DACH M&A markets from the “valley of tears” to new horizons in 2010?

Pieter Kraan is partner with PilotPartners covering client opportunities throughout Western & Central Europe. Here Pieter sets out the challenges for stress investors in the DACH countries (Germany, Austria & Switzerland) in 2010.

As in the UK, 2009 was dominated by tears in DACH - transactions particularly in distressed M&A based on the impacts of the financial and economic dip.  This was accompanied by the very active role of the governments as “top deal maker” in the financial sector but also as initiator of new regulatory standards affecting the M&A markets. Overall 2009 marked a drop in deal volume by -46% (Germany) versus 2008.

Parallel and contrary to this general doom scenario distressed M&A actually boomed, but could not compensate the overall decline. Drivers were restructurings, turnarounds, and probable insolvencies together with significant market consolidation in the financial and automotive sectors.

M&A Outlook for 2010?

We are seeing positive signs in the real economy deriving from foreign demand triggered by the weakened €.  For example EADS reporting a currency effect of € 22 billion in 1st Quarter orders alone at Airbus. The M&A markets in 2010 may well gain momentum from these positive impacts, together with improved buying power of foreign investors from outside the Euro zone.

Interesting new targets for distressed investors will arise from companies which recently have adapted “Programm Mezzanine”.   First tranches will mature in 2011, and it is apparent that not all cases will be able to repay or arrange for follow-up financing on their own.

Also local strategic investors appear to be building up M&A momentum: a recent CEO survey conducted by UBS and BCG suggests that 20% of the surveyed companies plan substantial M&A transaction activities in 2010. 

What is the debt market doing?

Contrary to previous economic downturns, this dip was marked by heavy capital constraints on the banking side, particularly the Landesbanken (state owned banks), who were faced with heavy losses in their sub-prime exposures. These banks, which are the most important lenders and equity partners to the “Mittelstand” (the core of the economy) have also been confronted with an increasing capital erosion in the key industrial sectors.  

Theoretically this situation would call for increased debt for equity swaps, however not so in DACH. German banks have opted to avoid the legal and fiscal risks associated with re-margining and converting loans into shareholder loans. 2009 has seen only 8 transactions (Stabilus, Bavaria, Treofan, VNU, Monier, Sanitec, Honsel, Neumayer Tekfor).

The situation may also have been influenced by new regulations loosening indebtedness as a reason for insolvency filing (the Finanzmarktstabilisierung law in Germany).  The aim of this law was to avoid insolvencies in the real economy following the then prevailing collapse of the credit markets in the aftermath of the bank crisis.

Unsurprisingly this policy has two sides to the coin. The bad part is that banks often have been keeping their credit engagements pending and refrained from taking action, avoiding the need of further depreciations, thus waiting for better times. The banking sector’s restraints heavily affect the supply of capital to distressed engagements and to the real economy in general, for good reason, as their own financial status remains under stress.

In the present market, credit trades are low. Portfolio transactions are offset by differing price expectations between selling banks and investors.

All in all the market’s anticipation can be likened to a “hibernation mode”, expecting the economy to recover, which will eventually enable both the industrial and financial sectors to build up fresh capital and to reinstall normal business initiatives. This actually blocks tough recovery measures, as may be expected by professional distressed debt investors.

However, there are new regulatory constraints (MaRisk) to banks in prolonging their problem debts. When debtor companies reach a situation close to insolvency, the lenders risk liability if they do not take action by calling for independent due diligence (Sanierungsgutachten) in accordance with the new IDW-S6-Standard.  Previously subordination may have solved the problem; today the requirements are becoming more stringent, but remain partially insufficient, as various assessment and valuation factors (e.g. goodwill, intercompany pricing, excess stocks etc) in distressed businesses stay difficult to grasp.

This may well work towards new opportunities for distress investors.

What are the challenges to corporate managers in 2010?

2010 will be one of the most challenging years for managers, having to deal with unusual restrictions in capital resources and increasing areas of conflict between stakeholders.  The role of management recruiters and providers will be vital to accelerate transformation. As an example, we are increasingly asked to provide CFOs with a successful track record in stress and distressed situations, for instance in dealing with multiple party international credit contracts.

This is supported particularly by German law, which enables a high degree of flexibility to dispose of incumbent or failed management, by the formal segregation between directorships (as a corporate function) and the underlying employment relationship. Hereby directorships (Geschäftsführer of GmbH or Vorstand of Aktiengesellschaft) can usually be changed by a simple majority ruling of the shareholders regardless of the employment contract.

For many companies in the DACH countries, 2010 may develop to become the “year of transformation”, in which efficiency, professionalism, communication and leadership skills will be the determining factors for success. Likewise, distressed M& A transactions in the DACH countries critically require taking on board the services of a specialist management solutions provider, especially in cross-border transactions. Our experienced managers will take a vital role to bridge the relationships between stakeholders in difficult times.