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Shares in investment companies: an alternative to private equity

German Mittelstand - a magic word that announces success and arouses desire among investors. But also a broad field. If a company has 500 employees and an annual turnover of 50 million euros, is that really still a German medium-sized enterprise?

Yes, says the Institute for SME Research (IfM). So we're talking about other sizes than the medium-sized painting company or the baker. With up to nine employees and a maximum of two million annual sales, the IfM speaks of small and medium-sized enterprises. Only small medium-sized companies are not organized as stock corporations, and larger medium-sized companies are also typically organized as partnerships: as OHG or KG. These are small and medium-sized businesses where ownership, management, liability and risk are all in one hand. And you cannot invest in a GmbH as a corporation on the stock exchange.

also read: How investors can participate in German SMEs with the MDax

Biallo tip: INVEST2WIN

From now on we don't just want to write about trends, we also want to offer specific solutions for your money. The digital investment concept INVEST2WIN was created for you from this thought. Developed with financial experts, INVEST2WIN offers you the option of investing specifically in thematic investments in addition to a basic ETF investment - including the topics of "German medium-sized companies" and "family businesses".

How can private investors invest in SMEs?

Even the smallest companies in the SDax have a multiple of the annual turnover, which is still referred to as medium-sized companies in the above sense. Not to mention the even larger small caps, for example in the US S&P 600 or Russell 2000. They call themselves "small" or "small caps", but in accordance with listed stock corporations.

And that means it is unfortunately not possible to invest in what is meant here by medium-sized companies via ETFs. Because these index funds only show the stock market indices, and unfortunately they are a number too big for the "German Mittelstand". So is that the end for private investors? Or can you, as a small investor, fly under the radar of the stock exchange listing and take advantage of the prospects of medium-sized companies? And what about diversification?

Indirect flying under the radar

As a private person on the stock exchange, you can invest indirectly in small and medium-sized companies - by looking for companies that in turn invest in medium-sized companies: the investment companies and holdings. These, in turn, are often traded on the stock exchange, and you can bet on a whole bunch of medium-sized companies with them.

In Germany, with such forms of capital participation, Franz Müntefering's dictum of the "locusts" still haunts many minds. He said in an interview in 2005: "Some financial investors do not waste a thought on the people whose jobs they are destroying - they remain anonymous, have no face, fall upon companies like swarms of locusts, graze on them and move on. Fight against this form of capitalism we."

What did Müntefering mean about the locusts?

The reason for the statement by the then SPD chairman was the takeover of Grohe, a manufacturer of sanitary products. At the end of 2004, the investment company TPG (Texas Pacific Group) and a subsidiary of Credit Suisse took over the sanitary ware manufacturer. They financed the purchase with loans, which they then topped up with Grohe. The company had to pay loans and interest from the company's coffers.

also read: Investing in family businesses

Another deterrent example for investment companies is the activity of Arques AG, which was traded as "the high flyer par excellence" in the noughties. For Arquana International Print & Media, the participation by Arques turned out to be fatal because Arques hardly invested in his new company. It was imagined that Arquana should recover on the stock market solely through its own capital increases.

As a restructurer, Arques turned out to be not just a grasshopper, but a gravedigger: At the beginning of 2008, Arquana filed for bankruptcy. Arques had been looking for a lucrative exit. The result was an early exit. The investee had tried an industry it was unfamiliar with. Arques then tried to hide the shambles with the help of a mailbox company.

Help with corporate succession

Since these chilling examples, "Heuschrecke" has been a dirty word in German for private equity companies or other venture capital. This notion assumes holding companies short-term or exaggerated profit expectations. In this context, people like to call them hedge or vulture funds. But this view is so shortened that it is wrong. Why?

Well, if you look at the financial investors in Germany who are active in the area of ​​corporate succession, then you no longer discover the locust clichés. Instead, the solution to a problem with which private equity firms can help many medium-sized companies emerges: the succession of the company management. Many medium-sized companies have problems finding a successor. There are around 22,000 transitions every year.

also read: How private investors can invest in private equity

Investment companies as a new "home" for medium-sized companies

Most of the time, the founders would like the company and the executive chair to remain in the family - in other words, to be passed on to their daughter or son. Because family businesses think long-term. Where financial investors look at the quarterly figures, founders and their families think in longer periods of time and often think of the next generation and the preservation of the company. Often, however, this path turns out to be poorly prepared, hasty or simply wrong. Or the generation of the founders has no children.

This is where investment companies come into play. Many of them think long-term and are a new "home" for medium-sized companies. The identity of the companies taken over is then preserved (brands, names or corporate culture). Such a responsibility can also exist if a later sale of the participation is planned. There are different strategies for private equity firms.

also read: Family businesses are well equipped for the crisis

Different strategies of participation

If a strategy does not provide for an exit from the investment, the medium-sized founder has security with regard to the fate of his life's work. And this is where the thought of Warren Buffett and Berkshire Hathaway comes into play: to gain an advantage over other, possibly more affluent prospects through trust and to invest over the long term.

The universe of investment companies can be roughly divided into:

1. short to medium term and profit-driven,

2. Special situations with no long-term intention and

3. long-term strategies without exit orientation.

Short to medium term investments

Of the companies in the first group (short- to medium-term, return-driven investments), Apax, Blackstone and KKR appeared in the "locusts" debate in 2005, and they are still active today. But they're investing in large-cap companies that don't matter here.

Among the investors in this group who invest in medium-sized companies, Deutsche Beteiligungs AG (DBAG) from Frankfurt am Main, a member of the SDax, stands out. It is a descendant of Deutsche Bank. As an independent company in the meantime, DBAG has invested in over 300 companies. An impressive number that shows a wealth of experience. The average holding period for Deutsche Beteiligungs AG investments in its own portfolio is five years.

Deutsche Beteiligungs AG and its funds

DBAG occasionally issues funds in which investors can participate (private equity). DBAG receives remuneration for advice. It also invests in well-positioned medium-sized companies with development potential. It focuses on the industrial sectors in which German SMEs are particularly strong in international comparison. With its experience, know-how and equity, Deutsche Beteiligungs empowers the companies in its portfolio to implement a long-term strategy. Your goal is the strategic development and the subsequent sale.

Once all the companies have been sold in funds, the investors get their capital and profits back. A new fund will then be launched. What deserves special mention at DBAG is an equity ratio of over 90 percent, i.e. high financial stability and creditworthiness. Those interested in Deutsche Beteiligungs AG should also mention that the drugstore entrepreneur Dirk Rossmann is the largest single shareholder and is also steadily expanding his position - most recently in November 2019 to more than 25 percent.

Also read:Value or growth - investing in ETFs

DBAG currently owns shares in almost 30 companies from various industries such as information technology, medical technology or mechanical and plant engineering. The portfolio is very broadly diversified. In the past five years, Deutsche Beteiligungs AG has continuously increased its dividend to EUR 1.50, which, based on the share price at the Annual General Meeting on February 20, meant a return of 3.7 percent. It is questionable whether DBAG can at least keep the distribution stable for the current financial year. The analysts at Factset Research expect a decline to 50 cents per share.

Special situations without long-term intention: Aurelius

Now we come to the second group: Investments in companies in special situations without long-term intent. The best known example is Aurelius from Grünwald near Munich. Stock marketers still remember the short attack by the US hedge fund Gotham City in March 2017. In its report, Gotham primarily criticized Aurelius' overvaluation of individual company holdings. This halved the Aurelius share price. Management announced two share buyback programs and a dividend increase as a defense. Gotham City's allegations turned out to be false in retrospect.

The investment company Aurelius buys failing companies (restructuring cases) or peripheral activities of large corporations if they do not want to continue to operate them. Aurelius finds low-valued assets and plans to sell them for a profit after a few years. The share is listed in the "m: access" of the Munich Stock Exchange. Due to the corporate structure and Aurelius' approach to buying, developing and selling investments, Aurelius is sometimes referred to in the media as the German Berkshire Hathaway. So here, too, Warren Buffett is taken as a role model.

Also read:Invest like the stock market gurus

The Aurelius Group is divided into five divisions, one of which, Aurelius Wachtumskapital, is a long-term investment company (Evergreen model) that invests in succession solutions and small, profitable medium-sized companies ("well-positioned, medium-sized companies in all sectors").

In addition to capital for investments and growth, you want to support the management of the acquired companies with your own experience and help to realize planned growth and leverage operational potential. Aurelius sees itself not only as an investor, but also as an entrepreneurially experienced, competent and independent sparring partner who supports the management in the long term. Since 2005 the Aurelius Group has carried out over 80 company acquisitions.

Specialized in renovation cases: Bavaria Industries and Blue Cap

Bavaria Industries from Munich is a listed industrial holding company that takes over medium-sized companies if they have identified considerable potential for optimization. That means in German: You specialize in restructuring cases and buy companies that are on the verge of collapse.

The default rate here is relatively high, but if one or two takeover properties get the curve and regain their footing, the returns in these cases are very high - analogous to the low entry prices for bankruptcy candidates. It is worth mentioning that the board of directors of Bavaria concentrates a good 90 percent of its own assets in the holding company and is therefore very interested in further increasing Bavaria's value. In this respect, the situation can definitely be compared with medium-sized family businesses.

Blue Cap from Munich is listed in the local m: access and in the Scale of the Frankfurt Stock Exchange. The holding company invests mainly in medium-sized companies in southern Germany and focuses on companies in need of restructuring or insolvent companies, company spin-offs and companies with unsolved successors. The daughters are run independently and entrepreneurially.

The Blue Cap portfolio currently includes ten medium-sized companies from the following areas: coating, adhesive, plastics, medical, metal and production technology. Blue Cap's business model is not entirely risk-free, but if the repositioning of the cheaply acquired subsidiaries succeeds, high profits can be expected.

Mutares restructures turnarounds

Mutares from Munich acquires medium-sized companies in turnaround situations and restructures them. The business model is similar to that of Aurelius. Since it was founded in 2008, the holding company has acquired 25 companies and sold several. The portfolio currently comprises 13 companies from the segments: Automotive & Mobility, Engineering & Technology and Goods & Services. Mutares shares are traded in the Scale segment of the Frankfurt Stock Exchange. One focus of the investments is in France.

GBK holdings from Hanover

GBK Beteiligungen from Hanover does not really fit into one of the three groups. On the one hand you invest in successful companies, on the other hand you work with exit strategies. GBK focuses on companies that are under the radar for the large private equity firms. One does not strive for an active role in the management of the respective subsidiary.

The GBK portfolio currently includes around 30 medium-sized companies from the automotive industry, electrical engineering, chemistry, transport and logistics, mechanical and plant engineering, trade and e-commerce and the service sector. Interesting: Dirk Rossmann also has a 26.6 percent stake in GBK.

Long-term strategies without exit orientation: Buy & Hold

We come to the third group: long-term strategies without exit orientation. First of all, Indus Holding from Bergisch Gladbach should be mentioned. As the name suggests, it is an industrial holding company. It has a long-term stake in medium-sized companies in German-speaking countries and is listed in the SDax.

Indus invests in companies that are particularly successful in their niche markets, that is, in unknown world market leaders - the so-called "hidden champions". The motto is: Buy & Hold & Develop - buy, hold, develop. The aim is to increase the company's value over the long term. The anchor shareholder of Indus Holding is the Versicherungskammer Bayern with almost 20 percent of the shares.

also read: This is how the buy-and-hold strategy works

Indus currently has a portfolio of 47 companies from the following five areas: eleven from construction / infrastructure, nine from vehicle technology, twelve from mechanical and plant engineering, five from medical and health technology and ten from metal technology. The holding company mainly acquires owner-managed companies. These subsidiaries continue to operate independently and economically.

Indus uses the increasing cash flow in order to be able to take over further investments. This business approach brings the holding company plus points in the face of more and more pending succession solutions in medium-sized companies, as many company founders would like to put their life's work in good hands and shy away from traditional financial investors.

Indus is involved in those economic sectors in which German medium-sized companies have developed a global leadership role over decades. Since hidden champions are successful worldwide, the holding company also supports its companies on other continents and outside the DACH region. The policy is not to think in terms of quarters, but in terms of several years. The daughters should have the time to develop and take advantage of opportunities without having to show quarterly successes.

Similarities to the spread in ETFs

An investment in investment companies such as DBAG or Indus Holding is similar to that in an ETF, which in this case is used to invest in a broadly diversified medium-sized company. You can make use of the expertise of the holding companies. The broad diversification of a portfolio is advantageous: Plant construction, for example, is repeatedly subject to economic cycles. In contrast, the health sector is usually more stable.

A holding company also has the function of advising its daughters. She can also be available to her portfolio companies as a sparring partner and take over the controlling. This can prevent falling into well-established structures instead of venturing into something new through continuous entrepreneurship.The same applies to the organization of growth capital. A medium-sized company can concentrate on the operative business with an experienced holding company behind them, even when it comes to expanding abroad.

also read: The best ETFs on the MSCI World Index

Gesco with a special business philosophy

Gesco from Wuppertal, listed in the Prime Standard of Deutsche Börse AG, belongs to the same group as Indus. It is involved in the fields of health, mechanical and plant engineering, vehicle technology and metal processing and plastics. Gesco concentrates on economically sound industrial medium-sized companies that are accepted into the group and further developed without any intention to exit, i.e. in the long term.

Just like Indus, Gesco is looking for takeover candidates with low debt, a broad customer structure, stable business model, good position in a niche and oriented more towards cash flow than profit - as evidence of what actually remains in the till.

Also read:With these key figures you decode the stock market

Gesco is currently involved in 18 companies. A special feature of this company is part of its business philosophy: the managing directors of a subsidiary should themselves acquire a stake of ten to 20 percent of the company taken over. Gesco holds the rest. The management is therefore liable with its own capital. The idea behind this is that the management of the acquired company also has its own financial interest in the company's success. This should make risky or ill-considered decisions less likely and thereby reduce the holding company's risk.

Max Automation and MBB: Medium-sized companies in the Prime Standard

Max Automation from Düsseldorf has been listed in the Prime Standard of the German stock exchange since 2015. The anchor investor with almost 35 percent of the shares is the Günther Group from Hamburg. It is involved in the core segments of environmental technology and industrial automation. The export quota is 60 percent. Max Automation is currently involved in seven companies. One belongs to Process Technologies, five to Evolving Technologies and one to Environmental Technologies.

MBB is an investment company from Berlin. The abbreviation MBB goes back to Messerschmitt-Bölkow-Blohm. The shares are traded in the Prime Standard of the German stock exchange. It is noteworthy that the two founders are the majority owners of the company to this day. MBB focuses on the acquisition and management of medium-sized, technology-focused industrial companies. The investment company is not aiming for a resale, but rather a long-term cooperation and focuses on growth through the purchase of new companies and the increase in the value of the existing investments. The portfolio currently consists of seven companies.

The oldest holdings (since 2003) are Delignit (wood-based materials) and OBO Werke (plastics for model, tool and mold making). Hanke Tissue (since 2006) is a leading manufacturer of printed napkins. DTS (since 2008) specializes in cloud computing, and CT Formpolster (since 2010) produces foams. Aumann AG (since 2012) is a machine and plant manufacturer. Friedrich Vorwerk (since 2019) works in pipeline construction.

The founders Christof Nesemeier and Gert-Maria Freimuth still hold 65 percent of MBB. Nesemeier described 2019 as the best in the company's history due to three successful acquisitions, solid business figures and very good future prospects.

The agony of choice

There is just as much potential in investment companies as in medium-sized companies. The companies offer the advantage of expertise and broad diversification. When deciding to invest in private equity firms, the question of choice arises. This article could only briefly outline the candidates in question. Which companies are to be counted on must therefore be determined from further research.

Roughly, it can be said that early-stage and problem investors certainly have higher risks and higher fluctuations than conglomerates that rely on constant development. From the perspective of a buy & hold strategy, investment companies in the third group are to be preferred: long-term strategies without exit orientation.

But if you want to rely on more frequent reallocations and a steadier flow of news, a company from the second group, such as Aurelius, can also be of interest. After all, a long-term investment approach of your own does not stand in the way of a commitment to Deutsche Beteiligungs AG.

Biallo tip

If you yourself value a long-term investment using a buy-and-hold strategy, then you are not going wrong with investment companies that operate long-term strategies without exit orientation.



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