Germany – Does M&A need to adapt to a new normal?

Activity

The transactional pace in 2023 remained at a low level compared to 2021. Following an abrupt drop off in the fourth quarter of 2022 due to mounting energy prices, inflation and financing costs at large, 2023 recorded just over 2,100 deals (50% domestic) valued at over €57.6 billion. Volumes were up just over 3% year on year, while recorded values were down nearly 40% year on year and 57% less than the heights recorded in 2021.

On the other hand, software and green technology, as well as the "old economy" including industrials, remained active in 2023. Increased efforts for digitisation and the pressure to gain access to AI technology saw companies developing and pushing strategic initiatives in these fields (eg, Deutsche Börse AG's approx. €3.9 billion offer for the Danish software investment management expert Simcorp – Germany’s largest recorded outbound deal of 2023). In the context of green tech, the sale of Viessmann Climate Solutions to Carrier for €12 billion was the largest renewables energy deal in Europe and Germany’s largest M&A deal of the year. While this landmark transaction underscored the significance of energy transition and decarbonisation, it sparked a political discussion questioning whether the economic framework was robust enough to retain key (green) technology in Germany. We look at energy transition and M&A in more detail here in our 2024 global M&A report.

Sectors

The German M&A market in 2023 exhibited a diverse range of activity spanning various sectors with the technology, industrial manufacturing and automotive, healthcare, financial services and consumer goods sectors emerging as the most active. The tech sector led the pack accounting for nearly 30% of the total deal volume (630 transactions, €10.6 billion volume) fuelled by the rapid pace of digital transformation and growing demand for innovative technologies, notably the €2.25 billion sale of Software AG to Silver Lake. The energy sector remained particularly active looking into strategic growth as well as private capital players eyeing German targets to increase their energy transition portfolios. In addition to the Viessmann transaction, we saw Fluxys' acquisition of a 24% stake in Open Grid Europe, Germany’s largest transmission system operator; and the purchase by Singaporean sovereign wealth fund GIC of a 20% stake in the industrial gas specialist Messer from previous minority owner CVC Capital Partners Fund for an estimated €2.2 billion.

Legal trends

Germany continues to see an expanding importance of the regulatory framework. A focal point in transactions remains the vigilance by the European and Federal Cartel Office scrutinising and enforcing antitrust regulations to protect competition in key industries. Foreign direct investment (FDI) controls also continue to play an increasing role. Due to further tightening of relevant regimes, focus on FDI is ever more prominent in M&A, as relevant as antitrust clearances with increasing review and intervention rights for the German Government, including the right to unwind transactions retroactively. Another layer of regulatory scrutiny was added with the EU Foreign Subsidies Regulation (FSR) which started to apply in July 2023. Under the FSR, the Commission has the power to investigate financial contributions granted by non-EU governments to companies active in the EU with turnover in the EU of at least €500 million.  Identifying and quantifying subsidies received can be challenging for the entities involved but is required to ensure FSR compliance. Read our "Merger control, FDI and FSR – the triple impact" article for more information on the regime and how to navigate it.

ESG aspects continue to play an important role in M&A transactions with ESG related due diligence sometimes examining the full range of sustainability and compliance of the target's business model including environmental and supply chain risks. Depending on the geographical centre of gravity of a transaction, however, ESG may be confined to legal compliance related aspects. We explore ESG and M&A in our global report here.

The gap between parties' commercial expectations often now seems to have become wider. Following from higher interest rates, seller and buyer views on cornerstones of consideration and risk appetite became more significant. Bridging these gaps has been a key focus of many transactions. When looking at pricing, this includes standard mechanisms, such as deferred payments or earnout clauses, but also more complex and sophisticated sell-side financing arrangements and pre-transactions restructurings – a theme we discuss in more detail in our article on "Selling the deal".

Outlook for 2024

Dealmakers are divided when looking into the future but optimism prevails. Such optimism is fuelled by signs of stabilising financial conditions such as inflation levels and financing costs. While they may remain higher than in previous years, we expect that the market will get accustomed to these new realities. With signs of the German economy starting to recover in 2024 or 2025, this could provide a supportive environment for M&A activity. The same is true for the geopolitical uncertainties in Europe and the Middle East as well as an increasing East-West division. Dealmakers have learned to deal with those uncertainties and while remaining cautious they will focus attention and resources on strategic acquisitions in key growth areas or new centres of gravity, as we discuss in more detail here.

The German economy is increasingly focused on innovation driving the demand for deals in technology and other high-growth areas. The growing importance of technology and digitisation will force companies to bolder moves in a race for further consolidation and strategic acquisitions. We see that securing or expanding access to software, automation capabilities and AI to gain competitive advantage will play an integral role in the race to digitise product portfolios, all of which will bolster M&A activity in the TMT sector. Companies' utilisation of M&A to transform their businesses and pursue their ESG, decarbonisation and digitisation agendas will continue to play a pivotal role in 2024 and beyond.

Further, the need for European energy independence and the transition to renewable energy means that the energy transition trend is set to continue. One example is the ongoing negotiations of the German federal government in their bid to acquire the local division of Dutch grid operator TenneT, a company that is central to the security of energy supply and the implementation of the energy transition.

Support for dealmaking will come from the still abundantly available capital held by sovereign wealth funds, private equity and venture capital investors. The acquisition of a 24.99% stake in the Hamburg Harbour by the Chinese sovereign wealth fund Cosco is an important example in this field – initially announced in 2021 as a 35% acquisition – which completed last year. While heightened regulatory scrutiny and an increasingly complex regulatory landscape, including the newly introduced FSR, may generally have a chilling effect on large M&A transactions this could create opportunities for companies capable of executing a higher volume of mid to small-cap deals that can help to diversify a company's portfolio. We also expect PE and venture capital to tap into these diversification opportunities.