This article is an extract from GTDT Market Intelligence M&A 2022. 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 and 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?

Despite the still ongoing covid-19 pandemic, 2021 had been an exceedingly strong M&A year in Germany, with record volumes, a number of strategic transactions worth several billion euros and exploding private equity activity. The first quarter of 2022 also started with this momentum.

However, with Russia’s invasion of Ukraine at the end of February 2022, the subsequent sanctions imposed and escalating geopolitical tensions have fundamentally changed the market environment. Transactions involving Russia and Ukraine or involving companies with significant operations in the region initially came to a standstill and had to be completely re-assessed. Ongoing supply chain disruptions, affecting the automotive sector in particular, a significant increase in energy and commodity prices, increased inflationary pressure, rising volatility in financial markets, and a turnaround in interest rates have been further consequences and subsequently created a climate of uncertainty that usually does not bode well for an active M&A market.

In fact, the statistics show that although the uncertainties have put a damper on M&A activity in recent months, there nevertheless remains an astonishing level of activity despite the challenging circumstances. In the first half of 2022, the total volume of transactions in Germany fell from €70 billion to €40 billion compared with the same period last year, but the number of deals remained almost constant. Restraint is particularly evident in the case of large deals. For example, the number of transactions with a volume of at least €1 billion fell from 22 in the second half of 2021 to just nine in the first half of 2022. In contrast, the share of small to mid-sized M&A transactions between €50 million and €250 million increased.

One of the drivers of M&A activity in recent months has been the continued high level of cash managed by private equity investors. Valuations for attractive transactions have so far remained at a high level in many areas due to investment pressure. The trend for private equity bidders to take German listed companies off the market through public-to-private transactions is continuing.

A further driver for transactions is the ongoing digital and technological transformation. The pressure to shift to digital business models, accelerated by the pandemic, continues to drive a number of transactions with technology companies offering related solutions such as software, cloud computing or e-commerce platforms. In addition, we see that technological change, such as in the German automotive industry towards e-mobility, is also driving deals and affecting entire supply chains. Finally, we see the transformation in the energy sector and related infrastructure accelerated by the impact of the Ukraine war. Companies are often making portfolio adjustments in light of these changes. While divesting their non-core units, leading to a stable number of complex carve-out transactions, they buy into new, promising companies with a corresponding technology and digital focus. Against the background of ongoing supply chain disruptions, suppliers are being increasingly bought out.

2 Which sectors have been particularly active or stagnant? What are the underlying reasons for these activity levels? What size are typical transactions?

Driven by the ongoing trend toward digitisation, the technology, media, and telecommunications sector continues to be the driving force behind German M&A activity. Almost one-third of transactions in the first half of 2022 were attributable to this segment. While the number of technology transactions in the first half of 2022 fell by a quarter compared with the second half of 2021, the transaction value increased slightly. M&A activity in the healthcare industry remains at a high level. Pharma and life sciences and healthcare services are areas of interest for investors. Traditional pharma companies are optimising their portfolios by divesting non-core assets with a view to generating capital to invest in innovation and filling gaps in their portfolios.

Given the trend in the automotive sector towards transformative investments, where both OEMs and suppliers are ramping up their investments in electric powertrains, autonomous driving, and battery technology, we have also seen increasing deal flow in this sector. Transaction sizes have generally slightly scaled back in comparison with 2021.

3 What were the recent keynote deals? What made them so significant?

The sale of the majority of Deutsche Telekom’s tower business to US infrastructure investor Digital Bridge and Canadian asset manager Brookfield, with a reported enterprise value of €17.5 billion, is expected to be the largest transaction so far this year. The deal was preceded by a heated bidding war for Deutsche Telekom’s 33,000 radio towers. The consortium of North American investors took a 51 per cent stake in the Deutsche Telekom subsidiary, with Deutsche Telekom retaining 49 per cenet of the shares. According to media reports, Deutsche Telekom will receive €10.7 billion in cash, which will be used to repay debt.

The recent €4.8 billion purchase of 72.5 per cent of the shares in European wagon hire company VTG Aktiengesellschaft by Global Infrastructure Partners and Abu Dhabi Investment Authority from Morgan Stanley Infrastructure Partners and the Joachim Herz Foundation is another major transaction involving a German target.

There are also two noteworthy billion-euro deals in the pharmaceutical market: First, the community of heirs of the Göttingen-based pharmaceutical and laboratory supplier Sartorius AG (listed on the DAX) sold around 40 per cent of its shares to Armira/Life Science Holding. Second, International Chemical Investors Group sold the German active ingredient manufacturer Corden Pharma to the private equity investor Astorg for €3 billion in the course of a bidding process. Corden Pharma develops and manufactures active pharmaceutical ingredients and drugs. Its products have recently been in high demand for coronavirus vaccine production.

An example of a strategic-transformative transaction is Siemens’ almost US$1.6 billion acquisition of software specialist Brightly, which was closed in August. The Munich-based group aims to achieve a leading position in the software market for building operations and existing infrastructure.

While we believe the SPAC market in Germany has not gained material significance so far in 2022, it is interesting to note that the top 10 transactions include a de-SPACing transaction: German e-car manufacturer Next.e.Go merged with SPAC Athena Consumer Acquisition Corp. The merged company is expected to be listed on the New York Stock Exchange.

Lastly, it is interesting to note that the top 10 transactions always involved a financial investor, either on the buy-side or on the sell-side.

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 also seems to be a renaissance of earn-out structures in an effort to bridge valuation gaps and pricing uncertainties caused by various global crises. 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.

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. We are aware of no more than a handful of public M&A transactions that have been conducted by foreign bidders in the form of stock-for-stock acquisitions in recent years. Another limiting factor for public stock-for-stock acquisitions is a 2021 decision of the Frankfurt Higher Regional Court, pursuant to which the offer 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.

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 shown an increased hurdle to in-bound and out-bound M&A transactions throughout 2022, as the German foreign direct investment (FDI) control regime (as in a number of other EU member states, including Italy) was tightened once again and merger review proceedings remain active.

The Federal Ministry for Economic Affairs and Climate Action (BMWK) implemented the 18th Amendment to the Foreign Trade and Payments Ordinance, which came into force on 2 May 2022, which penalises more effectively any failure to comply with the Russian sanctions packages, specifically introducing new rules on fines for the financial sector. Furthermore, under the FDI regime as updated by the second amendment of the Ordinance on the Designation of Critical Infrastructures, which entered into effect on 1 January 2022, the definition of ‘critical infrastructures’ was broadened significantly. The definition of what constitutes a ‘facility’ was comprehensively revised and thresholds lowered to designate critical infrastructures (energy, IT, telecommunication, health, finance, insurance, transport and traffic), hence likely increasing the number of transactions that must be notified under the German FDI provisions.

Over the course of 2022, two noteworthy transactions failed to pass the FDI hurdle:

  • GlobalWafers’ (Taiwanese semiconductor manufacturer) tender offer for the outstanding shares of Siltronic, a Munich-based chip supplier; and
  • the acquisition of German medical products manufacturer Heyer Medical AG by the Chinese Aeonmed Group (a company benefitting from financial support provided by the Chinese government), both active in the field of manufacturing ventilators for treatment of respiratory diseases and anaesthesia. The transaction was blocked on 27 April 2022, on the grounds that the acquisition of Heyer Medical by Aeonmed would impair Germany’s public order and security with regard to the supply of essential medical products for the healthcare sector and raise concerns over potential political influence of the Chinese government in the German economy by creating economic and technological dependencies in a key sector.

In addition, on 4 April 2022, the German Federal Ministry of Economic Affairs and Climate Action seized control over Gazprom Germania GmbH citing grounds of imminent danger for public order and security by implementing measures under the German FDI rules, installing the German Federal Network Agency as a trustee of all voting rights from shares in Gazprom Germany.

The 10th Amendment of the German Competition Act, which already entered into force in early 2021, while lowering the merger control thresholds to relieve mid-sized companies from notifying transactions of minor economic importance, has nevertheless intensified the Federal Cartel Office’s (FCO) already prevailing focus on internet, online, and big data issues. In its February 2022 competition policy agenda up to 2025, the BMWK announced its intention to strengthen German merger control through additional headcount and IT infrastructure. The FCO has already proceeded to designate Big Tech companies such as Alphabet/Google and Meta as having ‘paramount significance for competition across markets’, allowing it to subject these companies to stricter obligations.

6 Describe recent developments in the commercial landscape. Are buyers from outside your jurisdiction common?

Germany is generally considered an extremely attractive jurisdiction for FDI. The country’s strengths traditionally 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, after a bullish Q1 2021 German cross-border mergers and acquisitions have from Q2 2021 onwards been suffering from the war in Ukraine, the related sanctions and the global geopolitical tensions. Cross-border transactions involving Russia and Ukraine and larger assets in the region have in most cases been put on hold completely; diligence was generally increased to comply with sanctions and thoroughly evaluate the new situation from a compliance, commercial and reputational point of view.

Instead, we have seen a number of large and middle-market transactions driven by the big transformational processes currently affecting Germany and other leading industrial countries, such as transformation in the energy and infrastructure sector and transformation in the automotive industry, where tier-1-suppliers, OEMs and international technology giants compete with each other in terms of investments into new technology including with regards to electrification, hydrogen and autonomous driving.

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 129 companies with activist investors at the end of 2021 compared to 114 in the prior year, and a total of 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. Only recently, activist shareholder Enkraft Capital demanded that RWE AG divest of its brown coal business and focus solely on its renewable energies business. This is an example of ESG activism most likely representing a rising trend.

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 advisors 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 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 have to 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.

Public M&A transactions in Germany are, as in other jurisdictions, much more regulated than negotiated deals. It is customary to carry out substantially less due diligence. Notice periods and the prescribed contents of the offer document are set out in the German Securities Acquisition and Takeover Act.

9 Are there any legal or commercial changes anticipated in the near future that will materially affect practice or activity in your jurisdiction?

The Supply Chain Due Diligence Act, scheduled to enter into force on 1 January 2023, and putting companies under an obligation to ensure compliance with environmental protection and human rights in their national and international supply chains, is continuing to create practical worries. At a time when many companies are already far advanced in their preparation for the new obligations, in addition to some already existing FAQs, the Federal Office for Economic Affairs and Export Control (BAFA) finally published further guidance in August 2022. According to those guidelines, companies must conduct an appropriate risk analysis at least annually to identify human rights and environment-related risks in their own business area and at their direct suppliers. Moreover, they must conduct risk analyses on an ad hoc basis if they (1) either expect a significantly changed or expanded risk situation in any part of their supply chains or (2) if they get aware of a potential violation of human rights or environment-related obligations at indirect suppliers. Further guidance with respect to the principle of proportionality and complaint procedures is expected to be forthcoming in due course.

Against the background of the aforementioned focus by Germany’s FCO on internet, online and big data issues, transactions involving digital and data driven businesses can be expected to come under close examination, in particular with regard to the assessment of customer data, network effects and innovations. Confidential pre-filing may be recommendable to avoid delays and obstacles during the actual review process.

All in all, we expect deals having to go through a longer gestation period due to increased scrutiny from government and regulators, especially in sectors such as Big Tech.

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?

While the German economy remained on a growth path in Q1 of 2022 despite the consequences of the Ukraine war, current forecasts predict a significant decline in economic strength in the coming months due to the drastic rise in energy prices, with inflation currently forecast at 9.3 per cent for 2023.

For potential investors, rising interest rates and geopolitical instability will be a major obstacle, as they will make debt financing for acquisitions more expensive and difficult. In addition, inflation reduces the real return on investment. We expect distressed transactions to take on a greater role. Investors are likely to benefit from the availability of undervalued targets or carve-out situations if and when German corporations are looking to raise cash and reduce debt by way of selling non-core assets. Given the strong US dollar, we expect US investors to play an active role in this process.

From a sectoral perspective, we expect, due to the new geopolitical environment, that two sectors will become more relevant: First, we expect transactions related to renewable energy or the phase-out of fossil fuels to be high on the agenda. The goal of becoming independent of Russian energy reinforces this focus. Second, against the backdrop of the German government announcing the creation of a special fund of €100 billion for the modernisation of the armed forces and an increase in the defence budget as a result of Russian aggression, we anticipate an upswing in the defence industry that will favour M&A activities.

Lastly, as part of a major societal trend, we see the increasing importance of sustainability and social responsibility in M&A transactions in the future. Investors (and their investors) are increasingly demanding that companies adhere to ESG standards. In this context, we have already referred to the Supply Chain Act, which will come into force on 1 January 2023. ESG criteria are therefore increasingly coming into focus in due diligence and can lead to reductions in the purchase price or even walking away from a transaction.

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 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.