Elusive prey

IFR Germany Report 2014
9 min read

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They seek them here, they seek them there. Those growth-hungry investors seek them everywhere. Collectively speaking, Germany’s Mittelstand is hardly the Scarlet Pimpernel, the fictional English baronet who saved revolutionary-era French aristocrats from the guillotine, but there are more than a few adumbrations of Baroness Emma Orczy’s enigmatic character.

For one thing, it’s never been particularly easy to define Germany’s world-famous Mittelstand, which rose from the ashes of World War II to become a force of industry revered at home and replicated (wherever possible) from Britain to Brazil, and Singapore to South Africa. They remain elusive, hard to define or pinpoint.

“It’s always been a little difficult to define what size, scale or area of business a typical Mittelstand firm occupies,” said Michael Wolff, Germany-based managing director at Robert W. Baird.

“They tend to be private family-runs firms, tightly held, and with annual revenues ranging from tens of millions of euros to tens of billions. Some would say the local butcher with two employees is part of the Mittelstand family. Other would include a global auto parts maker in the category. The list, really, is endless.”

The vast majority, though, are best characterised as very well-run small and medium-sized enterprises, beloved by investors, and for good reason. Mittelstand firms tend to invest wisely and plan ahead, with the best expanding, alongside larger corporate customers, into East Asia, Latin America and Africa. They occupy highly profitable corners of the industrial world, specialising in everything from printing presses and plastic tubes, to cooling machines and wind turbines.

Germany has more than 1,300 globally scaled Mittelstand firms, against just a few dozen in each of the UK, France, and China, according to a 2013 report, “Hidden Champions”, from Biesalski, a Munich-based consultancy. Few scrimp on research and design. Spending on R&D rose by 71% between 2004 and 2010, according to data from German-owned development bank KfW and IfM, a Bonn-based SME research outfit.

Exports jumped 30% in the first decade of the century to €186bn, comprising one-fifth of all German-sourced overseas trade.

Yet few Mittelstand companies ever make it to market. They remain elusive and surface in the capital markets only very rarely, and usually on their own terms. Initial public offerings of this breed are as rare as hen’s teeth.

When they do crop up they tend to be found, said Armin von Falkenhayn, head of financial institutions group at Deutsche Bank, “where the growth capital is needed”, in sectors such as technology or healthcare. Industries, in short, with the greatest need for fresh funding to sate sometimes hefty R&D bills.

Over the past 18 months, only a tiny handful of good-sized Mittelstand companies have hit the market. Evonik, an Essen-based chemicals firm, is perhaps the most prominent among investors, if only because it took three swings at its listings before finally raising €345.1m through its initial Frankfurt stock sale in June 2013.

Kion, a Wiesbaden-based maker of industrial equipment, from forklifts to heavy trucks, raised €420.285m through its June 2013 IPO, also in Frankfurt. More recently, SLM Solutions, a cutting-edge 3D printing group based in the northern town of Luebeck, raised €180m from its initial stock sale, with primary proceeds fixed at €75m, putting the free-float at 49%.

Yet this still seems a pretty meagre return, particularly at time when European firms, notably those based in Britain and Nordic countries, are lining up to sell shares to an eager, global investor audience. The rather vexing truth, at least for funds and investment managers desperate to increase their exposure to the best and brightest firms in Europe’s largest economy, is that many, if not most of them, are quite happy with their funding lot.

“Most Mittelstand firms, particularly the smaller, family-run ones, have no financing needs,” said Jens Voss, head of equity capital markets at Commerzbank. “There are plenty of funds available for the bigger company names, but none of them really need to take the big step of pursuing an IPO.”

Most mid-sized German corporates have spent the past half-century relying largely on internal funding – revenues ploughed back into higher R&D and operating costs. Others dip, said Voss, into the “full array” of bank funding, from plain-vanilla loans to SME loans.

Bank funding remains the “classic source of funds” for Mittelstand firms, Voss said, noting that banks of all stripes, small and large, German and foreign, are “more than willing” to lend to leading German mid-market corporates.

Taking up Schuldschein

An increasing number are turning to Schuldscheine – traditional floating or debt instruments that offer a range of tenors and vary in size from €10m up to €500m – to sate their funding needs.

“The Schuldschein route is being increasingly adopted too by larger issuers,” said Voss. Bankers in general point to the ease with which well-run Mittelstand firms can still gain access to cheap financing. “There is plenty of cash available out there,” said Voss.

That’s not to say that Mittelstand companies are all superbly managed, nor that they will never, broadly speaking, eschew the temptations of a big, equity capital-led capital injection. True, as a group, their finances “haven’t been in such a strong state for a long time”, said Deutsche Bank’s von Falkenhayn. And true, balance sheets are in general extremely healthy, making their corporate credit “as an asset class … one of the most sought-after across the board”.

New avenues

In many ways, the past decade has been one of great, albeit quiet change in the sector. Broadly speaking, two types of firm have emerged. The first bet big on global expansion. “They were in China early, did the right things with product development,” said Robert W. Baird’s Wolff.

The second group consists of firms that didn’t take risks, opting to rest on their laurels. This group, typically smaller, less professionally managed, less entrepreneurial, and less forward-thinking, still exists. But this, said Wolff, “is where the bifurcation has happened.

“Nowadays, if you go to trade shows you see either these fast-growing tech-savvy firms with €200m or €1bn in revenues, and doing very well. Or you see the groups that look like they did 10 years ago.”

It’s to the latter group that investors and hungry predators, from US private equity groups to Chinese state, are looking, in the hope that they will either look to sell shares in the years to come, or go under the hammer, as they pass into the hands of a new generation with different priorities.

To be fair, said Robert W. Baird’s Wolff, pretty much every good Mittelstand firm is being targeted by would-be acquisitors and investors, “because they have a combination of attributes that are in high demand. They are tech-savvy, they have good management, good customers bases”.

None of the people interviewed for this story pointed to a future filled with IPOs by bright-eyed German Mittelstand issuers, though some are now starting to explore new funding avenues.

Some are actively bypassing the traditional banking market entirely, cutting costs and speeding up issuance by packaging private placements for an elite group of well-heeled institutional investors. Recent issuers include the likes of prosthetics firm Ottobock, component designer Krone Holding, and chip maker Semikron.

“Placements require an arranger [such as a bank] but the arrangement fees are [lower] than underwriting fees,” said Robert W. Baird’s Wolff. Bankers are in some cases left cooling their heels.

“More candidates willing to tap equity markets would always be better than [fewer],” said Deutsche Bank’s von Falkenhayn.

Yet Germany’s mighty Mittelstand firms don’t always have things their own way. Investors may love the story as a whole, but few recent prominent stock sales have gone ahead without a hitch. Evonik stumbled on a number occasions by overvaluing itself and its perceived value among investors. Both Kion and SLM Solutions priced their IPOs right at the bottom of the range. Real estate firm LEG Immobilien priced its €1.165bn January 2013 IPO in the middle of the range. It seems that even when it comes to valuing their IPOs, Germany’s Mittelstand is a mysterious asset class, and a master of disguise.

A hare runs away from a tame golden eagle