The talk in Frankfurt, Germany, about business conditions turns quickly away from matters regarding the European Central Bank (headquartered here) and toward the continuing boom in private equity investing in Europe. The outlook is that this volume of deal-making will significantly exceed 2005 and that Europe will outpace the U.S. Europeans foresee private equity deals totaling over $350 billion this year. What is happening in Germany may be an indication of the cause of the boom throughout Europe.
Germany’s mittelstand, or population of privately-owned small and middle-sized businesses, has been the source of that country’s buoyant economic expansion since 1945. Many of these companies were founded by young men and women who handed the reins to a second generation in the 1970s and 1980s. Now, it appears, the third generation does not have the appetite to run the family businesses. The private equity firms are stepping in to provide the desired exit liquidity for the long-standing owners. Many of these private equity firms come from the U.S. and London, the source of concern to some Germans.
In the May 2005 federal elections, Franz Muentefering, a leader of Germany’s Social Democratic Party (at the time, the dominant group in the German parliament) said that private equity firms amounted to a “swarm of locusts” that “graze” on these vulnerable firms, break the entitlement of lifetime employment for workers, and then exit profitably and quickly. The scholarly research on private equity investing suggests that this is a caricature of the effect of private equity investing. There is a small mountain of evidence that private equity investing and leveraged buyouts (LBOs) in particular, “pay” in the sense of enhanced economic efficiency and large risk-adjusted returns. Cash flows increase, asset utilization rises, returns rise. Some have feared that these gains derive from cuts in advertising, maintenance, capital spending, or R&D—but the research does not support this. Though there may have been a decline in returns from LBOs consistent with the flood of new money entering the field, LBOs seem to remain a durable source of attractive returns.
The SPD lost the German election, though the continuing boom in private equity deals may continue to feed anti-private equity sentiment. The U.S. is no stranger to doubts about foreign investing, so we should grant Germany her moment of disquiet. But the globalization of financial markets will almost certainly press the spread of foreign direct investing into sectors previously thought the preserve of natives.
Posted by Robert Bruner at 11/17/2006 04:02:24 AM