Mergers and acquisitions: A view from Germany

Slowing economic growth, geopolitical uncertainty, escalating trade tensions and volatile stock markets will continue to affect appetite for M&A in Germany.

Financing conditions are expected to tighten further, which is likely to result in an increase in the proportion of acquisitions being made by cash-rich corporate buyers and private equity. If leverages drop, buyers may increasingly need to turn to part or all-equity offers.

Dealmaking, in particular in the large cap market, generally requires confidence in future growth, which is likely to erode if Europe enters into a recession. Compared to Q3 2018, in Q3 2019 total European M&A values for the year to date had dropped by 29.4 percent to US$573.5 billion, with over 2,500 fewer deals (Source: Mergermarket). It seems that this trend is set to continue, so the number of deals is likely to decrease in 2020 compared to previous years, and even more likely so will the overall volume of deals. As most experts anticipate at least a slight and temporary recession across Europe, the question seems to be not if but when, how severe and how long the downturn will impact the German markets and therefore, German targets, most of whom rely heavily on exports to European markets. The likely outcome of this is an inevitable rise in distressed German targets fuelling restructurings, special M&A opportunities and market consolidation in many industries.

If sale conditions worsen in 2020 due to the onset of a recession period, this will increase the challenge to find common ground on valuation and risk allocation between sellers and buyers. As a consequence, dealmakers will be more likely to explore and need to implement variable purchase price models (e.g. earn-outs) to bridge the valuation gaps, which are likely to open up between sellers, spoiled by the historically strong sellers’ market, and cautious buyers who are factoring worst-case recession scenarios into their business plans. This increasing tension and the resulting increased risk of deals aborting will be more acutely felt by those industries less resilient to an economic downturn.

A decrease in buyers’ appetite for risk is also likely to increase take-up of warranty and indemnity (W&I) insurance, and will encourage the use of such insurance to underpin broader and deeper warranties and indemnities as well as remedies.

This could either force sellers to increase their own exposure in divestments, or – as is much more likely given past market dynamics – will put even more pressure on W&I insurers to further push the envelope and underwrite more risks.

In contrast, this increased tension and risk of deals aborting should remain the exception for M&A in the industries more resilient to an economic downturn, in particular in regulated industries like life sciences and healthcare where new legislation may shape activity.

Spotlight on life sciences and healthcare

Germany has the largest life sciences and healthcare market in Europe. This market is likely to continue to grow notwithstanding the wider economic pressures mentioned above. The sector’s relatively resilient revenue streams and attractive margins should continue to attract investors. A few key factors in this will be:

• Digitalization and changes in the regulatory landscape in 2020 will impact almost every part of the industry and increasingly drive M&A activity. These main trends, including German legislative digitalization initiatives like, for example, the Digital Healthcare Act (Digitale-Versorgung-Gesetz), will help to foster and shape data and digital health-driven R&D and M&A.
• The elderly, rehabilitation and intensive care sector, which has seen an increase in public funding as well as private equity investment, will have to cope with increasing quality standards and scrutiny as well as the ongoing challenge of shortages in qualified personnel.
• Another dynamic for M&A in the healthcare services sector is the widening gap between the growing out-patient services and clinics subsector on the one hand and German in-patient clinics on the other hand, of which one-third are reported to be in financial distress.
• Finally, the EU Medical Device Regulation (MDR) which takes effect on May 26, 2020 will increase the cost of medical device R&D as well as manufacturing and market access generally. This is likely to lead to supply chain disruptions and further market consolidation as many SMEs will struggle to bear the extra costs of additional regulation.