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Finance

German private equity weathers financial crisis

In an era of cheap money, traditional havens for investment offer just low yields. Private equity firms provide their well-off clients with better returns and, as such, are making their way out of the financial crisis.

Expensive suits, an impeccable demeanor and fluent English are the prerequisites at a meeting of representatives from Düsseldorf's private equity branch. The almost exclusively male finance experts invest money from banks and private individuals in leveraged company buyouts or mergers, and they also manage funds that buy shares in companies in an effort to sell them for a profit.

Germany's private equity branch invested around 5.8 billion euros ($7.57 billion) in 2012. Although that marks a six percent decrease compared with 2011, the branch has left behind the rough times that immediately followed the financial crisis.

There are signs of a private equity renaissance. Foundations, banks and a number of wealthy individuals in Germany have much capital on hand that they went to invest lucratively. But due to low interest rates, people with lots of money on hand see only limited profits from traditional types of investments, says Rainer Effinger of the private equity firm Nord Holding: "Investors looking for possibilities beyond five percent returns are very limited."

Anthony Bunker
(c) Anthony Bunker

Bunker: Returns of 'three, four or even five percent more'

And Triginta Capital partner Anthony Bunker agrees, adding, "Private equity sells itself by promising to earn three, four or even five percent more than other investment classes."

Lucrative business model

The branch's model is based on simple mathematics. Private equity firms buy shares in companies or take them over completely. The money for doing so comes from their investors and borrowed foreign capital. As the proportion of foreign capital rises, so, too, do the yields for investors. A simple example illustrates this. Assume a company costs ten million euros to buy, and the private equity firm finances the purchase with three million of its own money along with seven million in capital borrowed from a bank. If the firm then sells the company later for 11 million, then the total profit is around 10 percent. However, the yield for the direct investors is much higher: 33 percent minus the bank's loan. Those working in finance tend to call the borrowed capital "leverage" - the lever that pushes up yields.

During the boom times of 2006 and 2007, this model generated incredible profits for private equity firms and their backers.

Locusts or honey bees?

Rainer Effinger
(c) Nord Holding

Effinger: The industry has lacked transparency

But private equity firms saw their industry's social reputation deteriorate during those boom years, as well. Franz Müntefering, then the party chair of the Social Democrats (SPD), compared the branch with swarms of locusts that descend on companies, destroy their personnel and then sell the same companies for a profit - all the while on the lookout for their next victim. Peter Güllmann of Germany's Association of Private Equity Firms (BVK) is convinced that Müntefering's remarks made a critical discussion about the branch possible.

The BVK board member says that, as in all fields, there are people who operate in objectionable ways, but that the majority of investors are more comparable with "honey bees" than with vicious bugs. "Private equity is a long-term financial instrument that aims to develop companies and make them stronger than they were when the investment was made," Güllmann adds, noting that he believes workers generally profit from the investing process, just as investors do.

Nord Holding Managing Director Rainer Effinger claims the public discussion about private equity owes to the lack of transparency within the branch.

"The industry has worked in secret too much and hasn't made it clear how many companies it has developed and how many jobs it has generated," Effinger says.

The industry association BVK calculates that private equity firms invested in around 1,200 companies with approximately 1.2 million workers in 2012.

Focus on mid-sized German companies

Preqin, an industry information service, reports that the ten largest international private equity firms are raking in money because many large-scale corporate buyouts in Europe will take place in coming years. Peter Güllmann says large company buyouts dominate the media debate about Germany's private equity firms, even though their core business involves smaller and mid-sized companies.

"The base of mid-sized companies is attractive for investors from Asia and the Middle East, as well as Germany's status as a technological powerhouse," says Güllmann, adding that risky investments in small but ambitious tech companies are drawing foreign private equity firms to the German market.

Gao Zhen
(c) Mandarin Capital Partners

Gao Zhen reports high interest from China in German companies

Gao Zhen of the Italian-Chinese firm Mandarin Capital Partners believes that there are high expectations and positive signs for Germany. "Especially Chinese private companies, after they got IPO in the Chinese market, are now full of cash," Gao Zhen tells DW. Every day, she says, Mandarin gets requests from Chinese companies that seek shares in German companies but are looking for the right places to invest.

Mandarin Capital Partners plans to open another office in Munich in 2013.

Aftermath of the crisis

Even if there are positive signs for investors in Germany, many private equity firms are still under pressure in the wake of the crisis. Investors and banks remain careful due to the unclear economic outlook.

That's leading to a market division, says Rainer Effinger: "There are private equity firms that can get money very quickly and very easily, there are others that have to fight for a long time, and finally, there are some that don't get any money anymore."

Güllmann sees greater risk averseness in the branch and agrees that firms find it harder to get foreign capital for their investments. "What we're seeing now are transactions financed with up to 50 percent of the firms' own capital," the private equity expert says. Güllmann believes that it's likely healthier that private equity firms don't have such easy access to credit, but that also means that fewer firms are willing to invest in young, dynamic branches and companies, leading to a lack of money in those areas.

The phase in which investment firms could simply buy a company, contribute little to its worth or development, and sell it for a profit, are over for now, Effinger stresses. That period was bound up with market gains in wide swaths of the economy, which made it easy for private equity funds to turn a profit - less so these days, the firm director says.

DW.DE