World View: The International M&A Podcast

Alice Gardner 

Helge-Torsten Wöhlert 

Thanks for having me.

Alice Gardner 

Over the past few years, the UK M&A market has really been so volatile and shifting due to so many different factors including increase in interest rates, changes on inflation, the war in Ukraine, the cost of living, supply chain uncertainty, obviously the pandemic, ongoing political uncertainty and that's not even mentioning Brexit. Can you talk to us, Helge, about the key factors affecting the German M&A market over recent times and how they've changed the shape of your deals?

Helge-Torsten Wöhlert 

Yes, you already mentioned the key factors besides the general global economic environment, it's two factors which are driving the German market, it’s energy prices and financing. I mean financing has become much more expensive, interest rates have gone up and that of course has an effect on transactions with thus seen larger transactions, more and more disappearing from the market, mid cap transactions are less effect. And the energy prices, of course, in fact, and impact different sectors of the economy. This has, if you look at the specific sectors of the M&A market, this has changed the landscape a little bit for us because TMT used to be the absolutely dominant segment of the German market it still is in terms of volume of deals, but in terms of deal sizes that has gone enormously down and industrials has now become the dominant segment on the German market and another segment which has gone up is farmer and healthcare, Biotech that is also going on very strongly.

Alice Gardner 

That's really interesting because Tech still remains really dominant here in the UK in terms of the really active sectors. I'd say industrials is very different, but that just shows the difference is probably between the German economy at the moment and the UK economy in terms of which sectors our economies are particularly focusing on at the moment.

Helge-Torsten Wöhlert 

Yes, and this is why besides those ones we're very much seeing investments going into logistics. You know going into energies if it's new energies, that's a sector which is going pretty strongly, but nonetheless one needs to state that TMT is still first place.

Alice Gardner 

It's not completely dead. Well, TMT again here is very active, and as you said about new energy, new energy, future energy is a huge area in the UK, especially around the economic growth and potential change of the government next year and even with that, whatever the position or outcome will be the investment into new energy is a key focus here as well.

Helge-Torsten Wöhlert 

And besides you even have in the classical sectors, just like chemistry, which are suffering from energy prices, you do have divestment opportunities that is what we are more or less seeing. You know it's not the classical scenario because the sector is suffering, but it is sort of restructuring in that segment and therefore divestments are on the agenda.

Alice Gardner 

That's really interesting and one thing we get asked this so much in our jobs as lawyers, don't we about the dreaded timetable word?  It's a, a subject that's close to our hearts and our client’s hearts when trying to get a deal over the line. How long are you finding M&A deals in Germany taking to get across the line at the moment?

Helge-Torsten Wöhlert 

That has slowed down. That has slowed down and once again, sorry to say it is due to financing, you are having much more talks with the banks, they take longer, they have a closer look at the deal at the financing, so that has definitely slowed down deals. We are also seeing and I can't give you a reason for that. We're also seeing internally as far as the parties are concerned a slower speed, in transactions, maybe it's also because you know the parties themselves are closer, looking at the deals you know, especially if larger groups are concerned, it has to be reviewed by different committees, et cetera and maybe that in the current economic environment takes a little bit longer.

Alice Gardner 

Yeah, that's really interesting. I think we're seeing similar change here in the UK as well at the same time. I think one thing we're seeing in the UK is a big rise in split signings and closing due to some regulatory changes around new legislation on overseas investment into the UK, which we're still really grappling with here, which is all pretty new and introduced in the last 18 months. In terms of the structure of your transactions, are they, are you seeing any rise in that area as well?  Because I know you've got similar regulatory changes in Germany as well?

Helge-Torsten Wöhlert 

Yeah, I wouldn't say that that has changed that much. It certainly has had an effect on transactions with the UK and now I need to mention the word Brexit.

Alice Gardner 

That dreaded word.

Helge-Torsten Wöhlert 

And I apologise for that but of course, we do have the foreign direct investment control, which you're also having and previously you were part of the EC, thus you were only concerned for sector specific direct investment controls and that meant, that if we're talking about sensitive sectors, military and IT security, then of course foreign direct investment control sector specifically kicked in also for EC Member States. But now that you are out of the EC, you're also subject to the non sector specific foreign direct investment control, and that means if you look at the general statistics in Germany for foreign direct investment control you would expect that China is on top, but in fact it isn't. First place is the US and second place is the UK. You used to have four to nine cases prior to Brexit and now you’re second place, and I mean for obvious reasons and that of course to come back to the starting point has an impact because then of course you can't have a simultaneous closing and signing if you need to notify.

Alice Gardner 

Yeah, I know it's the same in the UK, I think our legislation is a bit wider than yours, so clients are being very careful at the moment and needing to notify and then that that changes the structure of deals accordingly, because if you'd asked me that question five years ago, very rarely, unless you needed kind of financial services regulatory approval, would we be encouraging or CMA approval? Would you be encouraging a split exchange and completion?  But we're just seeing it on the rise so much more at the moment, which just impacts transaction timing. Moving on to talk a little about pricing mechanisms, so in the UK it's still pretty common to be using completion accounts to bridge the gap between enterprise and equity value and you know completion accounts is where it gives both parties the right to do a post-completion assessment of the cash debt and levels of working capital in a business at closing and that balance sheet is prepared post-closing, whilst we still see that with the rise and lock box. So lock box is where you agree that equity value before completion based on agreed set of accounts that have been diligent and then the box is locked from that date to the closing date you know, in the UK we continue to see the rise in predominance in of lock box pricing, but the completion accounts still remain a firm favourite. What about in Germany, do you see a rise at all in lock box pricing with you?

Helge-Torsten Wöhlert 

We do and I think that's one of the major differences in terms of deal structure compared to the UK. The lock box model is still the dominant model on the market and that applies to all sizes of the deals. It certainly has more impact if you talk about mid cap transactions, but even in large cap transactions it has, it has gone up. I mean to give you an idea, it's now at about 62% of our transactions to have a lock box model compared to around 50% in 2020.  So that's a significant rise and if you look at deals which deal value up to 100 million, we're at 79%, which I think is quite substantial.

Alice Gardner 

That's really interesting because I think in the UK lock box has definitely been on the rise, but obviously it feels like in Germany that's really accelerated over the last two years because probably you know if we spoke on the similar topic five years ago, I'd have expected it completely the other you know the other way around, so that's really interesting there's been that that kind of flip there. I think it's a lot easier for clients to agree pricing on lock box in advance, everyone gets the certainty they want, which, I know a lot of clients really like, especially obviously in the PE market, but even wider than private equity market as well.

Helge-Torsten Wöhlert 

Exactly. This is why it's very popular in the PE market and the PE market is eaten up to 85%, to give you an idea, and you are absolutely right, some years back we would have talked about it differently. My personal view is that of course due to the fact that the past period has been very much a seller’s market that certainly has given rise to lock box models. It's interesting now that the deal volumes come down, I mean when I started saying we're having the deal volume, which is pretty stable but the deal values they have plummeted and therefore we're seeing a little bit of a change.  It's not a pure seller’s market anymore as it used to be and therefore it's going to be interesting what kind of impact that will have on the instruction meaning the popularity of lock box models or the enforceability, so to say for the sales side of lock box models.

Alice Gardner 

Yeah, and I'm picking up on that theme in terms of that move from kind of the seller’s market that it was in the last two years to moving into that buyer’s market a bit more, are you seeing anything in relation to changes on earn outs in that space as well?

Helge-Torsten Wöhlert 

Yeah, I mean we're definitely seeing some price negotiations which you had less previously so to say, and we're seeing gaps in price expectations and that means earn out models, especially if you're talking about the mid cap segment, they're going up again. It has got other reasons as well which are specific to the German M&A market, a lot of businesses are changing hands due to generation issues. And in those scenarios, it's very often the case that the prior owners are asked to stay on for a certain interim period, and that is usually three years. It's around three years that they are being asked to continue and for that period you're very often seeing on out models as well. So it has, different reasons, I guess, why it's at about 36 to 38%, we're seeing an out models being used.

Alice Gardner 

Yeah, that's really interesting. That's very comparable to what we're seeing in the UK at the moment in terms of size and definitely it being used in similar circumstances as well. So looking a bit towards the future and although we all would like to have a big crystal ball that we can gaze into, what do you think in terms of new laws or anticipated change, market changes you foresee in the German market with your crystal ball in front of you?

Helge-Torsten Wöhlert 

I'd like to have that crystal ball for my investments in the stock market. Actually one of the topics which are very, very popular and very much discussed of course, is the impact of ESG on transactions and that means on transaction values as well, because there's a lot of expectations that ESG will become a value driver and therefore, for example, the PE's, almost every PE investor has already its ESG criteria and schemes and they implemented, they have special ESG due diligences which are carried out. If you look at classical strategic investors, especially in Germany, they tell you but I'd say in less than 50% of the cases that they are not that concerned with ESG yet.  But of course if you look at the surveys, it's very interesting looking forward when you know executives are being asked what do you expect to be a value driver in the future? And would you say that ESG would be effective for you to lower your quote for purchase price or to increase it? The vast majority will tell you up to 10% of the purchase price, yes I'll take that into consideration.  Some even say up to 30%, ESG will come into play, so that is one of the important factors. Once again, that also slows down the transaction because it has got an additional ESG due diligence of course that's not an accelerator on the times the timeline.

Alice Gardner 

Yeah and it's an area that everyone's navigating a bit at the moment to make sure that they're thinking about ESG in a lot more detail and what it affects the deal, even as lawyers in the UK, there's been some recent guidance about how we need to be considering the impact of ESG, when advising clients on deals and I think everyone is navigating it, there's something that people just want to hear what people are doing and what is the next steps as we all kind of move through the kind of ESG journey together. And do you see anything around warranty and indemnity insurance at all because I know in the UK market, it's something we've used an awful lot and I know previously speaking to you a couple few years ago it was something that was less common in the German market.

 Helge-Torsten Wöhlert 

Absolutely. I think the US and the UK are at the forefront for the use of W&I insurances. We were lagging behind not as badly as the French, but I think we're still comparatively lagging behind the UK market W&I is increasingly becoming popular that has various factors. I mean the product itself, which the W&I proposes are getting more and more flexible, getting more and more attractive, they're proposing different standards.  For example, if you think about a definition of loss, what you can actually recover. Knowledge balance sheet warranties all that has developed enormously on the insurance side, you're getting much more attractive proposals and another factor which I see is that for example on the German market, you now also have German speaking teams. If you had a German SBA., you could previously. I mean, if we're talking five years back, you couldn't place it. I had a deal, I think four years back where there was only one insurance, being able to work on the German SBA and now that of course is not an issue anymore. That is completely gone.

Alice Gardner 

It's been really interesting just to hear the differences between the UK and Germany and despite not being that far away, you know, it's always interesting to share ideas and understand more about what each of us we're seeing in the markets at the moment. If there is kind of one key takeaway you would offer to listeners from what we've been talking about today, what would you summarise that to be?

Helge-Torsten Wöhlert 

Addressing the UK, I mean my message would be we're still the second most important trading partner for the UK we account for about 8% of the UK trade. So the relationship with Germany and especially on the deal side is pretty important, that's the first takeaway.  So despite of Brexit and all that, nonetheless the attractivity of the market is there. Second takeaway is when I was talking about the German market, I was saying, OK, the number of deal volume that has gone down, but if you look more specifically what has been going up is deals which have a cross-border aspect, meaning the domestic German market has gone down, but investments abroad have, and also M&A deals coming into Germany inbound, they haven't suffered, they are the driving key factors. So the transborder side is still on, it's not still it has become the predominant factor, so that's the second takeaway for the UK.  And the third one is that the latest survey amongst the PE's when they were being asked which country would they consider to be attractive for investments in the next three to five years?  Germany has come in third place and guess who's on top of the list? And that's my takeaway for you in the UK, you are a hat of everybody else, USA is second place we are third, UK is first place. And I mean that means I expect talking about Germany being very active in transborder M&A I would expect that especially transborder M&A with the UK will pick up, that's my personal view.

Alice Gardner 

It's good to hear that despite kind of a few economic headwinds, there's still a lot of interesting developments and things to look forward in the future coming into 2024 and beyond, so thanks this brings our podcast to an end and it leads me to offer my thanks to Helge-Torsten at Heu King for such an interesting insight into the German market. Thanks for listening, I hope you found this podcast interesting, and please do like and subscribe with your usual podcast provider. To listen to our other podcasts in this international M&A series, looking at the Japanese and USA M&A markets, please visit tlt.com.