The European Private Equity Outlook 2023 – the 14th by Roland Berger – shows how experts think PE will develop and which factors will be relevant in 2023.
Ready to reignite: Private equity in the DACH region June 2023
Our latest industry update finds that challenges remain but funds are ready to be deployed
While inflation and other macroeconomic challenges continue to hit transaction volume in 2023, the long-term outlook for the DACH private equity industry remains positive. In this update, the latest in our bi-annual series on the DACH PE sector, we assess the impact of the challenges and look at future growth opportunities.
"Rising financing costs are putting increasing pressure on the PE market. We see a stronger focus on cash generation and more resilient business models to ensure interest payments and mitigate risks."
With more than 400 active private equity (PE) funds and 183 transactions in 2022, the DACH region (Germany, Austria, Switzerland) has become a major player in private capital deployment in Europe. It currently ranks third in Europe (behind the UK and France) in buyout transaction volume with a 15% share.
But like other regions, the DACH PE sector experienced a tough time in the second half of 2022 and first quarter of 2023. Deal volume fell by 28% in 2022 compared to 2021, and is off to a slow start in 2023. In addition, investors are increasingly having to deal with major macroeconomic challenges, ranging from high inflation to sustainability shifts. This has cooled the industry and made fundraising difficult.
However, there is a silver lining. PE firms are sitting on large cash reserves, roughly equivalent to pre-COVID levels, that are waiting to be deployed. This suggests that investments are set to take off once again.
In this update, the latest in Roland Berger’s six-monthly series on DACH PE, we provide an overview of the current situation in the sector, look at the challenges facing it, highlight growth opportunities, and look at the long-term outlook.
Overview: The current situation
After a bumper year in 2021 with 257 PE deals in the DACH region, the number fell to 183 in 2022, a drop of 28%. All sectors experienced a decline in transactions, with Pharma & Healthcare and Consumer Goods & Retail the worst affected. The strongest long-term growth was seen in ‘Technology, Software & Digital Solutions’. Deal volumes in Q1 2023 showed clear signs of being impacted by the recent political and economic uncertainty.
Uncertainty is also weighing on fundraising. Investors have become more cautious as the outlook for private equity investment dampens. But funds still have sizeable cash reserves to deploy, with the EUR52 billion kept as dry powder in the DACH region in 2022 roughly the same as the EUR53 billion in 2019. This bodes well, providing the sector can overcome the challenges facing it.
Challenges: Macroeconomic headwinds and their impact on PE
The PE industry is facing four major macroeconomic challenges, with each having a significant impact.
High interest rates and inflation
The current European monetary climate is characterized by high inflation and interest-rate rises . The war in Ukraine and rising food and energy costs saw inflation in the eurozone hit 8.3% in 2022, while the European Central Bank key interest rate jumped from 0% in 2021 to 3.8% in 2023.
The impact on the PE industry has been a fall in transaction volume. Rate hikes and rising inflation increase costs at portfolio companies, reduce valuations and raise the cost of debt for new deals. In addition, banks are tightening lending requirements.
Sustainability shift
The energy transition and ESG awareness are a growing priority for DACH businesses. Germany, for example, aims to achieve a 100% renewable energy supply by 2035, and the European Corporate Sustainability Reporting Directive will mean many companies will have to report ESG metrics. Decarbonization regulation is also becoming stricter.
Due to the cost and other implications of sustainability regulation, PE investment decisions are receiving much more scrutiny. But while the energy transition poses risks of margin erosion, it also offers opportunities for new business models, particularly those around energy efficiency.
Operational obstacles
Supply-chain shortages created by the COVID pandemic and rising geopolitical tensions (war in Ukraine, China/Taiwan etc.) persist in 2023. While shortages in upstream manufacturing have eased, the mechanical and equipment engineering sectors remain strained. As a result, near-sourcing and re-localization is a growing trend.
Supply-chain disruptions have multiple impacts, with companies in demand-driven markets experiencing profitability losses due to higher supplier prices, higher operating costs and production inefficiencies. The decisive factor for PEs is how quickly their portfolio companies can make their supply chains more flexible to minimize disruption.
Low consumer confidence
Consumer confidence fell to a historic low in 2022, with economic/political uncertainty and high inflation making consumers more cautious about spending.
The main impact here is on companies’ top lines, particularly those in consumer-oriented industries such as consumer goods and leisure. However, ripple effects run through the entire value chain and so also affect downstream industries (manufacturing, construction etc.) and companies with low margins and high fixed costs (for example, consumer electronics, hospitality). Businesses need to adapt by taking comprehensive cost measures.
Key takeaways: Growth opportunities and long-term outlook
We have identified four key takeaways to help DACH PEs on their growth journey:
Focus on attractive industries: Resilient and energy-light businesses, for example, ‘Pharma & healthcare’, ‘Infrastructure’ and ‘Technology, software & digital solutions’, remain the most attractive target industries in 2023, driving M&A transactions with PE involvement.
Target public-to-private deals: P2P deals involving undervalued businesses are gaining in popularity in 2023. Investors might seek arbitrage opportunities from taking public companies private, as public company valuations have become stronger.
Value creation: The majority of PE professionals now consider value creation initiatives to be an increasingly important topic, with ESG, digitalization measures and cycle resilience seen as important measures.
Positive long-term outlook: There is a continued positive long-term outlook for PE, especially in the German market where PE is still underrepresented compared to the UK/European average.
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