This article is an extract from GTDT Market Intelligence M&A 2023. Click here for the full guide.
Thomas Lappe is a corporate/M&A partner in the Berlin office of K&L Gates LLP. He has 25 years of experience in advising corporate clients and private equity firms on international M&A transactions, including carve-outs, buyouts, joint ventures and corporate reorganisation. Thomas focuses on the technology and automotive sectors. He is one of the firm’s global leaders for the corporate practice area.
Wilhelm Hartung is a corporate/M&A partner in the Berlin office of K&L Gates LLP. He advises clients on national and cross-border M&A and commercial transactions, particularly in regulated industries such as transportation, life sciences, healthcare and telecommunications. He also counsels German and international blue-chip clients on high-profile, confidential internal investigations.
Judy Witten is an associate in the Munich office of K&L Gates LLP and is part of the corporate and transactional practice group. She advises national and international clients on (cross-border) corporate restructurings, M&A transactions, formation of joint ventures and general corporate matters, in particular in relation to public listed companies.
1 What trends are you seeing in overall activity levels for mergers and acquisitions in your jurisdiction during the past year or so?
While the first half of 2022 saw exceptionally brisk activity in the M&A market, the pace of transactions slowed significantly in the second half of 2022, mainly due to rising energy and commodity prices combined with further increasing inflationary pressure and steadily rising interest rates.
The M&A market entered 2023 with this burden, and we note that overall consolidation occurred at yet another lower level in the first half of 2023. In terms of value, the M&A market slumped by another third in the first half of 2023 compared to the first half of 2022, having already fallen by around 20 per cent last year compared to the peak year of 2021.
Notably, in the German M&A market, the second quarter of this year was again weaker than the first, despite the €12 billion sale of the Viessmann Group’s heat pump business to US building automation specialist Carrier Global Corporation announced on 25 April 2023. By contrast, there was a clear recovery trend on the foreign market in both German purchases and German sales in the second quarter, albeit still at a low level overall.
The main driver of M&A activity continues to be the ongoing trend toward digital and technical transformation, which has been accelerated by the pandemic. Technology companies offering solutions such as software, cloud computing and e-commerce platforms all remain attractive targets to fill any technology or skills gaps that buyers may not be able to fill with their current resources. In addition, the shift towards e-mobility in the German automotive industry continues to be a driving force for acquisitions and supply chain adjustments. There is also the transformation in the energy sector and related infrastructure, which has been accelerated by the impact of the Ukraine war.
Furthermore, growing importance of ESG issues continues to be key drivers of M&A activity in 2023. Complying with environmental guidelines, fostering diversity and exemplary business practices are becoming increasingly important in acquisition and divestment decisions. In addition, a company’s sustainability performance is becoming an ever more important factor in determining shareholder value, and more and more companies are repositioning themselves, streamlining their portfolios by divesting ‘non-green’ businesses, or making acquisitions to improve their sustainability performance.
2 Which sectors have been particularly active or stagnant? What are the underlying reasons for these activity levels? What size are typical transactions?
As in previous years, the technology, media, and telecoms sector remains a prominent driver of M&A activity in Germany. The ongoing digitisation trend continues to fuel transactions in areas such as software development, cloud computing and digital media. The need for innovative solutions and technology-driven business models keeps this sector highly active. Transaction sizes vary, with both smaller tech startups and larger, strategic acquisitions in play.
Also, M&A activity in the healthcare sector remain buoyant, with a focus on both pharma and life sciences as well as digital healthcare services. Investors are interested in innovative healthcare solutions and companies that can contribute to advances in healthcare delivery. Large pharmaceutical companies continue to optimise their portfolios through divestitures and acquisitions to support innovation. Transaction sizes can vary widely, from smaller biotech startups to multi-billion dollar pharmaceutical deals.
The automotive sector continues to see significant deal flow, primarily due to transformative investments in electric powertrains, autonomous driving, and battery technology. Both original equipment manufacturers (OEMs) and suppliers are actively seeking acquisitions to position themselves for the future of mobility. While transaction sizes may vary, many deals in this sector tend to be in the mid to large range, given the capital-intensive nature of automotive technology investments.
Likewise, the German aerospace and defence sector remained relatively stable in the first half of 2023, with a 25 per cent increase in the number of deals compared to the same period in 2022. Deal activity was dominated by financial investors, mainly from Germany. However, last year’s decision to increase the defence budget by €10 billion by 2024 and the commitment to comply with NATO’s 2 per cent of GDP defence spending guideline have not yet had a significant impact on M&A activity. This is likely due to the long-term nature of defence contracts and the time it takes for funds to flow from governments to contractors.
Traditional energy sectors, such as fossil fuels, on the other hand, are facing challenges amid global pressure for renewable energy sources. This change has led to a slowdown in M&A activity in traditional energy sectors as companies re-evaluate their strategies and portfolios.
In terms of transaction sizes in the German M&A market in recent months, there have been fewer mega-deals (over €1 billion), but there continue to be many mid-sized transactions in the €50 to €250 million range. In addition, smaller transactions involving start-ups and technology-oriented companies are common in sectors such as TMT.
3 What were the recent keynote deals? What made them so significant?
In April, German heating manufacturer Viessmann sold its air conditioning division to US air conditioning specialist Carrier Global for €12 billion. The air-conditioning division includes heaters and air conditioners as well as heat pumps, which are regarded as an important component of the energy turnaround currently under discussion in Germany. At Viessmann, the sale was presumably motivated by fears that the company was too small by international standards when it came to converting gas and oil heating systems to heat pumps. The takeover had triggered a political debate about whether the German government’s ‘heat turnaround’ was overburdening German manufacturers. There were also warnings that after the decline of the solar industry, Germany was now in danger of losing the next technology of the future. The owners will receive most of the purchase price in cash, with the remaining €2.4 billion in Carrier shares.
The second largest M&A deal with German participation is Deutsche Börse AG’s takeover offer to the shareholders of Danish financial software company SimCorp A/S with a total consideration of almost €4 billion. The offer is subject to a minimum take-up rate of 50 per cent plus one share of all SimCorp shares. It was expected to be settled no later than 29 September 2023, and will thus be completed.
Also, the third-largest M&A deal in recent months was a strategic deal between two companies: Bertelsmann sold its stake in the call center Majorel to the market leader Teleperformance from France. The previous shareholders will receive a total of €2 billion in cash and €1 billion in Teleperformance shares. Bertelsmann had most recently held 39.5 per cent of the shares, generating proceeds of around €1.2 billion.
Among the billion-euro deals in recent months in which German companies have been sold to international PE investors is the takeover of Darmstadt-based Software AG by US technology investor Silver Lake. Since the end of the second acceptance period at the end of July, Silver Lake has held 84.29 per cent of the shares in the Darmstadt-based software house. Provided the relevant authorities do not intervene, the takeover of the software company, founded in 1969, is expected to be completed this year – for more than €3 billion including debt.
Another example of a transaction to a foreign PE investor is the €2 billion sale of a minority stake in Griesheim-based gases company Messer SE & Co. KG, formerly known as Messer Griesheim, to the Singapore state fund GIC Capital. The proceeds will enable Messer’s founding family to secure control of the core business and buy out financial investor CVC from a joint venture.
Only a few major transactions have taken place in the domestic market (German target companies and German buyers) in recent months. Strategic buyers from Germany in particular have been very cautious. However, the largest domestic M&A deal with a purchase price of €440 million (transaction value €480 million) was the acquisition of BBS Automation GmbH by Dürr AG from EQT Private Equity of Sweden, strategic for the buyer and a successful exit from a solid investment for the seller.
In our view, SPAC (Special Purpose Acquisition Company) transactions are of little significance in Germany at present. However, a major de-SPAC transaction worth mentioning in the German market was the acquisition of Gebrüder Schmidt GmbH & Co KG, a manufacturer of printed circuit boards, by an American SPAC investor. De-SPAC transactions represent the reverse takeover process of an operating company by a capitalised acquiring company, which has more of a financing character for the acquired company than a classic takeover.
4 In your experience, what consideration do shareholders in a target tend to prefer? Are mergers and acquisitions in your jurisdiction primarily cash or share transactions? Are shareholders generally willing to accept shares issued by a foreign acquirer?
In German private M&A, we rarely see sellers accept anything other than cash consideration. While the total cash payment is occasionally paid in full on closing, deferred payment schemes including escrows and holdbacks are more common. There is also a renaissance of earn-out structures in an effort to align incentives and bridge valuation gaps caused by various global crises and market uncertainties. If shares form part of the consideration, we find that this is driven by unique circumstances, such as the desire to put in place a joint venture type structure or strategic partnership.
From time to time, we come across stock-for-stock transactions in the public M&A arena. An exchange of shares in public companies is generally more attractive than an exchange of shares in closely held private companies. In Germany, the shares offered as consideration in a public takeover offer must be liquid securities admitted to trade on a regulated market in any EEA member state. While offering shares issued by a foreign bidder can help navigate the risks of shareholder challenges under German stock corporation law, this raises rather complex issues of legal equivalence between the foreign offer shares and the German target shares. A significant limiting factor for public share exchange offers is a revised policy adopted by the German securities regulator (BaFin) in 2021, which was subsequently confirmed by the courts. Pursuant to the revised policy, the offered shares need to comprise a free float of at least €500 million with an average daily trading volume of at least €2 million in order to be considered equivalent consideration. Fewer than 100 German issuers currently meet these requirements, and after only two bidders (both foreign) made public share exchange offers in 2021, no such offers have been made in Germany since 2022.
5 How has the legal and regulatory landscape for mergers and acquisitions changed during the past few years in your jurisdiction?
Regulatory tightening and political uncertainty have continued to have negative impacts on German in-bound and out-bound M&A transactions throughout 2023.
The newly tightened German FDI control regime has shown its effects. Given the broad scope of industry sectors captured, the number of German FDI cases has risen from 78 cases in 2018 to 306 in 2022, with US and China among the top three origin countries of investors. Driven by the publicly declared political goal that Germany and Europe maintain economic and technological sovereignty in critical industry sectors, recent examples of FDI prohibitions include:
- the partial prohibition of the participation of a Chinese state-owned shipping company in a container terminal in Hamburg. Despite considerable concerns from multiple government branches, the BMWK ultimately permitted only a minority shareholding of 24.9 per cent, below the 25 per cent stake that would potentially give a shareholder a blocking minority, instead of the originally sought 35 per cent interest;
- the envisaged acquisition of the wafer production of the semiconductor manufacturer Elmos Semiconductor SE by the Chinese state owned investor SAI Micro-Electronics through its Swedish subsidiary Silex AB; and
- the envisaged 2022 acquisition of German semiconductor manufacturer Siltronic AG by Taiwanese GlobalWafers, which was de-facto prohibited because the longstop date expired during the BMWK’s review.
The 11th German Act Against Restraints of Competition amendment (GWB), enacted in July 2023, further strengthens the FCO’s merger enforcement powers and expands its powers following sector inquiries. After completion of a sector inquiry, the FCO now has the power to require companies to notify certain transactions, even if the specific turnover thresholds set out in the GWB are not met, provided there are indications that future mergers in the investigated sector could significantly restrict competition. With these legislative changes, merger control in Germany will become yet more interventionist. Where the FCO anticipates potential competition concerns, parties to M&A transactions must beware of FCO intervention making use of its new broader powers.
Finally, ESG aspects are increasingly considered in M&A transactions. For example, the German Act on Corporate Due Diligence Obligations in Supply Chains (LkSG), which came into force in January 2023, requires new and increased attention in due diligence, along with ESG topics more generally. Whether the target’s business model ensures sustainability and what risks and costs exist in relation to compliance with ESG criteria in the future will have a direct impact on company valuation, purchase price and deal documents.
6 Describe recent developments in the commercial landscape. Are buyers from outside your jurisdiction common?
Germany is traditionally considered an attractive jurisdiction for foreign direct investment. The country’s strengths comprise a powerful and diversified industrial network, a highly skilled workforce with a good command of English, reliable infrastructure, a favourable social climate, a strategic location at the heart of Europe and a stable legal framework. As a result, German companies in cross-border acquisitions have a long history of being favoured targets for investors across the globe, both on the strategic and the financial sponsor front. That said, the commercial landscape in Germany has recently been marked by ongoing changes and challenges, including the transition to cleaner energy sources, technological innovation and digitalisation, an enormous evolution in and challenges to the automotive industry and a focus on sustainability. Foreign buyers continue to play a significant role in the German market, attracted by the country’s strong economic fundamentals and opportunities arising from these developments. However, geopolitical tensions and regulatory changes have necessitated careful consideration and compliance efforts in cross-border transactions.
7 Are shareholder activists part of the corporate scene? How have they influenced M&A?
In recent years, there have been many high-profile cases of shareholder activism in Germany, including thyssenkrupp AG divesting its elevator business upon initiatives taken by the hedge funds Cevian Capital and Elliott Management Corporation, and Active Ownership Capital initiating the restructuring of Stada Arzneimittel Aktiengesellschaft. As in many other jurisdictions, shareholder activism currently plays an increasing role in Germany’s corporate scene, even though German-listed companies are traditionally more immune to shareholder activism than international companies by often having substantial anchor shareholders and relatively low free float. A report on shareholder activism in the DACH (Germany, Austria and Switzerland) region by Boston Consulting Group identified 160 companies exposed to an extremely high or very high risk of an activist campaign. Activists exert influence with regard to M&A matters in several respects, such as in connection with public takeovers when the activists buy shares to force the bidder to raise the offer price, a method used by Elliott in the context of Vodafone’s public takeover offer for the shares in Kabel Deutschland AG. In other cases, the activist investors push for specific acquisitions or divestitures of business lines by the listed companies in which they hold stakes. Also, Environmental, Social, and Governance (ESG) activism has gained prominence. Activists may push for ESG-related changes within companies, including divestment from businesses with poor ESG profiles or a shift toward sustainable practices. For example, activist shareholder Enkraft Capital demanded that RWE AG divest of its brown coal business and focus solely on its renewable energies business.
8 Take us through the typical stages of a transaction in your jurisdiction.
The phases of an M&A transaction in Germany largely conform to Anglo-American standards. Generally, everyone on the ground in Germany is comfortable with negotiating and documenting cross-border deals in English. In a bilateral deal, the parties frequently communicate with each other directly. Depending on the deal volume and company size, this can happen at all levels, including board level or the level of the internal business development teams. Financial advisers sometimes facilitate the initial contact and the overall process, especially when it comes to upper mid-cap or large M&A transactions. As a first legal document, the parties typically execute a non-disclosure agreement. Where parties are competitors, it may be necessary to put in place clean team arrangements early on.
While the parties frequently prefer to initially summarise key terms of the envisaged transaction in heads of terms, others jump into the due diligence exercise and the negotiations of definitive agreements. By way of exception, we have also seen sales processes without any diligence review at all. This must be justified by the buyer’s board on a case-by-case basis and include measuring any advantages and disadvantages by applying the business judgement rule. Due diligence is now, in most cases, managed through virtual data rooms, and in larger international transactions with thousands of contracts, buyers increasingly apply legal technology tools to review the data efficiently.
The negotiation of the sale and purchase agreement often takes two to four rounds; however, we have also seen fast track negotiations and negotiations that have dragged on for several months. In Germany, the first sell-side draft of the sale and purchase agreement tends to be a little less ‘middle of the road’ than you would usually expect from a US or UK perspective. Before a deal can be signed, it is the seller’s job to prepare the disclosure schedules against the warranties – Germany’s answer to England’s disclosure letter. Originally used predominantly by private equity sellers, now more than 70 per cent of the strategic deals use warranty and indemnity (W&I) insurance. One German peculiarity is that the sale and purchase agreement must often be notarised, notably if the transaction involves the sale of shares in a limited liability company. Occasionally, foreign investors find it surprising that, in a notarisation, the documents must be entirely read by the notary in the presence of all the parties’ representatives. This exercise may take several hours or, at times, may be an ‘overnighter’ if the deal has not been finalised in all respects prior to the notarial session. Immediately after signing, the parties will focus on all regulatory clearances, which must be obtained prior to closing. Similar to other jurisdictions, the German foreign direct investment control regulations have recently been enhanced. The practical significance of any foreign direct investment control clearance should, in these days of rising national protectionism, not be underestimated by investors from outside the European Union.
In an auction, a process letter will be provided with procedural guidance to all bidders. In preparation for auctions, German sellers often conduct a vendor due diligence review to provide all bidders up front with at least basic legal, tax and financial information on the target. Following the due diligence review – and sometimes subject to confirmatory due diligence – the bidders are asked to submit final bids, including a statement of the value they place on the equity and a mark-up of the sale and purchase agreement. Additionally, in German auctions, we frequently see ‘seller-buyer flip’ W&I insurance, where the seller begins to arrange for insurance with the preferred buyer, at some point in the process, then stepping into the shoes of the seller to finalise the underwriting.
9 Are there any legal or commercial changes anticipated in the near future that will materially affect practice or activity in your jurisdiction?
From July 2023, the EU’s new Foreign Subsidies Regulation (FSR) applies, giving the European Commission the power to take action against subsidies granted by non-EU countries to companies active in the EU that can be considered distortive. Large M&A transactions can be investigated if certain thresholds are met, as well as, upon the discretionary initiative of the Commission, any situation potentially involving foreign subsidies.
M&A transactions that meet the FSR’s thresholds must be notified starting from October 2023. Then, parties to a transaction will need to assess not only filing obligations and substantive risk under merger control and foreign direct investment/national security rules, but also under the FSR.
The German government is expected to adopt a ‘China strategy paper’ in the second half of 2023. A first draft provides for further amendments to German foreign trade laws. It can be anticipated that in future, investment control will not only cover direct or indirect acquisitions of shares in existing German companies, but potentially also investments in Germany from foreign (non-EU) investors though incorporating a company or venture capital financing. Closer cooperation between G7 member states is on the agenda to identify and coordinate the handling of (direct) Chinese investments in any G7 member state. Critical infrastructures, such as transport and smart city infrastructure, data networks and electronic payments, as well as electricity, water utilities and hospitals will continue to be the focus of such scrutiny, with a view to prevent future dependencies or threats relevant for public security.
Based on the draft of the European Corporate Sustainability Due Diligence Directive, existing supply chain due diligence obligations can be expected to be further tightened to apply also to indirect suppliers and increased liability for failure to take preventive and remedial action.
10 What does the future hold? What activity levels do you expect for the next year? Which sectors will be the most active? Do you foresee any particular geopolitical or macroeconomic developments that will affect deal sizes and activity?
How the German M&A market will develop in 2024 is indeed an intriguing question to which hardly anyone can give an answer on a sound basis at the moment.
On the one hand, we see that companies are still struggling with the effects of various crises: rapidly rising commodity and energy prices, changing regulatory requirements leading to changes in business models, skills shortages and uncertain customer demand, along with interest rates that continue to rise as inflation has proven more stubborn than expected. Although in June economic institutes already predicted a growth rate of 1.3 per cent for Germany in 2024, these positive forecasts have already been revised downwards again in the meantime. All these factors add up to an overall situation that continues to be characterised by great uncertainty and does not provide any good conditions for M&A activities.
On the other hand, we see a number of drivers that are likely to keep the M&A market active in the coming period: many companies are still under high pressure to innovate and transform and will, therefore, continue to rely on acquisitions and carve-out activities in the future. Also, private equity investors still have considerable capital to invest, and the current crisis offers interesting opportunities in the M&A market that market participants can exploit, for example, by acquiring companies that have run into financial difficulties as a result of the current turmoil, but otherwise have a solid business case and are well positioned for the long term.
We expect to see further expansion in the TMT sector in particular, as a number of industries continue to focus on digital transformation (including artificial intelligence, cloud computing and cybersecurity). A vivid example of this trend was Deutsche Börse’s aforementioned acquisition of Danish data provider SimCorp for €4 billion this year. Deutsche Börse used this acquisition to strengthen its competencies in the area of data analysis for its newly established investment management solutions business.
We also expect ESG and sustainability issues to continue to be a driver for M&A transactions in the coming months, as the pressure on companies to demonstrate good ESG performance continues to increase. Likewise, we believe that the transition to renewable energy sources and efforts to reduce dependence on fossil fuels to continue to drive M&A activity in the renewable energy sector.
Finally, we expect to see transaction activity in the defence sector in the coming months. The ongoing Russia-Ukraine conflict has prompted the German government to invest €100 billion in expanding the country’s armed forces. This was followed by a €10 billion increase in the defence budget by 2024 and a commitment to comply with NATO’s defence spending guideline of 2 per cent of GDP. We assume that rising orders and production rates to replenish depleted ammunition, missiles and weapons inventories are likely to create opportunities for M&A as companies seek to build capacity or resolve supply chain issues. Given the high cost of development programmes and the stability of the long-term defence budgets, we also expect to see further cooperation between European countries in the form of partnerships and joint ventures, similar to the joint venture between Rheinmetall and Ukraine’s Ukroboronprom to build and repair tanks in Ukraine.
The Inside Track
What factors make mergers and acquisitions practice in your jurisdiction unique?
The formalities of German corporate law give rise to a number of practical restrictions, which are not experienced in Anglo-Saxon jurisdictions. For example, it is sometimes required to use ‘limitation language’ to fit upstream loans into the requirements of German capital maintenance rules. Legal features integral to group structures, such as domination and profit pooling agreements, demand special provisions in sale and purchase agreements. In a nutshell, Germany has established a practice over the past decades to combine Anglo-Saxon legal concepts with mandatory German corporate law.
What three things should a client consider when choosing counsel for a complex transaction in your jurisdiction?
When facing a complex M&A transaction, a client should initially look for a truly cohesive external legal team with an experienced team lead who understands the commercial aims of the transaction and focuses on the key points. Second, the team should include expert lawyers with proven track records in the functional focus areas of the deal. Third, the client should bear in mind that one important task for counsel will be to stay on top of the international aspects of the deal.
What is the most interesting or unusual matter you have recently worked on, and why?
Acting for an international consortium of bidders in an auction for a private company held by a governmental entity under the rules and regulations of European public procurement law. Combining traditional corporate and M&A issues with issues of large government contracts, public concessions and public procurement presented a unique set of challenges for the large cross-practice team in the auction process and the negotiations.