value growth of investments key influential factor for corporate performance
Investment managers co-invest own money alongside the Company
A four-member Board of Management heads the Company. All active staff of Group companies are employed by Deutsche Beteiligungs AG; they are located at the Company’s headquarters in Frankfurt am Main.
The Supervisory Board consists of six individuals; they are exclu-sively shareholders’ representatives.
Return targeted to exceed cost of equity on long-term average
The key target and performance indicator for Deutsche Beteiligungs AG is the return on equity per share. To that end, we compare the net asset value (NAV) – or equity – per share at the close of the financial year with the opening NAV per share, less dividends, at the onset of the financial year. The Board of Management pursues the objective of achieving an NAV per share on the long-term average at a rate that exceeds the cost of equity. The Company estimates that the current cost of equity is approximately 8.8 percent.
We employ the capital asset pricing model (CAPM) to determine that value. This conforms to a recommendation by the Institut der Wirtschaftprüfer (IDW) on determining the cost of capital in con-junction with enterprise valuations and follows general practice.
Based on the CAPM, to arrive at the cost of equity rEK it is neces-sary to determine
n the risk-free base rate rf,
n the stock market risk premium rM and n the company-specific risk ß.
The cost of equity is derived as follows:
rEK = rf + ß * rM
12) Source: “Maschinenbau ist Beschäftigungsmotor”, Frankfurter Allgemeine Zeitung, 5 October 2007, page 18.
We derive the risk-free base rate from the interest structure curve for German Government bonds with a term of 15 years and the value at which the rate converges over a perpetual term. At 31 October 2007, this value was 4.8 percent.
The market risk premium used was five percent, which is within the IDW-recommended spread of four to five percent.
The individual risk measure for Deutsche Beteiligungs AG (ß) is determinable using the regression method, which shows the relationship between the expected return of a market index and the expected return of the shares of Deutsche Beteiligungs AG.
Different beta values result, depending on the choice of market index, the period of time and the length of return intervals.
Moreover, the beta values thus determined are unstable over time. In view of these methodical problems, we chose a prag-matic approach, using 1 as the beta of the shares. This value is adjusted based on the differences between the financing struc-ture of Deutsche Beteiligungs AG and the average financing structure of securities quoted on the stock market. This proce-dure assumes that of two equal companies, which differ only in the companies’ financing structure, the company with the higher level of debt also bears a higher risk. In view of the low level of debt Deutsche Beteiligungs AG had compared with the total market at the close of financial year 2006/2007, the adjusted beta of the shares is 0.8.
Applying the three values in the CAPM formula results in equity costs of 8.8 percent for Deutsche Beteiligungs AG. In the report-ing year, the return on equity per share significantly exceeded this value, and the long-term value also clearly surpassed this mark:
In financial year 2006/2007, the net asset value (or equity) per share rose by 6.02 euros to 25.09 euros per share. Taking account of the dividend distribution of 3.00 euros per share, the total return on equity per share is 56.2 percent. Over the past ten-year period (1997/1998 to 2006/2007) we achieved an average return on equity per share after taxes of 21.4 percent. The spread over this ten-year period ranged from -9.7 percent to 56.2 percent.
value growth of investments key factor in corporate performance
The level of NAV (equity) per share is largely determined by the value development of the portfolio: Changes in the fair value – the current market value of an investment – are directly reflected in the NAV through profit or loss. The development in the value of investments is the key factor on the Company’s income account.
The Valuation Committee, which includes the entire Board of Management, monitors the valuation of each portfolio company on a quarterly basis. The measurement is geared to rules that correspond to the fair value approach of the International Financial Reporting Standards (IFRS); the principles of the valua-tion methodology are discussed in the Notes to the consolidated financial statements on pages 96 ff.
NAv (equity) per share
Valuations may be subject to short-term fluctuations, since they may partially be influenced by industry-related cyclical trends and conditions on capital markets. Short-term changes do not convey a true picture of a portfolio company’s development. Rather, the performance of a private equity investment requires a longer-term view. This is the primary reason why Deutsche Beteiligungs AG has geared its target to the long-term average return on equity per share.
Board of Management members involved in operative business
The members of the Board of Management are personally involved in the core processes of business operations at Deutsche Beteiligungs AG. Due to the significance of individual transac-tions for the Group, they take on assignments in generating investment opportunities (deal flow), screening and negotiating acquisitions and disinvestments as well as supporting the investee businesses. Members of the Board of Management of Deutsche Beteiligungs AG also take offices on supervisory boards or advi-sory councils of major portfolio companies. For each investment, a further member of the Board of Management is responsible as a co-consultant. Additionally, key issues are discussed and deci-sions prepared and taken in weekly meetings with those staff members involved in investment transactions or the development of portfolio companies.
Stable control structures in risk management
We have installed a risk management and surveillance system that addresses exposure both to operational risk and to risk inher-ent in the developminher-ent of portfolio companies. The risk
manage-ment and surveillance system is a constituent of the independent auditors’ year-end audit. The risks addressed by this system are discussed in the Risk management report (pages 72 to 79).
A risk management report is drawn up on a quarterly basis. The Board of Management is confident that it has a comprehensive view of the risk situation within the Deutsche Beteiligungs AG Group: Personal involvement in monitoring the investments and quarterly controlling reports on the investments contribute importantly towards that end.
Investment team members invest their own money in portfolio companies
In line with their significance for the performance of Deutsche Beteiligungs AG and with international standards in the private equity industry, the members of the Board of Management and select, experienced staff share in the performance of investments in a specified investment period at their own risk. Each invest-ment period principally corresponds to the period defined as the
“investment period” by co-investment funds. With the launch of DBAG Fund IV in 2001, the managerial team committed to co-invest in the funds at their own risk; the same practice applies to DBAG Fund V. Consequently, the management team shares in both the upside and downside of the portfolio investments of Deutsche Beteiligungs AG. This system serves to promote the staff’s initiative and dedication to the portfolio companies and the long-term retention of high calibre personnel for the Company.
These investments are realised within the scope of a partnership participation in the respective funds by the individuals concerned.
For those participating, this can result in a superior profit share from the fund’s overall performance. The profit share is only paid if Deutsche Beteiligungs AG or the investors in the co-investment fund concerned have realised a minimum return on their invested capital. For DBAG Fund IV and DBAG Fund V, this minimum return amounts to eight percent annually. The structure of the profit share, its implementation and conditions are in conformity with common practice in the private equity industry and consti-tute a prerequisite for the placement of private equity funds.