fund investment services €0.7m. NAV per share increased from €29.57 at end-September 2017 to €30.34 at end-December 2017.

The first three months of the financial year were characterised by a high level of transaction activity involving DBAG’s existing portfolio companies, including Cleanpart selling one of its business lines, the partial disposal of Silbitz to a strategic investor, a number of strategic acquisitions by Pfaudler and vitronet, and Polytech pursuing a merger accompanied by a capital increase.

DBAG agreed two new investments alongside DBAG ECF during the quarter, representing the fund’s first transactions since the start of its new investment period in June 2017. The management buyouts of Sjølund and netzkontor nord were completed after the quarter-end and, following these investments, more than a quarter of the capital committed to this investment period (referred to as DBAG ECF I) has been called.

In January 2018, the DBAG ECF fund acquired a c 51% stake in specialist aluminium and steel component manufacturer, Sjølund, from its founder and CEO Søren Ravn Jensen, with DBAG investing up to €4.5m for a c 21% stake. Søren Ravn Jensen has retained a c 49% stake in Sjølund and continues to serve as CEO alongside the other members of the management team. This is the first acquisition within the DBAG ECF I investment period, and the second buyout transaction for the DBAG ECF fund, which broadened its investment criteria in 2016 to include MBO transactions as well as expansion capital investments.

Since 1994, Sjølund has grown to become a leading manufacturer of complex bent aluminium and steel components, generating around half of its c €31m revenues in the year to 30 September 2017 in the wind power industry, mainly from wind turbine components. Headquartered in Denmark, with a production site in China and around 110 employees, Sjølund generates c 35% of its revenues from German customers but has established a global presence.

Sjølund’s end-markets are expected to grow significantly over the next few years, driven by the increasing use of renewable energy, global population growth and increasing urbanisation. DBAG’s investment will support the company’s plans to expand its business with existing customers in high-growth markets such as China and the US, as well as increasing its focus on the highly profitable mechanical engineering sector, one of DBAG’s core areas of expertise.

Also in January 2018, DBAG ECF invested in the management buyout of netzkontor nord, with DBAG contributing up to €4.6m for a c 34% stake. The company’s founders, Dirk Müller and Peter Schmidt, have retained an equity stake and continue to serve as managing partners. Established in 2008 and headquartered in Flensburg, Germany, netzkontor offers planning and supervision services for fibre optic network construction, while its subsidiary OpenXS provides fibre optic network management services. Currently focused on the region of Schleswig-Holstein, netzkontor has c 100 employees and generated sales of c €8m in 2017.

Broadband coverage has expanded at a sluggish pace in Germany, with over 40 million households not yet connected to a fibre optic network, and the government is subsidising network development. Its reputation as a reliable, high-quality provider and its project management expertise provide a strong foundation for netzkontor’s plans to pursue regional expansion and diversify its customer base. DBAG will support this development with the investment and expertise gained from its three current investments in the sector (inexio, DNS:NET, vitronet).

At 31 December 2017, DBAG had €256.4m in undrawn capital commitments to the DBAG ECF and DBAG Fund VII funds. Based on the expected investment programmes for these two funds over the current and two following financial years, DBAG management anticipates an average annual investment run rate of c €70m.

During the first quarter of FY18, DBAG’s financial resources declined modestly from €161.6m to €155.3m (including €33.5m of securities classified as long-term assets), with no major new investments or divestments completed during the period. At end-December 2017, a further €25.9m in cash and securities was held in unconsolidated investment entities, which included proceeds received following the sale of a business line by portfolio company Cleanpart and its subsequent refinancing. DBAG’s share of the new investments in Sjølund and netzkontor nord, which were completed after the quarter-end, totalled €9.1m, leaving DBAG with sufficient funds to meet its expected financial commitments over at least the next 12 months. In addition to its current funds, realisations from the existing portfolio would add to DBAG’s financial resources and it also has a €50m credit facility, which it can draw on to manage short-term cash flow timing differences.

As illustrated in Exhibit 2, DBAG’s shares have traded at a premium to NAV for most of the period since end-January 2015, shortly after it started reporting separately on its private equity investment and fund services businesses. While its investment portfolio is reported at fair value, DBAG’s published NAV does not reflect the market value of its fund services business, which has c €1.7bn of third-party assets under management and generates a substantial fee income stream. DBAG’s share price reflects the value of both businesses, and we see the value attributed by the market to the fund services business as the principal reason for DBAG’s shares trading at a premium to NAV.

In our view, the expected strong valuation gains from several successful realisations accounted for the premium reaching 62.4% in May 2017 (an all-time high at that point), while the current c €240m or 52.8% premium to NAV appears to reflect a premium being applied to the private equity investment business, in addition to the value attributed to the fund services business.

Our earlier analysis (included in our August 2017 note) suggested that the market was attributing a valuation of up to c €160m to DBAG’s fund services business, giving a market-implied valuation multiple of between 23x and 40x earnings. We do not consider that the earnings outlook for the fund services business has altered materially since the launch of DBAG Fund VII at the end of 2016, which leads us to infer that the market is applying a c €80m premium to DBAG’s private equity investments business, which equates to a c 18% premium to NAV. The implication of this premium is that the market has increased conviction that DBAG’s robust NAV growth will continue over the next 12 to 24 months. This expectation is arguably driven by DBAG’s exceptionally strong performance in FY17, as well as the broader development of the business, giving an expanded universe of investment opportunities.

Exhibit 3 shows a comparison of DBAG with a selected peer group of Europe-focused, listed private equity investment companies. As well as its particular focus on German Mittelstand companies, DBAG is differentiated from its listed private equity peers by managing third-party funds, with the exception of 3i in the UK. As noted in the Valuation section above, DBAG’s shares are trading at a substantial premium to its reported NAV. This contrasts with the majority of the peer group that do not manage third-party funds, some of which are trading at a significant discount to NAV. DBAG’s 3.0% yield, based on its proposed €1.40 dividend for FY17, is higher than the peer group average.

DBAG’s NAV total return in sterling terms to 31 December 2017 is appreciably ahead of the peer group average over one, three, five and 10 years, ranking second or third out of eight over each time period. DBAG’s share price total return has outperformed its NAV total return over all time periods shown to end-December 2017. This reflects the shares moving to trade at a significant premium to NAV over the last two years, while the shares traded at a discount as wide as 57.8% during the 2008 global financial crisis.