Coffee Break with Hubertus Leonhardt, Managing Partner at SHS Capital

By Fabian Zähringer

First of all, I would like to thank you for taking the time to speak with me on behalf of BSPEC today. Maybe you can give our readers a quick introduction about yourself and your background?

I have been managing director and shareholder of SHS Gesellschaft für Beteiligungsmanagement mbH in Tübingen since 1997.

SHS is a private equity company based in Baden-Württemberg (Germany) with a focus on investments in medical technology/life science companies. The range of tasks is very varied and includes in particular the areas of fundraising, deal flow generation, due diligence, investment and exit management.

Previously, I worked as a project manager in the corporate finance department of the international auditing and tax consulting firm Arthur Andersen in Frankfurt. During that time, I completed my professional examinations as a tax consultant and CFA (Chartered Financial Analyst). My main areas of activity were, for example, advising corporate groups and private equity funds on due diligence and company valuations.

Prior to that, I studied business administration at the Mannheim Cooperative State University, which was combined with guided internships in Germany and abroad at Siemens Nixdorf AG in Paderborn, Frankfurt and Chicago.

Medical technology is a very narrow industry focus. How did you and the other partners at SHS Capital decide to invest in this sector?

Allow me to give you a brief overview: Professional investors manage their total assets in such a way that a significant proportion is also invested in private equity (PE). When selecting private equity providers, investors are increasingly considering sector-oriented sector funds in addition to general PE funds. The rationale behind this is that sector specialists are better able to assess complex industry challenges or gain access to proprietary deals.

At SHS, we believe that the medical technology market is an attractive submarket within PE. This is because the market is quite large and growing. The main growth drivers are an aging population, more chronic diseases and a wealthy middle class in the emerging markets that demands high-quality medical care.

Since we at SHS already carried out our first transactions in this sector at the end of the 1990s, we have made use of the experience gained and expanded our company as a sector specialist in this area. Today, we are one of the leading medical technology investors in Europe.

What other investment criteria besides the sector focus on medical technology does SHS Capital take into account when selecting targets?

We strive for qualified minorities as well as majorities in companies in the DACH region, but we also look into exciting companies from Benelux and Scandinavia. Additionally, we pay particular attention to a strong and experienced management team with a focus on growth and value enhancement of the company. Also, targets should show an attractive business model, i.e. the product or service offered represents a clear additional benefit for the customer (USP). Another extremely important point is also the clear exit route, where we aim for an exit after 3-6 years for more mature companies and an investment duration of 4-8 years for younger ones. For younger portfolio companies, in addition to the aforementioned criteria, a worldwide market potential of at least €300 million in a strongly growing market (approx. 5% p.a.) must be available, as well as a strong patent portfolio or the possibility to build it up. Each of the above criteria is thoroughly analyzed prior to an investment in the due diligence phase. This makes our work extremely versatile and exciting on the one hand and on the other hand it ensures a high level of quality in terms of risk and return for the fund.

You have developed the SHS Medical Technology Index. What exactly is it about and what developments do you see?

In cooperation with Prof. Dr. Christian Koziol, Professor and Head of the Department of Finance at the University of Tübingen, we have developed the SHS Index. This index quantifies the developments in the medical technology sector, which is important for Germany, in relation to the overall economy and thus identifies trends. We use 4 indicators as a basis: revenues, employment figures, patent registrations and share price developments.

We currently look at a decline from 2016 (112%) to 2018 (109.7%). Among other things, we attribute this decline to the stricter regulatory requirements that came into force in 2017 with the new EU Medical Devices Directive. Small and medium-sized companies in particular face the challenge of complying with the regulations, which usually means higher development and approval costs. As an industry specialist and private equity fund, we not only provide financial support, but also support regulatory and reimbursement processes. Nevertheless, we feel confirmed that the industry’s performance over the past few years has been above average and that this is likely to continue to be the case. The reasons for this can be identified as rising population growth and rising per capita incomes in developing and emerging countries. In the industrialized countries, demographic aging is leading to rising demand for medical technology.

Another area of growth is the area of digital health care, which will be further boosted by the Digital Supply Act, which will come into force in Germany in 2020. In recent years, we have already seen a steady increase in investment inquiries in the digital sector and consequently see attractive opportunities to participate in this trend.

What challenges do firms regularly face on the individual level, particularly early-stage enterprises backed by your firm (e.g. patents, regulatory approval, … )?

For the protection of patients, there is a very high level of regulation, which we now feel to be somewhat excessive, with Europe falling behind the USA in some respects. Companies are called upon to provide significant funds for the regulatory sector and to find good personnel. Health insurance reimbursement often takes longer, and the importance of health economic studies is increasing. Intellectual property rights are another important issue in the industry, and companies need a good positioning here.

How does your firm go about valuing the pipeline of a company’s developments, given that you are early stage investors?

During the evaluation we usually try to infer how much the product portfolio, if it has the necessary approvals and refunds, can be worth in the hands of a strategic buyer or how much he is willing to pay for it. We then rate the value with the risks of reaching the exit in a reasonable time.

For example, the quality and breadth of management plays a very important role in the success of an investment. Our current fund, the SHS V, only invests if a strong management team with a focus on the performance of the company is in place or can be installed or co-installed.

We also look at the technology and product risk. In detail, we examine already existing clinical data for their plausibility, the usability of the product as well as all technical risks that may arise in the course of necessary further developments or industrialization.

In addition, there is the IP position, i.e. the strength of our own patents, as well as the freedom to act in relation to other patents. The market and expansion strategy will also be closely examined, taking into account the regulatory environment and the reimbursement of products, particularly in Europe and the USA. Furthermore, financial risks are taken into account. For example, we analyze manufacturing costs or working capital. For legal protection, we review all critical supplier and customer contracts. In the end the investment will be sold according to its duration, SHS uses its contacts to many large national and international healthcare companies to check on their interest in a potential investment during the due diligence phase.

Finally, we obtain an overall picture of the potential investment on the basis of which an investment and its amount is decided.

How does the German PE market for medical technology set itself apart from the rest of Europe/the world?

First of all, let me give you a few statements that our German Private Equity Association (BVK) has compiled:

The US market and the European markets differ in their historical development. Whereas in the European markets until the mid-1980s investments were primarily made in established companies (later stage venture capital), the investment market in the USA was characterized by early stage venture capital. It was not until the mid-1980s that a strategic rapprochement took place, when the European markets increasingly followed the US model of venture capital with the focus on early stage, while at the same time the buy-out business in the USA decoupled itself from venture capital and became independent.

Due to by far the longest market experience, the USA and Great Britain are the most advanced and largest investment markets worldwide.

By European standards, Germany is one of the leading private equity markets. In the upswing phase at the end of the 1990s, Germany at times developed into the second-largest investment market in Europe after Great Britain.

If one looks at the topic of venture capital in Germany in comparison to gross domestic product (GDP), one unfortunately has to conclude that the percentage of investment compared to the USA is quite low, there is still clear upward potential to provide sufficient capital for innovation in Germany.

The German medical technology sector is certainly outstanding in Europe, given its investment possibilities. By this I mean both the number and the innovative strength of the companies. I would not leave unmentioned that Switzerland is also very strong in relation to GDP.

Given the vast liquidity in the market, did you feel the pressure to invest surplus capital into smaller or potentially “less-than-investment-worthy” targets?

Companies above a certain size show a high price level, especially if they are put on the market via auctions. We have often not followed up processes here, as valuations are called for from the outset that were not attractive for us and our investors.

Fortunately, through our specialization, we have access to transactions that are rather difficult for a generalist PE fund to assess and in which we can add value through our strategic support. 

Throughout your career you worked on countless deals. If you could name one, which deal would you describe as the most important one of all (for you or the firm) and why?

For reasons of confidentiality, we do not comment on individual deals regarding the data we publish in press releases. Cross-border transactions are always particularly exciting, however. Here, for example, I have a special memory of the sale of a portfolio company to Japan.

Great discussion, thanks a lot!


Editor: Eric Peghini

Author: Fabian Zähringer