Why Germany's M&A Party Pooped Out

The feeble Neuer Markt has spooked investors

For the past year, Frankfurt's mergers & acquisitions crowd has had one heck of a party. The fun began in February, 2000, when Vodafone Group PLC's bid for industrial conglomerate Mannesmann prevailed. That generated $1.4 billion in fees for seven lucky investment banks. Acquisitions in Germany reached an all-time high of nearly $440 billion in 2000 as companies swallowed each other and swapped assets, all to bolster their position in Europe's more competitive economy.

But lately, the champagne has lost its fizz. The value of Goldman, Sachs & Co.'s European deals dipped 19% in 2000 compared with 1999; Germany accounted for much of that decline. Domestic M&A activity plunged 79% in the fourth quarter of 2000 from the third quarter, and 87% from a year earlier, according to Computasoft Research in London. The pace has picked up only slightly so far this year. "Everybody's waiting. They're trying to position themselves for next year," says Christopher Dill, manager of M&A International, a Frankfurt-area consultancy.

One cause of the downturn may be a perverse side effect of a promised cut in German capital-gains taxes. Since the law doesn't go into effect until 2002, companies are postponing deals until they can profit from the tax cut. That means the M&A scene could sizzle come summer. "I expect an even greater boom in 2001," says Andreas Stilcken, M&A partner at White & Case, Feddersen in Frankfurt.

A tax-related delay is no cause for concern. But some investment bankers worry there are more fundamental reasons for the slowdown, such as the plunge in Frankfurt's Neuer Markt, down 75% since its peak last March. Only 16 companies in its NEMAX-50 index saw their share prices rise in 2000, says the German Association for the Protection of Shareholders. That discourages venture capitalists from taking stakes in small companies in hopes they'll go public. "The situation at the Neuer Markt has lowered the perception that the sky's the limit for certain valuations," says Marija Korsch, co-head of corporate finance at B. Metzler, a Frankfurt-based private bank. The cooler Neuer Markt is also affecting interest in more established stocks.

SKEPTICAL. One ominous development: The number of foreigners buying German companies has dropped for two years running after peaking in 1998, according to M&A International. This was partly because the U.S. economy drew so much money. Yet foreign direct investment shows no sign of reviving despite the U.S. slowdown. One possible reason: Overseas companies are skeptical of Chancellor Gerhard Schroder's promises to create a business-friendly environment, notwithstanding the capital-gains tax cut. Schroder's recent steps to expand unions' power could revive jitters.

Dimming foreign interest may also reflect a perception that German businesses are losing enthusiasm for restructuring. And there's plenty left to do. Take Thyssen Krupp. Analysts say the sprawling company is taking too long to cut costs and concentrate on its strongest businesses, such as auto parts, elevators, and services. As a result, investors have punished the company, pushing its stock down 25% in the past 12 months, to $19.

Many of Germany's Mittelstand companies, whose founders and current owners came of age after World War II, badly need the cost-cutting and consolidation that should follow a listing or a merger. And Germany's banking sector is too large for an economy of its size, making it ripe for mergers. "There are remarkably few industries where you can say consolidation has occurred," says Ernst Fassbender, co-head of investment banking for Merrill Lynch & Co. in Germany. "There is enormous potential for deals to happen." If they don't, no one is likely to take up a collection for underemployed investment bankers. But a downturn in M&A activity would be bad news for the German economy.

Dealmakers themselves are still bullish. "We expect extraordinarily strong volume," says Raimund Herden, head of German M&A for Goldman Sachs. Whatever the cause of the problem, this is no time for German businesses to get cold feet about joining the global economy.

By Jack Ewing in Frankfurt

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