| Walter Moldan | ||||||
Germany’s Mittelstand companies are the backbone of the country, comprising something like 60% to 70% of the economy’s gross national product. But a large number of them are starting to feel persecuted by their government, their bankers and their potential investors, as they are squeezed between, on one side dynamic, high-technology businesses and on the other, by large, blue chip companies.
These traditional mainly family-run firms, which thrived in the conservative, protected post-war German market, are finding modern life much harder. They believe that the government, far from safeguarding their interests as it has done in the past, has betrayed them. They accuse ministers of introducing tax reforms, which, they insist, treat them less well than the country’s major blue chip corporations. This happens because private family Firms do not get the advantages available to joint stock companies.
And this downturn in their fortunes comes at a time when they are already finding it hard enough to meet the demands of global markets.
Company owners are being forced to find new investors or industrial partners and to surrender control of companies that they had expected would provide pensions for their retirement.
The reality is that they have to adapt or fade into decline. To succeed in the single European market, they need to expand geographically and invest in new technology so that they can compete with non-German companies in the same sector. Worst of all, these traditionally secretive Firms are having to accept, when they go public, that they must provide the detailed information that equity investors require and then deliver value to these demanding outside shareholders.
And those that have come to terms with the need for change are finding that their timing could not be worse. Potential investors are no longer friendly. As a result, only a few of those going to the equity markets are welcomed enthusiastically. Some Mittelstand companies that have gone public are now seeking to return to private ownership. Others are finding it impossible to make initial public offerings (IPOs).
Banks turn their backs
In the past, these companies could have turned to their banks to raise money. But the banks, labouring under new Basel regulations and facing pressure to return value to their own demanding shareholders, are no longer such an easy source of finance. “There is a clear change in emphasis from loan-driven growth to capital markets driven growth. Companies are arguing that the commercial banks will not advance loans for growth so they have to raise money on the stock exchange,” says Dorothee Blessing, executive director at Goldman Sachs in Frankfurt.
Stuck between reluctant investors and less friendly banks, the Mittelstand Firms face further pressures. One particularly pressing challenge in high technology sectors, where qualified senior executives are at a premium, is to attract and keep key staff. According to one banker, “you have to lock in these people by offering them equity holdings. Otherwise they will leave the company. One information technology company said recently that one of its main objectives in having an IPO was to bind in its employees.”
This becomes increasingly sensitive as a growing number of Mittelstand companies face succession problems. “A lot of companies were founded in the 1950s and now need a successor to their founders. Quite a lot of these family-run companies have no successor from within the family so they must find another way.
Moreover a lot are developing new technologies or are expanding into international markets and need more capital than the family can borrow,” says Jörg-Heinrich Kranz, senior vice-president and head of new issues at Helaba, the Landesbank for Hessen-Thuringen.
Some Mittelstand companies are succumbing to trade buyers. More than 2,000 acquisitions involving the Mittelstand have taken place in the past year, of which 600 involved foreign purchases. Not all have been happy stories.
Some are reluctant decisions by owners close to retirement and without a successor. Others have entered the brave new world by selling to foreign companies, only to find there is a massive gulf in understanding between financially oriented Anglo-Saxon firms determined to maximize profits and the German companies’ focus on technical expertise.
But the sales that have gone ahead make only a small difference to middle-sized corporate Germany. There are many more companies who accept that they need to raise money from the equity markets if they are to invest in technology and become large enough in the single European market and perhaps eventually in the US.
Despite the short-term problems, bankers says the long-term opportunities for this sector are considerable. And the traditional lenders to middle-sized companies are themselves building expertise in the debt and equity capital markets. “The potential for the Mittelstand is huge. But one must select candidates carefully,” says Kranz. He says that Helaba has “a list of traditional Mittelstand companies which are planning to go public. They are normally in a traditional Weld that they want to develop. Many have been clients of ours, and of the savings banks, for a number of years.”
| Jochen Grossmann | ||||||
A growing number of larger companies are now finding a place on the Neuer Markt. “If you look at the number of deals done in the last year and their respective volumes, the Neuer Markt started with smaller companies and smaller offerings. In 2000 year to date, more than 20 IPOs took place of which 40% were larger than e500 million, including transactions such as T-online,” says Blessing.
In the days before dot com fever, the Neuer Markt was keen to attract listings from such larger and medium-size established companies.
At that time, most owners of Mittelstand companies believed there was neither advantage nor need in public flotation. Now that they are interested in floating, investors are delivering a resounding rejection to many Mittelstand names.
One consolation is that public stock market investors are not the only source of new equity capital. Walter Moldan, senior partner and head of UBS Capital in Germany, a firm specializing in private equity investments, says: “This market appreciates larger companies. Those with a turnover of Dm50 million to Dm70 million have become less attractive. Valuations have gone up for companies with a turnover of Dm300 million to Dm3 billion.”
The reluctance of public market buyers to invest in Mittelstand companies is partly a product of fashion. German investors, particularly on the retail side, have always been susceptible to the latest fad, ranging from emerging market bonds to Japanese warrants, say Frankfurt bankers. But their enthusiasm has not extended to the Mittelstand and is unlikely to do so in present market conditions.
“The reality is that it will be increasingly difficult for well-managed, profitable ‘old economy’ companies with single-digit growth rates to come to the market. They might be very solid with a track record of good earnings quality but very often they lack the necessary ‘new economy’ transition of their business to attract the market’s interest.
Consequently, I don’t see a huge pipeline of this type of Mittelstand company coming to the market, even though there is a strong demand at present for fundamental earnings quality,” says Achim Schäcker, assistant director of global corporate finance for Dresdner Kleinwort Benson in Frankfurt.
According to Schäcker, “the problem is that the market is looking for size, liquidity and growth with underlying earnings quality. Thus, investors refraining from the risk of high-growth technology stocks will typically rather go all the way to liquid blue chip companies than invest in solid small-cap Mittelstand companies hitting the market. If you want real earnings quality, buy a bond.”
The difficult stock market conditions have little impact on many Mittelstand companies. They are small, operate in a local market and don’t need to consider changing their present status. Others in high-technology sectors can still make themselves attractive.
But those in less fashionable sectors, where there are real commercial problems, are finding conditions extremely difficult. Construction companies that have international business have survived Germany’s economic downturn. But those that operate only in Germany, and their suppliers, have been badly hit. Companies linked to the motor industry, which has transferred much of its production to former eastern bloc states such as Hungary, have had to adjust or suffer.
The transport sector will also have problems. “In this sector you have a capital intensive industry that is being squeezed. Road haulage is being internationalized, German haulage companies are no longer protected by legislation and they are also hit by fuel prices,” says Moldan.
Even those in more favoured sectors are finding conditions difficult. This October there was a vivid illustration of this, when even a medium-size hi-tech company with a strong international reputation had to drop its IPO. Leica Microsystems, one of the world’s biggest suppliers of microscopes and related instruments, pulled its IPO only three days before book building was scheduled to start.
Leica should have been an ideal candidate for flotation. It had a long track record having been part of a broader industrial company that split into three businesses in the 1990s.
Other elements of the company have been successful in attracting investors. Leica Camera was floated on the Frankfurt exchange in 1996 and Leica Geosystems on the Zurich stock exchange earlier this year.
Leica Microsystems has also produced acceptable financial results – though interest rates forced the company into a net e29.3 million loss last year, it is expected to move into net profit next year – and has moved successfully into international markets. Sales totalled e506 million last year, of which only 8% came from Germany.
The company had also adopted a path that is increasingly popular with Germany’s Mittelstand companies, attracting investment groups to take a private equity holding.
Schroder Ventures, with other investment companies, took 93% of Leica’s shares in a debt-financed buy-out two years ago.
There are a few examples of companies that until recently might have seemed rather too dull for investors grown used to hi-tech growth stories but that have successfully come to the public market, after having a private equity investor for several years.
One is Techem, which undertakes energy and water measurements – a job that used to be performed by blue collar workers reading the meter. The company has introduced more technical systems to measure personal, rather than general, consumption.
One of the company’s main attractions is that it has long-term contracts that guarantee earnings and it has diversified into water measurement in the US. It is also developing environment-friendly buildings, enabling central heating to be turned on by mobile phone and introducing a central unit that controls heating in each room.
“Techem is one of the very few examples of well-managed ‘old economy’ companies that – albeit not listed on the Neuer Markt – succeeded in convincing investors of its combined ‘new economy’ growth appeal and underlying earnings quality, thus attracting a strong institutional investor base and outperforming the market since IPO,”says Schäcker.
Another successful strategy is to launch a high-technology spin-off from a well-established company. Earlier this year, Biodata, a company from the northern part of Hesse, was floated at Dm45 per share and is now trading at Dm240 on the Neuer Markt. Its shares could have been placed twenty times over, say bankers.
It was a classic mix of a traditional track record and an innovative idea. Biodata provides security solutions for ISDN and other internet links and is run by a 35-year-old chief executive with a staff of 40, located in a castle in Hesse. It is a spin-off from a traditional Mittelstand company, operating in the medical area. Its track record helped establish Biodata’s credibility.
One test of whether the market is recovering next year will come when Helaba tries to take one of its corporate customers producing detergents for industrial washing to the market. The company, which Helaba would not identify, is a typical Mittelstand company, which has been a family business for more than a century. It has developed a compound detergent that will enable users to make substantial savings by washing at 30 degrees rather than the standard 90 degrees.
| Michael Betz | ||||||
“We see the Mittelstand as a prime corporate target. Some of our major competitors are reducing their exposure to the Mittelstand. We are not doing that and want to bring more such companies to the market. But the key question remains whether a company can meet the requirements of investors,” says Rolf Michael Betz, executive vice president of DG Bank.
The public stock markets are not always the promised land. Some Mittelstand companies that have been public for some years are now buying back equity as they feel the trading price of their shares does not reflect the company’s worth.
Moldan believes that more companies will consider deals with a private equity investor and then introduce the modern management expertise that would help prepare companies for a successful flotation. “This route will be increasingly popular. Private equity is no longer the cheap buyer. Private investors are paying similar amounts and sometimes more. It offers the high price without imposing the burden of openness and regular reporting,” says Moldan.
Taxi drivers ride Markt, but keep the day job
A few months ago, the successful launch of a high technology company on the Neuer Markt stock exchange would have passed with little notice. Such transactions, with newly-listed shares quickly trading up, were quite commonplace. Last month, there was a palpable sense of relief when Heiler Software’s shares moved to a slight premium after trading opened.
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Hans Joerg Schuettler |
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The company’s managing director, Rolf Heiler, said this vindicated the decision to move ahead with the launch in the face of investor caution and a market so nervous that it was trading at a 52-week low in mid-November.
Heiler Software, which placed one fifth of its 3.8 million shares with private investors, is typical of the companies that can still float on a market where new issues have recently fallen to a trickle.
“Companies which display strong fundamentals such as a healthy market position and superior financial performance will increasingly attract attention. As the companies listed mature, investors will not only monitor the top line but, increasingly, the bottom line as well,” says Jochen Grossmann, director, equity capital markets at Commerzbank Securities.
Although it is dwarfed by Nasdaq – its capitalization is 38 times smaller than the American market – the Neuer Markt is, despite its current problems, the dominant growth market on the continent, representing 80% of the capitalization of the Euro-NM network.
Among the keynote offerings in the first half of the year were T-Online, Deutsche Telekom’s online business, which was the largest internet IPO in Europe.
It has also attracted foreign companies, which now account for 20% of all listings. And growth companies from outside the eurozone have chosen the Neuer Markt as the best way to tap European investors and boost their continental profile. US company Broadvision, the world’s largest internet software developer, is the Neuer Markt’s biggest stock.
The Neuer Markt is now at a crossroads. It no longer makes overnight fortunes for the private investors who rushed to buy technology company shares at the start of this year, accelerating Germany’s gradual change from a bond-owning to a share-owning society.
During this boom the Frankfurt taxi driver was showing signs of becoming every bit as famous a retail investor as the fabled Belgian dentist who once underpinned the growth of the Eurobond market. “Every second taxi driver was talking about his equity position and how he was trading on the internet. One even told me that his income came from buying and selling shares and he drove his taxi as a hobby,” says Hans Joerg Schuettler, managing director of Morgan Stanley Dean Witter in Germany.
The taxi drivers are only one example of the dramatic growth in the retail investment sector in the four years since the sale of the first stake in Deutsche Telekom.
“That development, followed by the creation of the Neuer Markt, enabled retail investors to participate in the appreciating capital market. You cannot do a deal without a great deal of support from institutional investors, but this expansion was retail driven – before then holdings were mainly in savings and bonds,” says Dorothee Blessing, executive director at Goldman Sachs in Frankfurt.
Those taxi drivers should now be grateful that they kept on their day jobs, as the market went on a roller-coaster ride this year, experiencing both its steepest rise and sharpest correction in an eight-month period.
In this period, retail investors have shown more commitment than their institutional counterparts.
Even though only 9% of Germans hold shares directly or through funds, there has been a fundamental change in the investor mix in the Neuer Markt. In the first two years, retail investors held only 30% of available shares.
That has risen to 60% and, with equities now being marketed heavily by the savings banks, it is set to rise.
The change in balance has been accelerated by the greater readiness of institutions to liquidate their holdings. According to Dresdner Kleinwort Benson: “In the last six months, institutional investors in particular have been big sellers of Neuer Markt stocks.
With a debt ratio of about 6% – low by international standards – German retail investors on the whole have not been in such a hurry to sell, in spite of the sharp drop in price.”
The most damaging blow came when the Nasdaq crashed earlier this year and, for the first time, the Neuer Markt found its fortunes linked to the American high technology market.
This influence is likely to continue, says Rolf Michael Betz, executive vice-president of DG Bank, one of Germany’s leading co-operative banks with 20% of the new-issue market.
“The pricing link will become even stronger. There will be global trends and markets will develop in parallel. If, for example, the semiconductor sector comes under pressure in the US, why should this not happen in Germany?
With 330 quoted companies on the Neuer Markt today, it is broadly based and should be affected by global developments,” he says.
Bankers predict with some confidence that the Neuer Markt will return to steady growth in 2001, though many were predicting, incorrectly, that the same thing would happen after the correction in March this year.
Bankers also believe that foreign companies will come to form an even more significant component of the market’s capitalization.
There are reported to be about two dozen non-German initial public offerings (IPOs) in the pipeline, most of which are internet application companies, “We don’t expect the market to rebound before mid-December, followed by strong Neuer Markt IPO activities in the first quarter and significantly increased investor receptiveness for new issues,” says Achim Schäcker, assistant director of global corporate finance at Dresdner Kleinwort Benson in Frankfurt.
Bankers, including those who have brought companies to the market that are now trading below their issue price, profess themselves happy with the correction. Some note ironically that it is no longer a sacking offence to consider a company’s P/E ratio before bringing it to the Neuer Markt.
There is, they say, a long list of innovative companies with no track record or financial reporting system which could have been floated in the past, but are impossible to do today.
This view is endorsed by Blessing, who says: “Expectations were far too high as people only saw stock price appreciation but did not focus on the risk involved. There has been a healthy inversion, but the Neuer Markt is still highly valued compared to the Nasdaq.
Good deals still do get done, but there has to be a superior business model and growth story.”
Investors, however, may not be so impressed by this sudden reaffirmation of old-style market values among bankers responsible for floating some very weak companies.
Out with the old
At 6.30am on a busy Saturday morning, the coffee shops and restaurants in virtually every airport in the world are doing a thriving trade. But not at Frankfurt’s international airport, where their doors are firmly closed until 7am. “You must remember that this is Germany,” shrugs one local businessman as he waits for his flight.
It remains to be seen how long such sleepy trading practices will continue. For in the centre of Frankfurt the old German corporate and financial assumptions are being swept aside. The once-vaunted German economic model of companies, banks and government working in unison is disintegrating. Shareholder value is becoming king, foreign ownership is becoming acceptable and the complex structure of corporate cross-shareholdings is starting to unravel.
Until recently there has been a reluctance to change an arrangement that began with post-war strategic partnerships between banks and companies and continued more recently when banks have taken equity stakes through debt-for-equity swaps when companies hit trouble.
There has no more vivid symbol of the new Germany than Vodafone’s successful bid for Mannesmann. Siemens has already divested itself of several large divisions, now trading as large independent companies, including Infineon.
A new force for change has been the amended tax law introduced by chancellor Gerhard Schröder. This will enable banks to make disposals almost free of tax, compared with current tax rates of around 50% on capital gains of large equity positions that have been carried on banks’ books at very low prices for many years. Tax changes make long-talked-about sales of these cross-shareholdings suddenly attractive to execute.
The links between banks, insurance groups and industrial companies are being disentangled with increasing speed. Although the new tax laws are not due to come into effect until 2002, institutions are keen to start the process as soon as possible. The only barrier remains the as-yet-unresolved dispute between the banks and tax authorities over whether deals can be constructed in such a way as to be completed now and the capital gains tax based on the eventual 2002 level.
Bankers say that this is essential to an orderly market. If a queue of transactions builds up in the next 13 months, they will swamp the market at the start of 2002.
It is probably not a moment too soon. As Deutsche Bank itself acknowledges in a recent market report: “The banks’ portfolios have in effect become expensive DAX trackers. In general, the banks have not been good asset managers…..”
The banking system has first-hand experience of setbacks in corporate restructuring with the messy collapse earlier this year of Deutsche Bank’s own e33 billion ($28 billion) attempted takeover of its leading rival, Dresdner Bank. This was followed soon after by Dresdner’s second failed merger attempt with Commerzbank. This is likely to be a temporary glitch.
Deutsche Bank said it would continue to expand its investment banking operations and also speed up its sales of some $18 billion of stakes in major European companies, completing the process by 2007.
These include a 9.6% stake in Allianz and a 9.6% holding in the insurance and reinsurance group, Munich Re. The bank also has stakes of 1.6% in Fiat and 11.9% in DaimlerChrysler.
Other companies considering sales include BASF, which is thought to be attempting to sell its Knoll pharmaceuticals business, which has annual sales of $2.5 billion and could earn its parent company $6 billion.
Some German companies are using the war chests gathered from sales of companies that they no longer consider core businesses to build up strong positions in chosen market segments.
Eon, Germany’s second largest utility, has accumulated an e13.5 billion fund and is now attempting to gain control of Ruhrgas, an acquisition that would make it one of Europe’s biggest energy conglomerates. It is also targeting the Swedish gas market with the Swedish part state-owned energy company Vatenfall.
