Frankfurt/Main – Purchase prices are soaring in the German private equity market and company valuations have moved up significantly. Investment managers in Germany thus find themselves in an increasingly uncomfortable position, with new investments in particular requiring unprecedented amounts. Those are the key findings of the latest private equity panel survey, which is conducted three times a year by CMS Germany and FINANCE magazine. More than 50 different private equity (PE) firms in the German SME sector provide assessments of the market for the survey. “Prices may look high to buyers, but that hasn’t harmed the overall market as yet, it continues to boom. The moment of truth will come a few years down the road, at exit time. Then we’ll see who made the right call,” said Dr Tobias Schneider, a private equity partner at CMS in Germany.
Valuations in the M&A market climbed markedly over the summer, with the less cyclically sensitive sectors benefiting in particular and being rated more favourably than in the last survey. Private equity investors currently regard software/IT (8.30 points), healthcare (8.27 points) and electronics (6.97 points) as exceptionally attractive sectors. The latest panel findings also support the view that the earning power of portfolio companies is now on the wane. Furthermore, private equity managers are less optimistic about business prospects over the coming twelve months, awarding the lowest rating for two years (6.97 on a scale of 1 to 10).
Mounting pressure: private equity investors need to take on more risk
According to the latest survey, German PE managers are under mounting pressure, with private equity players showing a willingness to invest significantly more boldly in German SMEs than of late – despite rising company valuations and weaker earnings prospects. They also don’t see themselves as being firmly on the buying side or the selling side. A score of 5.94 points on a scale of 1 to 10 suggests more of a 50:50 split, although the survey results indicate an increasing propensity to buy. The corresponding value is 14 per cent above the spring survey and the highest level for nearly two years. The share of respondents placing themselves on the selling side fell by three percentage points to 58 per cent. CMS partner Dr Tobias Schneider said: “Private equity firms are still sitting on huge piles of cash that urgently needs to be put to work if there is to be any chance of delivering the promised returns – or even getting near them.”
In the past two years, PE managers adopted a more restrained position in the M&A market. As a measurable shift to a selling stance became evident, they regarded purchase prices as less expensive than they do now. Sentiment around portfolio companies was just about to scale the record highs reported between the start of 2017 and spring 2018.
“As usual, it’s all about timing, and the latest indications may suggest that it is now very late,” said Dr Jacob Siebert, a partner in the Private Equity team at CMS.
Automotive industry losing favour
The surveyed private equity managers predict a turning point for the German economy. That impression is reinforced by the sectors favoured by the panellists. The biggest loser is the automotive industry, with a rating of 3.64 points on a scale of 1 to 10. As such, it lagged all the sectors covered by the survey. Private equity has clearly turned its back on the automotive industry for now. CMS partner Dr Jacob Siebert commented: “Automotive was already not on the A list of possible targets for many funds. The recent scandals are likely to have accelerated the existing disruption, leading to widespread uncertainty, but opportunities also beckon.” The chemical industry, which is highly dependent on the state of the wider economy, has likewise declined in attractiveness, as has the service sector, despite being less prone to volatility.
When it comes to investing in German SMEs, private equity investors are following the herd instinct. They are avoiding cyclical industries and focusing instead on companies with reliable cash flows that are less susceptible to changes in the economic environment. The most favoured sectors are software/IT, healthcare and electronics.
Half of all transactions covered by W&I insurance
W&I insurance remains very popular as protection against breaches of warranties and indemnities contained in the sale and purchase agreement. 63 per cent of the private equity firms polled now use W&I insurance on their transactions, far in excess of the proportion recorded just three years ago. The latest survey also shows that buyers regard such insurance policies as being an attractive option for both buyers and sellers. Almost 70 per cent of those surveyed view the tool as positive for both sides.