Germany: the deal conundrum

It’s not always the case that private debt deals garner the attention of what tech-savvy readers might refer to as the ‘Twittersphere’. When Berlin-based music streaming service SoundCloud took on a recent financing package, however, that’s what happened. 

SoundCloud received an investment of $70 million from three investors: Ares Capital Corporation, Kreos Capital and Davidson Technology. The investment followed the company announcing a loss of €52.2 million for 2015.

Picked up by the Silicon Valley-focused press, the financing garnered attention based on its status as a large online music platform. It also drew attention to a technology start-up scene in Berlin that is becoming more globally recognised.

Observers looking at this deal as a premonition of things to come in Germany, however, will be missing the mark. In reality, debt managers tell PDI the German market is still one where investors have to be flexible and opportunistic.

Private debt still faces headwinds. As a result, there is no ‘typical’ German private debt deal, although there are some areas where funds might prosper if they are flexible enough. Managers also note there are certain practices funds need to follow if they are to have any success in Germany.

“In terms of volume of private debt transactions it’s a distant third behind France and the UK,” Jeremy Golding, founder and chief executive at Munich-based fund of funds manager Golding Capital Partners, tells PDI.

According to Deloitte’s most recent Alternative Lender Deal Tracker report, Germany has accounted for 11 percent of private debt transactions across Europe during the last 17 quarters. By comparison, the UK has accounted for 40 percent, and France 26 percent.

Additionally, the report outlines the relative scarcity of major private debt deals in Germany, compared with the rest of Europe. Just two unitranche deals in excess of €90 million were transacted in Germany during Q4 2016. By contrast, the UK had 15 and France six.

Beware of the Bank

The dominance of banks in Germany means there isn’t low-hanging fruit or typical financing deals falling into the laps of debt funds. Berlin may have its start-up scene, but most of the companies it comprises aren’t ripe for debt financing. The country’s economic rhythm may sway to the beat of the Mittelstand, but these companies are already familiar with the local banking system and have little incentive to explore alternative financing options.

Germany’s mid-market corporates know full well they can take advantage of the Schuldschein market, Claus Fintzen, chief investment officer for infrastructure debt at Allianz Global Investors, tells PDI. “That’s always existed and it continues to exist,” he says.

What’s left is almost two extremes for private debt to mine opportunities and these tend to typify the deals seen. “You’ve got this dumbbell situation,” says Golding. Domestic small debt funds might be able to find financing opportunities in the extreme low end of the market.

At the other end of the spectrum, large pan-European investors might be able to find debt deals if they can identify a particularly complex leveraged buy-out scenario. 

“Banks tend to like the more plain vanilla, straightforward-type deals,” says Golding. “If it’s too small, too big or too complicated, that’s when the private debt funds might come in.”

Eric Gallerne, partner at Idinvest, notes that being flexible and quick is one way private debt can pick up some market share. “You have to be able to provide them quickly with financing,” he says.

Gallerne also notes a typical feature of the German market is that larger deals, when they occur, are dominated by pan-European managers, rather than purely German-domiciled players. “In Germany there are no pure German players,” he says. Gallerne says he’s also encountered competition with larger players when focusing on small deals. “From time to time we have to deal with the bigger players because they are hungry,” he says.

Price aggression

But while it might be hard identifying what qualifies as a typical private debt deal in the German market, there are certainly some consistent features.

The most obvious is private debt deals usually have to stave off fierce competition from banks. Fintzen tells PDI banks in Germany can often be aggressive with their pricing. While there’s a strong private equity presence within German infrastructure, it’s not often that private debt providers will get involved in providing acquisition finance for prospective buyers.

Indeed, one feature of the German infrastructure market is the virtual exclusion of private debt from swathes of the space. Areas like social infrastructure, which can take advantage of the pfandbriefmarket (German collateralised bond) market are almost entirely devoid of private debt investments. “If there was something special in Germany, it’s certainly social infrastructure,” Fintzen says.

In areas where debt funds can find opportunities there are some consistent characteristics of managers able to find deals. One of these, according to Gallerne, is entrusting the negotiation of private debt deals to native German speakers domiciled in the country.

“Most of the time the management teams feel more comfortable speaking in their mother tongue,” says Gallerne. This also allows debt providers to go into greater detail in legal agreements and specifics related to various debt facilities.

Idinvest recently hired native German speakers in a new Frankfurt office. It’s not the only firm trying to expand its German activity, with players like Valin Funds and Ardian also recently telling PDI they see the market as attractive.

If debt funds are waiting for a shift in the German economy to create more opportunities, however, they might be twiddling their thumbs for a while. “What can change?” asks Golding. “At the moment the economy is on a roll.”

Even if the German technology scene took off significantly, most of these companies are too small, or not profitable enough to take on debt financing, Golding notes. Deals like the recent facility extended to SoundCloud are more the exception than the norm.

Indeed, SoundCloud has its quirks. The firm has registered offices in the UK, perhaps aligning it more to the well-established UK debt market rather than Germany. A spokesman for Ares, who led the recent debt financing, did not respond to requests for comment. 

If funds want to crack the German market, they will need creativity and opportunism in abundance.