Deutsche Beteiligungs AG

XETRA:DBAN

Earnings Call Transcript 2018-Q4

[Thomas Franke]

Good morning. My name is Thomas Franke, thank you for your interest in Deutsche Beteiligungs AG this morning. I will now pass you over to Susanne Zeidler, Chief Financial Officer of Deutsche Beteiligungs AG.

[Susanne Zeidler, CFO & Member of the Management Board]

Good morning, ladies and gentlemen. It's my pleasure, too, to welcome you to our conference call. In the next 30 minutes, I would like to present essentially the figures for the financial year 2018. I will also tell you about our dividend proposal and explain our guidance for 2019 and beyond. Before I start, I would like to make one comment about year-on-year comparisons. We changed our accounting practices after an error was identified by BaFin, the Financial Supervisory Authority. In this context, we were obliged to adjust the comparative figures for the previous year in accordance with the International Accounting Standard #8. As you will remember, this agreement was about the timing of recognition of carried interest. We commented on this in full in the Q3 report. Our accounting now follows the guidance from BaFin, which assumes each fund is liquidated in full as at every reporting date. Based on assumed sales proceeds, we now calculate whether carried interest is payable, and if so, how much. This amount is then deducted from the valuation of portfolio companies in the given fund, or more precisely, the corresponding investment entity subsidiary. But now to the financial year 2018. Net income of EUR 33.6 million does not meet our expectations. You will remember that we adjusted our forecast during the course of the year. Lower valuations from capital markets impacted our net income. But in some of our portfolio companies, things are not progressing as quickly as we expected. 2018 is well down on the exceptional year 2017. We are using our dividend policy to translate volatility that is inherent in our business model into a dividend, which is at least stable or growing whenever possible. Continuing this policy, we are again proposing to increase the dividend to EUR 1.45 per share. Reference to the 7 management buyouts we have agreed to invest in the outlook. We have invested more capital than ever before and thus laid the groundwork for future value creation. Our business should not be judged by the results of the financial year. The strong influence of capital market developments means our business model is more volatile than others. On the long-term scale, the year 2018 was below average. The return on equity per share of 7.8% is below the average for the past 10 years, which was 11.4%. By the way, a year ago, this 10-year average was significantly lower, however, at less than 9%. Although the share reached a new all-time high at the beginning of the financial year, 2018 was not a successful year for shareholders either. But here, too, it is the long-term return that is important and over 5 and 10 years per share significantly outperformed the relevant indices. Let us look more closely at the sources for the natural result of valuation. The contribution made by the change in the result and in debt can be considered an indicator of operational improvements at the portfolio companies or an indicator of their strategic further development. On balance, the value contribution of EUR 17.2 million from the operating performance of the portfolio companies is higher than last year, indeed, more than twice as high. This value contribution, however, comes from a significantly larger number of companies, meaning that the average value contribution per portfolio company has fallen. The value contribution from the operating performance does not meet expectations, and I will return to that in a moment. First, I would like to examine the high negative value contribution due to the portfolio companies’ debt then the impact of changes in multiple. Acquisitions in the portfolio tend to, first of all, increase the company's debt and reduce their value as a results before the strategic and operational improvements associated with the acquisitions take effect and increase value of the investment. This is the case at duagon, for example, especially in the context of acquisition of MEN. The investment in More than Meals was initially fully financed by equity and short-term shareholder loans. Now the acquisition financing has been completed and the investment is carrying more debt as a result. Occasionally, we also have restructuring situations in our portfolio companies and this may reduce their value. In the value contribution from changes in multiples 2 effects, more or less, balance out: Firstly, the influence of changed, and on average, lower capital market multiples, which have been negative over all this year, as already mentioned; and secondly, the impact of gains on disposal. The individual valuations take into account the expressions of interests from potential buyers as well as the implied multiples determined as a result of the agreed disposal of the investment in Cleanpart. Overall, this resulted in a positive contribution of EUR 13.6 million. This, however, was largely offset by the headwind coming from the capital markets, the worsening mood on stock market costs us EUR 10.5 million. Value contribution from disposal processes in capital markets development cannot be planned. They can, nevertheless, have a significant impact on our earning, and this year, that impact was unfortunately negative. The number of companies delivered a lower value contribution than initially expected last year. The budget deviations are essentially due to change processes at these companies that are developing more slowly than planned. It is also important to note that at the account reporting date, the portfolio was younger than it was a year ago. Performance is not linear, but rather accelerates over the cost of investment. As we have shown here in this example of an investment over 2 years ago, its valuation was 4 years behind expectations, which were based on a straight line value creation, but we ultimately generated significantly more than we first expected. Our shareholder of note, DBAG, is a stock that pays high dividend and this is something we do not plan to change. Our dividend policy translates our long-term business model, which can, of course, show short-term volatility in an individual year, ensure predictable and reliable distribution. Our dividend should be stable and increase whenever possible. As a result, we are proposing an increased distribution of, as already mentioned, EUR 1.45 for 2018. This once again, produces an extremely attractive dividend yield usually.It is not only the high retained profit under German GAAP of more than EUR 170 million and our comfortable liquidity situation that encouraged us to offer this sort of dividend over the next few years. In future, increases in the value of the new portfolio companies will contribute to our net income. Never before have we invested as much as in 2018. Income from Fund Investment Services rose yet again to reach an all-time high of EUR 28.5 million. I see that the slides are behind my -- a technical reason, I believe. I'm already on Slide 11 -- 10, 10.Income from Fund Investment Services rose yet again to reach an all-time high of EUR 28.5 million. We received transaction-based fees from DBAG ECF for the first time amounting to EUR 1.1 million. And the EUR 28.5 million I mentioned do not include the internal management fee we [ prey ] from the target equity investment business for to the Fund Investment Services business. The segmental net fee income is EUR 29.4 million. Higher income was reflected 1:1 in an earnings improvement from Fund Investment Services segment. Segment expenses remained unchanged. Two opposing effects came into play here. One effect already mentioned in Q1 was a one-off effect nonrecurring expenses from the subsequent adjustment of remuneration for work on the Supervisory Board of portfolio companies in DBAG Fund V. And these are offset by a lower addition to the provision for performance-based variable remuneration. The volume of advised assets increased slightly. It is in the nature of our business that managed assets only rise when a new fund is launched. Every realization, every dividend and also every capital core for management fees reduces the volume of managed assets. However, we saw a slight increase in 2018. This is the impact of capital commitments by investors of some EUR 56.3 million for the second new investment period of DBAG ECF, we reported on this in our Q3 report. Two new investors were also acquired by solicited capital commitments for DBAG ECF, too. We see the fact that 90% of LP commitments come from existing investors as further proof of our reputation as an adviser of private equity funds. The value of the portfolio rose by almost 40% in financial year 2018. At around EUR 349 million, this is the highest figure in the past 10 years and also comprises the largest number of portfolio companies, 29 to be exact. I will come back to the investment and disposals in more detail later on, and I have already explained the value changes. Sales and earnings were up significantly for the portfolio companies that were already onboard at the start of the financial year. 1/3 of the growth is also due to acquisitions. Earnings quality has improved again overall, which is good news, therefore, higher in relation to EBITDA, but a multiple of 3.1 is still moderate for the industry. The increase is primarily due to the younger portfolio and different sector mix. The weighted average multiple for valuations also rose slightly. At 7.8, it is back at roughly the same level as 2016 when it was 7.7. The radiology group is not included in these figures. We agreed this investment back in March 2017, but it has not been completed yet. For this, we need approvals from the Administrative Association of Statutory Health Insurance doctors, which are still outstanding. We expect that they will be granted soon. The portfolio is younger, a result of the investments in the past 2 financial years and the disposals in the previous financial year. The portfolio -- the current portfolio is valued at 1.4x acquisition cost. Just to remind you, over past 20 financial years, we have generated an average capital market below 2.9 on disposals of majority investments. As shown on the graph on the right, the greatest value contributions are achieved in the companies that have been in the portfolio for more than 2 years. You will have noticed that we have expanded the range of sectors in our portfolio over recent years. This is clearly visible in the change in entry valuations, which we expect when we invest. It is obvious that fast-growing software companies are valued at a higher multiple than engineering companies. And so the range of entry valuation is correspondingly broad for the MBOs completed in the past 2 financial years. We are also still able to invest at valuation that you may feel are low or good value. The focus of our portfolio is still on investments in sectors that are particularly characteristic of the German economy and as we describe as our core sector, Automotive suppliers, Mechanical and plant engineering, from companies that produce industrial components, from engine blocks to high-tech films and electronic controls for trains and industrial service providers. But we no longer want or are able to focus exclusively on these sectors. Our success over the past 15 years has significantly increased the size of the funds we advise. The size of the market for equity investments, on the other hand, is finite. That's why we are now also taking a challenging look at the business models outside the industrial sector. Incidentally, this is not a new trend that started last year. DBAG Fund VI was the first to include 2 investments that did not come from the traditional core sectors, which were Schülerhilfe and [ unser heimatbäcker ].For the first time, we are also showing you how different value-added strategies impact the value of the portfolio. The approaches we use to achieve value appreciation are systematic. The most important value lever is the company's strategic focus. The management teams of the portfolio companies usually have more than one approach at their disposal when it comes to refining this focus. The expansion of the product portfolio, geographical market development by way of international expansion and the expansion of the service business, accelerated by making company acquisitions and also with the aim of sector consolidation are other possible methods for achieving value appreciation. Operational improvement can be achieved, for example, by optimizing production processes. We use extensive compliance and sustainability standards as well as KPI-based reportings to improve corporate governance. Our investment activities can be divided into 3 main core business focuses. First, we identify and assess investment opportunities; second, we support the portfolio companies' development process; and third, we realize the value appreciation by means of a portfolio company's well-timed and well-structured exit. As discussed, we agreed 7 new investments in 2018, of which 5 were completed in the financial year and the remaining 2 were completed at the beginning of this financial year. To do so, we made capital cost of EUR 65.8 million within 2018. Another EUR 19.3 million were provided to portfolio companies to finance acquisitions. This amounts to investments totaling EUR 85.1 million. We received EUR 25.5 million from disposals, more than EUR 20 million of this came from recapitalizing the investment in Cleanpart at the beginning of the year. In 2018, we screened 261 investment opportunities. While this is much less than in the previous year, the quality of our deal flow has improved. The proportion of investment opportunities that we investigated in more detail increased considerably year-on-year from 74% to 81%. We followed up 200 -- on 211 potential transactions, almost 55% of them much more than in the previous year related to our core sectors. The number of investment opportunities for growth financing fell considerably again, coming to less than 5%. We made offer for 44 investments, another increase as against the previous year mainly by more than 50%. The fact that we improved our selection process again is particularly important for our success. We need to do less work internally to obtain new investment. Without these improvements, it would not have been possible to make 7 new investments with the existing capacity. DBAG has been the most active private equity company in the German mid-market sector over the last 10 years. Last year alone, our partner were the founder of families of 6 of the company's concerned. We see this as evidence of our positive reputation on the private equity market. DBAG obviously has something that other private equity companies don't: the achievements of entrepreneur and their employees in mid-market companies are something that really inspires us. All the founders have one objective in common: they want the new shareholder to develop their company in the best way possible and at the same time, at least, preserve what the founder has achieved to date. I think that we can all keep to a point with our understanding of the business model concerned. We have told you about our new investment over the course of the year. So here I will concentrate a bit on the last 2 completed in the financial year under review, those MBOs, one with DBAG ECF and one with DBAG Fund VII. Those transactions have since been completed. FLS develops and distributes software for planning appointment and travel in real time and Kraft & Bauer produces fire-extinguishing systems for machine tools. These 2 MBOs illustrate the range we now cover. Inorganic growth has become a vital part of our value-creation strategy. It enables the portfolio companies to develop much faster. And because more companies are often available at lower valuations, it means we can reduce our overall entry valuation. The high volatility of cash flow is typical for our business model. In some years, there are more investments as in 2018, and in others, there are more disposals as in the financial year before. The decline in cash as a result of investments was in line with our expectation. Net asset value rose by a good 5% in the financial year under review, above all, as a result of the increase in the value of the ongoing portfolio. The structure was improved at the same time. By year-end, the proportion of financial assets is much higher, especially due to the high level of investments. Cash holdings continue to dilute the return, however. I would like to finish with a brief look at the segment results. Net result of investment activity of the Private Equity Investment segment are significantly down on the previous year as well expected. A total of 6 disposals in 2017, including 3, which were exceptionally successful contributed to the highest net income in 2017. The investment team's entitlement from carried interest reduced by EUR 7.8 million net income -- net result of investment activity, and correspondingly, net income. I've already mentioned the specific nature of our business model. We have responded to this by no longer allocating the value contribution from a single investment on a straight-line basis. Instead, we assume that the value contribution is higher at the end of the holding period, which corresponds to the actual pattern of performance in the observable historical data. In a year was a particularly large number of recent investments, which are far removed from being disposed of, this leads to a dip in the planned value appreciation of the portfolio. In addition, we have broadened the system for evaluating KPIs, which depends, to a large extent, on the investment business and so are highly volatile. This applies to earnings from the investment business, but also to net income. It is no secret that by expanding the forecast range, we also hope to make it easier to meet our forecast. And now that BaFin obviously looks particularly closely even at the difference between forecast and actual quarterly figures, we believe this is also necessary as the earnings performance cover the course of the year is even less predictable. Having said this, the following forecast can be given for the new financial year and beyond. And in view of the economic and political conditions, however, this forecast is subject to even greater uncertainty than in recent years. Just as example, I would mention the trade dispute between the U.S. and China, the open outcome of Brexit, EU's statutory wrangling and the homemade attacks on the automotive industry. In the Private Equity Investment segment, the pretax earnings should be moderately below the reference for the forecast. And the reference is, in this case, the 5-year average and mark the financial year 2018. For the 2 subsequent years, we then expect them to be significantly higher than in 2019. In the Fund Investment Services segment, we are expecting 2019 earnings to be slightly lower. Going forward, the results will arrive significantly under the end of the planning period in 2021. So by the end of 2021, we are planning to launch a new fund, have higher advice assets, and thus, generate much higher income from fund advisory services than in 2019. So what are these new funded income. We expect net income for 2019 to decline moderately compared with the reference point of the forecast. For example, a fall of 20% to 40% compared with the benchmark of EUR 48 million. Compared with the figure of EUR 36 million for 2018, our forecast was aim to slight increase, however. For 2021, we then expect to see values that are significantly more than 40% higher than the value for the current financial year. This development will be based, among other things, on the current 8 structure of the portfolio, which is dominated by investments that had been in the portfolio for less than 2 years on the reporting date. With this, I come to an end of my presentation with a special outlook to 2019 because we are planning to organize for the first time a Capital Markets Day in order to give you more insight in our portfolio, to present to you our investment managers as well as managers of our portfolio company, and we look forward to seeing you there. And now, Mr. Franke and I are happy to take your questions.

[Thomas Franke]

Okay. Thank you. A lot of information. Who wants to start the Q&A session? Please go ahead.

[Gavin Peter Wood, Analyst]

Gavin Wood here from Edison. I just -- I had question. Obviously, the market volatility has effected the performance in full year to FY '18. Within the current year, obviously, we've seen the markets fall in October. Have you incorporated the decline in valuation multiples in your forecast for the current year, perhaps still effects on the end September valuation multiples?

[Susanne Zeidler, CFO & Member of the Management Board]

As we account under IFRS, we are obliged to take the multiples on at the closing of the stock exchange on 30 September 2018.

[Gavin Peter Wood, Analyst]

So effectively, there could be a further downgrade just if the October sort of market forward sort of stays? No valuations in the first quarter, you'd see a negative effect that's not in your current for the year.

[Susanne Zeidler, CFO & Member of the Management Board]

No. The next update will come on 31st December and we don't know as of today whether it will be higher or lower than today.

[Gavin Peter Wood, Analyst]

Yes, but just to be clear. So the October market fall isn't in the current number, so if nothing changes from today, say, then there should be a negative effect, which shouldn't surprise?

[Susanne Zeidler, CFO & Member of the Management Board]

Correct. We don't take into account this negative effect as we had to do to make a valuation today as we didn't take into account corresponding positive effect in other quarters in the past. It's always -- for the multiples, it's always the closing of the stock exchange on the valuation date. The only thing we take into account after the balance sheet date in the course of the process of making the financial statements are any newer knowledge from the portfolio companies, especially in those cases where we are in negotiations with potential buyers.

[Gavin Peter Wood, Analyst]

Yes, I understand that. And just in terms of the market volatility, I appreciate that most of your sales of portfolio companies are made through trade sales. Since it's not completely dependent on market conditions. But has market volatility affected the interest or speed of sales processes developing? Do you think that will be increasingly likely to lead the...

[Susanne Zeidler, CFO & Member of the Management Board]

No. No, I would like to say no, because when we made the guidance, a little bit tough for the financial year 2018, we did not expect a similar number of exits than in the previous year. And this was not due to market conditions, but due to the status of the portfolio and the status of the development process in the portfolio companies. And there might always be a slight difference from our assumption. For example, one of the exit in 2017 had been planned for 2019, for example. And last financial year, maybe that could have been a second exit and not only one was Cleanpart, but these are minor influences on the figures.

[Gavin Peter Wood, Analyst]

Yes, okay. And just in terms of the pricing of deals, has market volatility decline and market valuations affected sort of factored into lower investment prices for deals? Or is it the demand for new deals still keeping prices at a relatively high level?

[Susanne Zeidler, CFO & Member of the Management Board]

We did not see a decline in, overall, in size level in the M&A market. But what we see is that especially if you negotiate directly with families of founders that you're still able to get companies for prices that are, in our opinion, not too high. But I would not translate this into a sentence, which is prices decreased because there still -- there is competition, there is still a lot of money in the market in competition for a limited number of transactions. But -- so no price decrease in our observation.

[Gavin Peter Wood, Analyst]

Yes, okay. And just a final question on your comment that this whole company development was below expectations. Is that comment relative to your sort of linear value increase assumption that's now changed? Or are there particular companies the underlying business is not progressing in line with expectations?

[Susanne Zeidler, CFO & Member of the Management Board]

The main reason for this was that I said that the financial year was below our expectation and I referred to what happened in the quarter of the year. You might remember that after Q2, we had to give -- to make a new guidance, a new reduced guidance, based on the multiples, which plummeted down at the end of Q2. And then again, naturally reduced that guidance in the context of negative result of the enforcement process because of the -- because we had to adopt the valuation methodology, which led to the effect that more carried interest had to be accounted in this financial period than originally planned. So these were the 2 effects, which led by the end to the reduction in guidance. And in addition, yes, we have some companies on launch where the -- unlocking the development potential we saw at this point of time of the investment takes more time, and I would like to say that this is a number of 2 or 3 companies.

[Gavin Peter Wood, Analyst]

Yes. And in those 2 or 3 companies, was it just that it's slow to start and the endpoint is still where you expect it, it's not just a straight line? Or is it just a longer so that maybe 5 years instead of 3 years to achieve? Or 5 years instead of 4 years to achieve the endpoint you want to get to?

[Susanne Zeidler, CFO & Member of the Management Board]

May be that it is a combination of those. In the past, the average -- the holding period, on average, between -- well, between 4 and 7 and the overall average was 5. Maybe that it takes 1 year longer. But what we see as of today is that it will not only take 1 year to implement the matters and to -- we won't see the fruits of the matters made in the companies after 2 years, but maybe after 3 years. And therefore, we adopted our planning methodology, which had, in the past, a straight line value creation. And therefore, we have recorded a postponement of value creation, which will come to reside 1 or 2 years later than expected in the past.

[Gavin Peter Wood, Analyst]

And can I just ask you one, so one final extra one. On the restructuring and so high net factor, is that sort of you revalued that investments in sort of a new plan for that now? And is that within the 2 to 3 companies? Was that ...

[Susanne Zeidler, CFO & Member of the Management Board]

We have a restructuring manager onboard for some months now, for nearly a year now, and he is working intensively with the team and within the company. But for shareholders, this investment is no longer at risk because it is valued at nearly 0 for many quarters already, I have to say.

[Thomas Franke]

Okay. Who's next? Okay. So a lot of information in the information pack we sent out this morning. We'll be available for further questions during the day. And if there's nobody else ready with questions, I suggest to end the conference.

[Susanne Zeidler, CFO & Member of the Management Board]

Okay. Thank you, again, very much. Have a nice weekend.

[Thomas Franke]

Thank you. Bye-bye.