The “rigid” European business community will have to learn to embrace change to remain internationally competitive. Investment opportunities abound on the old continent, but investors must look beyond its tarnished image.
To compete with China and the U.S., European businesses must show decisiveness by adopting new innovations faster and saying goodbye to the old economy sooner. Investors alsocling too tightly to traditional industries, such as the German automotive sector, while overlooking unique innovations in software and healthcare.
So says Hilco Wiersma of Add Value Fund, which since last year started investing in Europe outside the Netherlands because of the opportunities there, and Rob Deneke of Juno Investment Partners, an asset manager with a focus on European small- & mid-caps.
Europe’s image suffers from a lack of innovation in its business community and among investors. On top of that, the region is seen as over-regulated and lacking ambition. The phrase “the US innovates, China replicates, and the EU regulates” has become a popular slogan that reflects this sentiment. New innovations, especially in tech, are struggling to gain a foothold due to a plethora of regulations. This contrasts sharply with the U.S., where a booming AI hype continues to attract global capital.
Europe is therefore sold at a discount, says Hilco Wiersma of Add Value Fund. ‘The global benchmark is 75 percent concentrated in the United States, while Europe represents only 15 percent. Europe is underinvested and therefore also undervalued.’
Different kind of innovation
Innovation in Europe has a different focus than in the United States, where the focus is primarily on AI. The AI hype in America overshadows the groundbreaking innovations that do take place in Europe. ‘In Europe, we see broader innovation across different sectors,’ states Frans Jurgens of Juno Investment Partners. ‘Switzerland, for example, has healthcare companies with unique propositionsthat leverage pricing power to deliver strong financial results. Investors should look beyond AI when considering innovation.’
According to Wiersma of Add Value Fund, investors overlook the fact that companies such as Nvidia depend on production equipment developed by the Dutch semiconductor industry. ‘Companies such as ASML, ASM and BE Semiconductor Industries deliver cutting-edge technology essential for producing advanced chips. This equipment plays a crucial role globally.’
Wiersma also sees a lot of potential in software companies. His fund’s first investment outside the Netherlands was in a French software firm, with 50 percent of its revenue generated in the U.S. He explains: “Software companies offer highly predictable, recurring revenue streams that are scalable and often critical for businesses. With annual revenue growth of about 20 percent and high profit margins, these companies offer attractive opportunities for investors.’
Letting go of old industry
In contrast to Europe’s potential, the once-mighty German automotive industry has become a source of concern, raising questions about its long-term viability. ‘The Chinese produce high-quality and cheaper cars. Where Munich was once a tech hub, little remains of that today,’ says Jurgens. ‘We need to ask whether we can do without these traditional industries.’ According to Wiersma, the problems in the automotive sector are twofold: in addition to competition from Chinese car brands, demand for German luxury goods from China is also falling, making the dependence on this market painfully clear.
Additionally, Europe struggles with high energy prices, partly due to reliance on Russian gas. In some cases, European companies pay three times more for energy than their U.S. counterparts, who benefit from self-sufficiency. ‘Europe is in a bind and would do well to address these challenges structurally,’ Deneke concludes. ‘Companies need to embrace change.’
Attractive valuations
The attractive valuations of companies outside the old economy are likely to draw investors’ attention sooner or later, Wiersma predicts. Only once before has he seen such high earnings growth. This was in 2021 after strong pent-up demand following the corona crisis in 2020. ‘Then the weighted earnings growth of our portfolio was 63 percent and the yield 57 percent; now it is above 25 percent. Earnings growth ultimately leads to stock price growth, which should attract investors sooner or later. Europe is simply too cheap to ignore.’
Some European companies are taking proactive steps, launching share buyback programs. About 2 percent of the total trading volume in the STOXX 600 in 2024 is attributable to buybacks. Barclays reports that this trend has been ongoing since 2020 and expects it to continue in the near term.
Private equity players are also taking advantage of the sell-off and falling interest rates. The three-month Euribor dropped sharply from 4 percent early last year to 2.7 percent now, enabling private equity firms to acquire listed small- and mid-cap companies in Europe at bargain prices.
This is a bitter pill to swallow for Juno’s portfolio managers, as they invest a lot of time and effort in researching their companies. Deneke: “People think we are happy with the 30 percent upside we receive on the acquisition of one of our portfolio companies by a private equity firm. But given the time and effort we put into it, we would rather see these companies remain publicly listed so we can capture the full 80 or 100 percent upside. Unfortunately, private equity firms recognize this value and want it for themselves.”