Operational and digital expertise are becoming crucial in an increasingly competitive private equity landscape

Following strong growth in deal volume in Europe in 2014, 2015 maintained that high level and 2016 saw it surpassed by a further 5%. The market seems to be settling for the fact that it is just not possible to pause and wait for less turbulent times – particularly as these don’t seem to be in sight. The uncertainties that defined the market in 2015 – stock market and currency volatility, geopolitical and economic uncertainty, low macroeconomic growth – have all been there again and defined 2016. The economic framework and competitive conditions of the private equity market have not eased either – the competition is fiercer than ever seeing even more participants as well as different players entering; investment opportunities are still scarce and value expectations, which although on average are slightly lower, are still at a very high mark.

Private equity companies continue to place more emphasis on developing equity stories based on operational value creation and digitisation initiatives, as well as targeting sectors ripe for market consolidation and developing buy-and-build strategies. With anaemic growth in Europe, there is an emphasis on driving down portfolio company costs and improving margins, while focusing on increasing the top line by sales force effectiveness initiatives as well as seizing new digital sales channels.

In all of this Germany is well on the way to becoming the new core market for Private Equity in Europe. What this means for the future and what to expect, in conversation with Steve Roberts, Partner and Private Equity Leader at PwC Germany.

The GSA investment market has been flourishing in the past years. However, the findings in the Private Equity Trend Report 2017 seem to suggest that the boom has reached new heights.

Roberts: That is correct. In 2016 in Germany, Switzerland and Austria 214 companies were acquired by financial investors. With a total of €25bn in deal value, which represents an increase of 83% compared to the prior year. That is remarkable and noteworthy for at least two reasons: first of all the level in 2015 was already substantial; the market has, therefore, grown from an already very high level. Second the private equity market in Europe has barely grown at all in 2016. The GSA region clearly stands out.

What are the reasons behind that?

Roberts: One of the reasons lays surely in the Brexit referendum. The decision of the British to exit the EU, the already booming German market was given an additional boost. Even the private equity investors, which concentrated mainly on the UK, are increasingly looking towards continental Europe for investment targets. And in this case Germany is, among others, because of its strong middle market and the “safe haven” argument particularly attractive.

Does that mean 2017 will continue the same way that 2016 ended?

Roberts: In the GSA region we have reached a level, at which it cannot be an easy task to achieve further growth. However, it is quite striking that the German private equity investors, which mostly invest their funds in Germany – are particularly optimistic for 2017. In preparing our trend study, we questioned 250 international private equity manager. The result: while in total every third participant expected growth for the coming year, the number was 43% among German financial investors. In addition 80 percent of German investment managers are satisfied with the current development of their portfolios. On an international level it was only 42%.

This optimism reminds us almost of the record-breaking years before the financial crisis…..

Roberts: On one hand that is true. On the other, however, that comparison falls short. The current private equity boom is based upon a lower leverage than then – so on the basis of much less debt so the speak. In the past year only 8% of German private equity investors chose to predominantly debt finance their transactions. This shows that the industry has become more mature. The times, when returns were mainly generated by financial engineering are over. Instead the investment funds add value and drive their portfolio companies forward on an operational level. One can observe this development just by taking a closer look at the structure of the deal team. Earlier eight out of ten had a financial background. Nowadays, you meet professionals there, who are predominantly come from the industry. So ex CEOs, previous COOs – and naturally more and more digital experts. PE has quickly understood that digital transformation is crucial for this portfolio companies to make them „future-ready“. They have realised that through this they can counteract to the increasing holding periods as well as the relatively low levels of macroeconomic growth.

So the boom stands on a solid fundament?

Roberts: Absolutely! However, private equity houses need to be careful not to get pulled into a fierce price competition. More and more competitors from outside the industry, such as pension funds and insurance companies, are developing taste for the private equity model; this increases of course the competition pressure. In addition, further players such as Chinese investors, which are getting progressively more serious, are establishing themselves in the market. Many German strategic players have become buyers rather than sellers. This means for private equity houses: If they want to still generate the lucrative returns on their investments despite increasing prices, they have no other choice but to focus even more on the operational alignment of their portfolio companies.