But that was more than 10 years ago, and for a while after that it looked like buyout firms, once eyed with suspicion, were finally beginning to crack the holy grail in Europe—the German "Mittelstand."
Unlocking the MittelstandThe Mittelstand refers to small and mid-sized manufacturing and engineering companies with revenues ranging anywhere from €5 million to several-hundred-million euros. Their significance is underscored by the fact that they create almost 60% of the jobs in Germany and represent more than a third of the country's economic output.
A number of companies that sit in this category also tick almost every box on a buyout investor's wish list: steady and predictable cash-flow, healthy balance sheets and the potential to add leverage, as well as a score of them being efficiently run. The fact that many of them are still family-owned and are now facing succession problems also offers an opportunity for the firms—which just a few years ago might not have been invited to the table—to bid for some of these businesses.
However, evaluating the current situation is not easy. Looking at overall PE deals involving German companies, of which a large number fall within the Mittelstand bracket, 359 investments were completed in 2017 for a total of €48.4 billion, per PitchBook data. One year later, capital invested reached €44.8 billion across 379 deals. So far this year, €9.9 billion has been invested across 39 deals.
A nuanced outlookThere are, of course, a number of possible factors influencing the numbers and currently the situation appears to be nuanced rather than clear-cut. Confidence in the German private equity market has dampened recently, according to the German Private Equity Barometer, an index compiled by the state-owned development bank KfW. While the index got off to a good start in 2018, sentiment changed in the second half of the year and it has been declining since, decreasing 4.2 points in 4Q to 67.9 points currently.
However, the recent decline appears to be a short-term correction rather than an overall change in sentiment, which remains positive when viewed over a longer period of time. Even when factoring in the fall in 4Q, 2018 saw the highest levels of confidence in the German PE market in 15 years.
The recent dip may simply stem from external factors, such as the expectation of a softening macro back-drop. There is also anecdotal evidence that suggests that some conservative German business owners feel that the investors have overpromised but under-delivered on some recent deals.
Opportunities aheadUnlocking the Mittelstand, which forms the backbone of Europe’s largest economy, was never going to be easy and most investors took the long-term view that time is on their side and deals would emerge.
This might prove to have been the right strategy, since a shrinking economy—Germany is widely predicted to fall into a recession either later this year or next—could lead to a dealmaking bonanza. Investors are sitting on record amounts of dry powder after raising massive pools of capital during the last two years. An economic slowdown is likely to see valuations decline and interest rates remain at their current low levels. Add to this the fact that business owners facing succession issues may be forced to sell in a declining market and you may conclude that buyout investors will be able to pick up some of these companies on the cheap.
For more information on the region, check out our Venture Ecosystem FactBook: DACH