Germany 2007 - A changing culture
With the German economy seeing strong growth, and corporates increasingly looking beyond the country's borders for acquisition-driven growth opportunities, investment bankers are hoping to reap the rewards. The market is becoming more competitive though, and foreign firms have eroded local players' market share. Mark Baker reports.
The face of German corporate culture is changing, and investment bankers believe they are best placed to take advantage of this rapidly shifting environment.
The country is enjoying strong annual GDP growth of about 2.7%–-2.8%, and the budget deficit is expected to come in at less than 1% next year. The economy, which is Europe’s biggest and still the third largest in the world after the US and Japan, is sound after tough years at the start of the millennium.
"Germany will be one of the fastest growing investment banking fee pools in Europe," says Flavio Valeri, the new head of investment banking for Germany and Austria at Merrill Lynch. Valeri, who this year moved to Germany from running Merrill's European ECM team in London, has also previously worked at Deutsche Bank.
"Corporates have gone through their problems and their restructurings and are now able to think much more about growth," he says.
Although some bankers at Germany's home-grown banks are less optimistic than Valeri, the fact that the country is attracting serious attention from investment banks should come as little surprise. The positive financial indicators, on both a macro and micro level, are feeding through to corporate activity, which is now changing quickly after decades of sluggish and unexciting progress.
"The last few years have seen very strong development, and last year saw some of the largest corporates coming back to the market," says Stephan Leithner, head of global banking for Germany at Deutsche Bank. "A lot of that activity was long-awaited, however, and the market will now move towards the less obvious and more difficult situations."
By almost any measure, Germany is becoming more and more important in investment banking terms. According to data from Thomson Financial, completed merger and acquisition activity with any German involvement (i.e. target or acquirer) in 2006 totalled US$197.4bn, up 33% from the US$147.9bn recorded in 2005.
The change in announced M&A activity was even more startling, totalling US$321.5bn against the previous year’s total of US$177.6bn, an increase of 81%. And although those top-line figures include huge deals such as E.ON’s US$71.4bn sweetened bid for Endesa, announced mid-market activity (deals up to US$500m) has also been brisk, totalling US$47bn last year.
What has changed to prompt such an increase in activity? As well as external stimuli such as the EU-driven removal of state guarantees for German savings banks, and the disciplines imposed by Basel II and IFRS, bankers working with senior German corporate management say that there has been nothing less than a complete transformation of mindset.
Take lending, for example. Traditionally, German corporates have relied on close relationships and bilateral lines. But in the last couple of years, they have cut loose from these historic ties and embraced the syndicated approach. Syndicated loans for German borrowers hit US$296bn in 2006, some 64% above the total recorded in 2005.
And it is not just volume: benchmarks are being set. Last year’s syndication of a US$46.5bn-equivalent loan for E.ON’s bid for Endesa was the largest in the world. In total, five of the largest 15 global syndicated loans were for German borrowers, and four were to finance takeovers – with E.ON joined by Merck, Linde and Bayer.
In equity deals, Germany is the third largest market in Europe after the UK and France, accounting for roughly US$30bn of issuance in each of the last two years. In the recent past, German names have also been some of the keenest users of the equity-linked market in Europe. Last year’s US$2.8bn-equivalent deal from Bayer – part of its financing package for its takeover of Schering – was the largest European convertible bond in 2006.
In debt capital markets, German domiciled issuers last year accounted for 18.2% of all euro-denominated issuance. Globally, the country was the third most active source of issuance for all international bonds in any currency after the US and the UK, with deals totalling US$411bn in 2006.
That German firms are increasingly looking beyond the country's borders for expansion is partly the legacy of an economy whose major players have always been largely export-driven. Now that corporate Germany has come through the financial restructuring pain of recent years, it is in a position to follow its strategic ambitions.
Helping to achieve this is a new generation of up-and-coming CEOs and CFOs – frequently educated abroad and often having worked for years in the US and Asia. Bankers argue that the more international and sophisticated approach of management figures such as Klaus Kleinfeld, CEO of Siemens, and Alan Hippe, CFO of Continental, makes them more open to financing discussions with the big bulge-bracket banks.
"The new generation of senior managers is much more internationally minded," says Wilhem Schulz, head of German M&A at Citigroup. "And if you want to do a multi-billion cross-border deal then you need a full range of financing options, which the major international firms can provide."
That view is certainly backed up by the extent to which foreign banks have established their positions in German corporate activity, leaving Deutsche Bank as effectively the only domestic competitor.
But some firms see themselves benefiting from the traditional German approach to advisory work – particularly when dealing with those corporates below the global giants. Jefferies is a US investment bank that is expanding rapidly in Europe having increased its staffing in the region by 50% in the 18 months to early 2007. It argues that this opens up opportunities outside the bulge-bracket firms.
"One theme that emerges again and again is that investment banking has not been a traditional part of the mix for many mid-sized corporates," says Alex Hofmann, a director covering Germany at Jefferies. "There is not the same financial advisory tradition of selecting a bank solely for financial advisory services and you can often find yourself competing with an accountancy firm or a lawyer for a mandate. That is an opportunity for us though, since we have a global perspective and offer a full range of investment banking services including a unique capital distribution platform for growth companies. We also have specialist expertise in areas such as high tech and cleantech, which is very important in Germany."
That said, a local presence is still an important factor for all the non-domestic firms. "The important thing, as in many European markets, is making sure you are culturally assimilated," according to Michael Bonacker, co-head of German investment banking at Lehman Brothers. "For example, expertise in the language is important and because of this it is often the local coverage banker who has built the relationship with the corporates based in that country, rather than the global or European head of the industry group."
And while cross-border activity is an increasingly significant part of the business, bankers caution that domestic activity should not be neglected, particularly from the Mittelstand – Germany's raft of small and medium sized companies, often family-owned.
"There is a considerable amount of activity to come from the Mittelstand, with many companies reaching the point where there is no obvious family successor or where private equity investors are looking to sell out," says Ingrid Hengster, head of Germany at ABN AMRO.
In Thomson Financial's rankings of completed M&A deals involving German firms in 2006, Deutsche Bank was number one, followed by Morgan Stanley and Goldman Sachs. Dresdner Kleinwort, in sixth place, was the only other German firm in the top 10. Deutsche is also number one in announced deals, with a 47% market share, seven percentage points ahead of Citigroup.
The situation is not so different in the mid-market M&A rankings covering completed deals up to US$500m. Deutsche Bank still tops the table, Sal Oppenheim is third and Dresdner Kleinwort is 11th. Drop down to deals of up to US$200m, however, and a different picture emerges. Sal Oppenheim leads the way, with MM Warburg-Brinckman Wirtz, DK, Commerzbank, Metzler Corporate Finance and UniCredit (which owns HVB) all in the top 15.
In equity capital markets activity, while Deutsche Bank still ranked number one in Germany in 2006, its dominance has been sharply eroded as other firms have boosted their efforts in the country. Having done more than three times as many German ECM deals as any other firm in 2005, and capturing a 31.5% market share as a result – ahead of Goldman on 17.7% – DB’s share fell to 14.7% in 2006, with Morgan Stanley, Goldman, JPMorgan and UBS all within a few percentage points.
Nevertheless, the financial performance of the main German players has still been among the most striking in the global industry. Deutsche Bank reported strong full-year results last year in its corporate and investment bank, with pre-tax profits up 24% to €4.75bn.
Dresdner Kleinwort has been slashing costs and reorganising its operations, and last year logged profits up 315% to €199m, while a similar restructuring has been going on at Commerzbank, where profits rose 72% last year to €614m.
And although banks have profited from the broader German corporate recovery story, some also envisage opportunities arising from a rising rate environment.
Oliver d'Oelsnitz, head of corporate finance at WestLB, argues that firms like his – which claims to be able to support a longer-term relationship with domestic firms – are well placed to help corporates that may have over-extended themselves, and might well be able to step in where international firms are unwilling.
"It is not yet a widespread problem, but we anticipate more cases as rates go up," says d'Oelsnitz. "German banks such as ourselves are seen as more aligned with their interests because of our background, and we will not be looking at the situation purely in terms of quick return in the same way as some of the international players in this market."
There is one other – often overlooked – consequence of building strong relationships in Germany – its geographical position. The country is a natural bridge to its Eastern neighbours. German corporates have strong interests in economies such as Poland, Bulgaria, Romania and the Czech Republic.
"Look at Lufthansa, which has not just become as powerful as it has from serving 85m Germans, but because it covers the whole of emerging Europe," said one senior banker in Frankfurt.
And while for an investment bank a German franchise will not automatically lead to a clutch of emerging European deal mandates, an understanding of business in Germany will stand firms in much stronger stead further east.