Sound and steady growth

PEI: Starting with the big picture, the Financial Times recently asked whether Germany's current economic problems were beginning to look like Japan's. Is that a fair question?

Roland Berger: I am much more optimistic. We are certainly not Japan. But we are in a recession at the moment, the economy hasn't grown for the past three years, and we have a business structure that definitely needs innovation in order to return to growth, particularly in the high tech and the service sectors.

There is momentum, however. There are several paradigm shifts underway at the moment, starting with the tax reforms, pension reforms and Agenda 2010. The stock market is recovering, and our strength in exports will allow us to benefit from growth in the US. All of this is reflected in the Business Climate Index, but I think we will experience a real growth rate of not more than 1.5 per cent in 2004.

Comparisons with Japan are wrong also because Germany is a more open economy and a member of the European Union, and hence in an entirely different situation. Of course, there are a lot of weaknesses, but I think these weaknesses are actually a great opportunity for financial investors in this country.

PEI: What are these weaknesses and opportunities?

RB: Many conglomerates are refocusing their businesses, and we still have too many of them. Second, equity prices are relatively low compared to other countries. Third, there is a desperate need for profit-oriented restructuring, so there is a lot of value that can be created. Bankruptcies such as the Kirch Group, Babcock and others are also generating opportunities for private equity. Last but not least there is a generation change taking place in the German Mittelstand, with many of the younger heirs open to the possibility of selling. These are typically businesses that have never been managed for profit, but rather in order to please the owners and the employees, and so with a tough restructuring approach one can generate a lot of value.

PEI: Privatisation played a part in helping private equity develop in Germany after the reunification in the early 1990s. Is it still a factor today?

RB: There are around 100,000 companies that are still state-owned, be it by the federal government, the states or the municipalities. Many of them will have to be privatised, as states and municipalities desperately need to raise money. Most of them, however, such as local energy providers for instance, might look for strategic investors who understand their sector and can bring in management know-how. But there is no doubt that opportunities will be coming up for financial investors as well.

PEI: Is private equity on the agenda when you and your colleagues talk to public and private sector clients about strategic planning?

RB: Of course, increasingly so. There is also a paradigm shift in financing which means that for the first time since World War II, lending is no longer the primary source of funding in Germany. More and more businesses understand that they will have to finance operations and restructuring efforts with equity. And it is not the capital markets that lend themselves to these initiatives. It is the private equity market that can provide the necessary capital and expect adequate returns on investment.

PEI: Do both corporate managers and Mittelstand executives recognise the potential of private equity?

RB: This is an important distinction. Corporate managers tend to take a more rational approach, looking to sell assets to the highest bidder, typically through auctions. For the Mittelstand owner-manager on the other hand, emotions count as well as price. And they are typically less used to talking to private equity investors who therefore need to make more of an effort to persuade Mittelstand owners of the merits of a transaction. Mittelstand owner-managers also want to speak to senior executives at private equity firms, and I think most private equity firms have too many young financial wizards who don't understand the operational and social side of a business, or at least give the impression that they don't understand it. A firm that wants to be successful in the Mittelstand probably needs to have more senior, grey haired and German executives than firms dealing with sell-offs of corporate divisions.

PEI: German managers are often said to be less driven by shareholder value maximisation, making them more difficult to work with from the point of view of financial investors. Do you agree?

RB: That's very true, but on the other hand, there is nothing to stop investors from putting a mixed management team in place and ensuring the right criteria for management success, let's say economic value added instead of return on sales or return on equity. If you then install the right incentive systems, you will see German managers working towards criteria of shareholder value management in the same way as managers in other markets.

PEI: What role do government institutions play in German private equity investment at present – are they helping or hindering the development of the market?

Because there is still so much fat on the bones, I think the opportunity is much bigger than the risk

RB: Job preservation is obviously a big political issue in today's climate, and many politicians view private equity firms as taking a more rational stance on the necessity of shedding jobs in a restructuring. That said, many municipalities and particularly the States are very interested in attracting private equity firms, which can therefore realistically expect some help and assistance from the governmental side. But of course, in Germany you have to take politics into account – not after you make an investment, but before you invest. And you must take into account the power of unions as well as several legal issues that are unique. But it is certainly possible to overcome these obstacles and work well with them.

Germany is a different animal, and you do have to adapt to its culture, its corporate governance style, workers' co-determination et cetera. That is why you need practitioners who know the local circumstances without neglecting the Anglo-Saxon know-how you want when restructuring a Mittelstand company or a corporate division. But because there is still so much fat on the bones, I think the opportunity is much bigger than the risk.

PEI: Reducing that fat is widely thought to be extremely difficult because of the cultural and legal characteristics. Is this view exaggerated?

RB: Definitely. If an investor like Ripplewood can be successful in Japan with the restructuring of companies, why should it not be possible in Germany? I know Japan very well, having travelled and worked there for 28 years, and I think restructuring is a lot more difficult there. In order to create value, you have to deal with the cultural differences without losing sight of your target. It may take more time and require more of a communication effort, but you calculate the value of the time, and decide whether to invest based on whether the return of that investment is positive. I would approach the issue of cultural difference in a rational way, and investors who do this tend to be successful.

PEI: There have been some high-profile failures of private equity-backed companies in Germany recently, such as Bundesdruckerei and Fairchild Dornier. Was that a serious setback for the industry?

RB: Every failure has a negative impact on an industry. The SwissAir collapse had, rightly or wrongly, a negative impact on McKinsey in Switzerland and on the consultancy profession as a whole. A case such as Fairchild Dornier, where private equity investors were not successful despite full control and state subsidies, has shown other companies that private equity may not be the only solution. But there are positive and negative examples, and each case is different. I think some failures essentially resulted from mismanagement, whereas others happened because of misjudgements in preinvestment situations, but look at how Permira is on track, with the right management of course, to turn around Premiere and to really create value.

Today more and more of the larger companies wanting to sell off non-core businesses are finding it faster and much easier to divest to a private equity firm instead of spending a lot of time looking for the right trade buyer. So yes, the recent failures have affected private equity's image to some extent, but they will not break the current positive tend. Private equity in Germany is a growing market.

PEI: Does this apply to the venture capital segment also? The German venture market has gone very quiet…

RB: At the moment, venture capital is pretty dead. But it has to come back, because Germany has to develop in sectors such as high tech and services. So the real question is first of all timing: it might not happen now, but in a year or 18 months from now. The second question of course is to invest in the right technology or business model or both. Third, you must make sure you have the staying power to wait for the right opportunity to exit. Right now, the stock market is obviously still very reluctant to provide venture investors with an exit route.

Venture capital is pretty dead. But it has to come back, because Germany has to develop in sectors such as high tech and services

PEI: In conclusion, will there ever be the big private equity boom that has been predicted time and time again?

RB: There won't be an explosion, but there will be steady growth, and very sound growth at that. But another important conclusion is that no one should think they can be successful in the German private equity market only with Anglo-Saxon methodologies, management tools and managers. You have to have the German element as part of your know-how and capabilities. You can't make an impact operating from London and without German professionals.

Roland Berger
For over thirty years, Roland Berger has been one of Germany's most influential business practitioners. In 1967, aged 30, he founded Roland Berger & Partners and proceeded to build it up from a one-person operation into one of the world's leading strategy consultancies. Today, Roland Berger Strategy Consultants has over 1,000 consultants and operates from 33 offices in 23 countries. In 2002 the firm generated revenue of over €500m.

In July 2003, Roland Berger handed the day-to-day running of the firm to his successor Burkhard Schwenker and became chairman of its supervisory board.

He is widely published commentator on management issues and economic affairs and is actively involved in German economic policy-making.

Roland Berger sits on the advisory boards of several international corporations, and currently serves as Co-Chairman of the European Advisory Board of The Blackstone Group, the US private equity group which in 2002 entered into a joint venture agreement with Roland Berger Strategy Consultants. He is also a member of the advisory board of CMP Capital Management-Partners, a turnaround manager based in Berlin.