2019 was a record year for deal value in the DACH market and 2020 was off to another strong start before the coronavirus hit. Nevertheless, copious amounts of dry powder in the region mean that sponsors are still looking to make deals and this liquidity may prevent a significant fall in multiples, say Clearwater managing partners Axel Oltmann and Heinrich Kerstien.
Technology and industrials deals dominated dealflow in the DACH region in Q1 2020 with the healthcare sector also favoured by GPs, demonstrated by Deutsche Private Equity selling its stake in Pharmazell to Bridgepoint in February. However, overall deal volume fell in Q1.
The industrials sector has long been a staple of Germany’s economy and has historically drawn interest from investors in the region, too, with the largest ever private equity deal in the DACH region and the industrials sector being announced in February, when a consortium of Advent, Cinven and RAG-Stiftung bought Thyssenkrupp Elevator in a deal valued at approximately €17.2bn. However, the sponsors are reportedly seeking additional equity backers to reduce their own risk exposure to the asset and the sector, indicating a shift in the view of the sector from Q1 to when the coronavirus crisis hit.
I would expect that healthcare or SaaS businesses, for example, will be sold at basically the same multiples as before.
Certain industrials sub-sectors are ones that GPs would approach with caution and might be increasingly viewed as coming with a higher risk. “We saw lower multiples for machinery and engineering pre-coronavirus. These sectors are even more affected now,” says Oltmann. “The time gap to recover after the coronavirus effect will be longer for the companies whose multiples were low before the crisis.”
As Oltmann points out, even prior to the coronavirus crisis, there was already a significant spread of multiples across cyclical and non-cyclical hot sectors. “The impact of coronavirus might increase the spread of multiples between sectors. I would expect that healthcare or SaaS businesses, for example, will be sold at basically the same multiples as before.”
The hot sectors of technology and software have become obvious non-cyclical focuses for investors since the coronavirus crisis began to take hold and are likely to bounce back more quickly than others, or may not have seen any negative impact from the coronavirus at all. Many players in the DACH market had been moving towards these sectors long before the coronavirus crisis. As Oltmann explains: “Over the last years we certainly saw a tendency towards healthcare and technology businesses. In principle, private equity was closed to the automotive sector and focused on the smart part of industry competitors. Some sponsors have benefited from this shift towards less cyclical markets, but I would doubt that there are any larger funds with no impact on their portfolios. People saw things developing towards a recession, but not in this manner.”
Beyond distressed M&A for businesses that are struggling with liquidity problems, sellers in the current market are generally those who believe that they have resilient and strong businesses, and they are unlikely to accept significant multiple decreases. Nevertheless, the coronavirus has naturally had an impact on dealmaking and dealflow in the region, says Oltmann. “Plain vanilla M&A for the sell-side is only happening for really robust sectors with no clearly measurable coronavirus impact, and otherwise most deals are on hold,” he says. “For deals in an early stage or premarketing there was an immediate hit and most of them were shelved. But we also see a number of deals in the market that were already in the due diligence phase and we are trying to make these happen and to find a bridge where we can balance the potential risk of corona hits: key words are earn outs and vendor loans, tools to bridge the gaps.”
Kerstien suggests that sponsors are likely to double down on their existing investment strategies to weather the storm, particularly those with a specialised sector focus. “As a sponsor, I would follow my investment thesis at this time. The worse the market environment gets, the more you focus on what you know, rather than venturing into something that you have not done before. The investment focus will grow narrower.”
We might expect prices to come down due to financing restrictions and the coronavirus – but the counterargument is that sponsors are still open for business with significant funds to spend
Oltmann concurs and does not expect classical PE investors to target struggling sectors where multiples might be lower or turn to distressed investing. “I doubt that normal PE funds would go for sectors that are in serious trouble claiming that they could be a good buy – they will rather be looking for robust businesses where they can still buy something for a good price.”
In an uncertain environment, the sheer quantity of capital that GPs are waiting to deploy may help bolster multiples. “A large amount of money is competing for fewer targets in the market,” says Oltmann. “We might expect prices to come down due to financing restrictions and the coronavirus – but the counterargument is that sponsors are still open for business with significant funds to spend.” Kerstien concurs: “Liquidity hinders pricing from coming down significantly; at the moment, we don’t see assets valued at 10x EBITDA going down to 6x or 4x, for example. If there is an equity story to tell and lots of capital available, there is no real reason for multiples to go down, other than financing getting more expensive.”
Buy-side strategies have built on the pre-existing trend in the market of buy and build, but they are currently less popular with banks, an issue that is set to persist both during and beyond the coronavirus crisis. Kerstien attests: “If you want to create a platform by buying several businesses in one go, this is more difficult to finance than it would have been previously as banks are focusing on a fully integrated management during the months of increased uncertainty.” For the larger deals, the absence of underwritten bank deals is an issue, as Kerstien explains. “You are left with some unitranche lenders who can provide these debt volumes. Smaller deals are still doable. As many banks and funds are focusing on their portfolio deals, interested financing parties may include local providers, specialised lenders or market participants who have not been that active before.”
The financing market, while currently challenging to navigate, is by no means closed for business, however which means that deals in hot sectors can still get done. “In attractive sectors, for robust businesses, you can still find financing.” says Oltmann.
Ultimately, the full impact on pricing and multiples remains to be seen, says Oltmann, although dry powder may be the determining factor in the coming months. “I doubt that the coronavirus will have a balancing impact that will lead to an overall decrease in multiple levels – it depends on how fast refinancing will be back when financing sources are there and at what prices, and how strong the pressure is to invest. The liquidity in the market is still so dominant and you still pay good prices for good businesses.”