About-face

For a country often characterised as resistant to change and anti-capitalist, the success of the private equity market in France is perhaps surprising. Leveraged buyouts have been present in the market for nearly 20 years now, but over the last couple of years, there has been an explosion of activity. Last year saw a record €31.6bn worth of buyout deals in France, according to CMBOR statistics – that’s up 50% on the record value in 2005. “To our constant amazement – and delight – activity in our area of the the mid-market continues to be extremely strong,” says George Pinkham, partner at SJ Berwin’s Paris office. “It’s remarkable because we’ve already seen two years of a very hot market and there’s little sign at the moment that 2007 will be any different. Our pipeline is full.”

We’ve seen records broken across the world for M&A and private equity. And many of the reasons for this apply equally to France as elsewhere. It has certainly seen a lot of money come into the market as firms have raised ever-larger funds. Last year saw Chequers Capital raise €600m for its fund XV – double the amount of its predecessor – for example. Atria Capital managed to raise €300m after just three months on the road, significantly beating its €250m target and 21 Centrale raised €330m, hitting its hard cap. Then there was Credit Agricole, which raised four funds last year: one targeting renewable energy, one for public-private partnership-type deals, a mezzanine fund and a generalist buyout fund.

There are signs that this year could be active on the fund raising front, too. Activa Capital is rumoured to set for a final close on its second fund any time soon at a level that is above its previous €150m fund. And there are plenty more, says Pinkham: “We are also doing a lot of fund structuring and creation work. It’s clear that firms are confident that the deal flow is there.”

In addition to a strong supply of equity capital, France’s debt markets have been white hot – another factor in the extraordinary level of activity. “Debt packages in France have been getting more aggressive over the last couple of years,” says Pinkham. “The banks’ appetite is such that they are lending to businesses that they might not have done two years ago on terms that we would not have seen two years ago.” CDOs, hedge funds and CLOs are now firmly established in the market and with so much competition to lend, terms and repayment schedules are becoming increasingly borrower-friendly. Bullet-only structures have become a feature of the larger end of the market and are starting to creep down to mid-market transactions, and covenant-lite debt packages are just beginning to emerge, for instance.

And, as elsewhere, the amount of debt going into deals has been on the rise. “We’ve seen debt multiples increase to around six and a half to seven times EBITDA in deals above €150m and creeping up to eight or eight and a half in the largest deals,” says Dominique Gaillard, member of the executive board, Axa Private Equity. “Enterprise values have also risen and so we’re seeing prices of ten times EBITDA even for smaller deals. Two or three years ago, that was unheard of in all but those deals above €500m.”

This combination of plentiful equity capital and a willingness among institutions to lend on ever-more favourable terms is being played out across Europe and the US. But there are some factors in the recent high levels of private equity activity in France that are specific to the country. One of these is its proximity to other potentially more tricky areas. “France is attractive to investors because it has a large potential market and is less developed than some others in Europe,” says George Elliston, partner at Close Brothers Corporate Finance in Paris. “It has also benefited from the perception that its neighbour, Germany, is just too difficult. A lot of money has come into the market over the last few years.”

Another is a shift in the way that the business community defines success. “The attitude of entrepreneurs and managers in France has changed over the last few years,” says Pascal Stefani, director at Advent International. “Private equity now has quite a few success stories that show how it can benefit companies and management teams. Before, people felt that you were only really successful if you worked your way up a large company. Now, they can see that working in and running fast-growing businesses is an attractive thing to do – they can still be successful.” He points to Materis, which has been through several private equity hands. “It was not considered the most attractive business when it initially spun out of Lafarge, but after a succession of private equity owners – including us – it is now one of the leading speciality chemicals business in Europe. The company has been transformed – and that is a good success story for private equity.”

This shift in perception is also freeing up some family-owned businesses for private equity ownership. Activa Capital backed a management buyout last October of French mail order group Françoise Saget from family-owned cosmetics giant Yves Rocher. “The company had a poor view of private equity a few years ago,” explains Philippe Latorre, partner at Activa. “They would never have sold part of their business in a buyout. But the culture is changing. So much so that Yves Rocher even agreed to invest alongside us.”

France has seen its fair share of new players over recent times. There are the usual types of new fund, for example, such as Weinberg Capital Partners, established in 2005. And there are also the infrastructure funds that we’re seeing spring up in other markets. But France is also seeing some more unusual developments: some firms that have historically concentrated on venture capital are now targeting buyouts, for example. Turenne Capital Partenaires and the private equity arm of La Poste, Xange Private Equity, are just two of these. We’re also starting to see firms with no presence in France take a serious look at the market – something that’s pretty hard to do now, but would have been almost unthinkable just a couple of years ago. “We’re seeing some US, but in particular UK, funds with no offices or affiliates here investing in France,” says Frédéric Bucher, corporate partner at DLA Piper in Paris. “This is something I’ve never seen before.” He points to last year’s acquisition of cosmetic surgery business COSFI by Englefield Capital and says there are likely to be more.

Existing players in France have also been upping their presence to ensure they can take advantage of the current boom in activity. Industri Kapital set up a Paris office last year and Duke Street Capital and Montagu Private Equity each took on two new people.

All this, of course, means that finding the right deals is getting harder as more people and capital pour into the market. “Competition has increased in the market over recent years,” says Gaillard. “There is such an abundance of equity capital in the market and the availability of debt is very high as banks become more aggressive in the amount they are willing to lend and the way in which it is structured, that prices have increased a lot. It’s got to the stage where people are seeing what stapled packages they can get, and then adding 30% to arrive at the price.”

With so much competition in the market, much of the low-hanging fruit has now been plucked. Firms must work that much harder to find deals and then to make them work, given the elevated entry prices. “Funds are now prepared to do transactions that they would never have looked at just two or three years ago,” says Bucher. “They are having to look at less obvious targets, such as underperforming companies and build-ups. That doesn’t mean the opportunities are not as good – on the contrary, the companies that require more work may well be better for private equity in the long run.”

It’s a point not lost on Stefani. “Prices have risen over recent years, largely driven by more aggressive lending among banks and the successful fund raisings many firms have had,” he says. “Nowadays, we have to accept that we will pay full prices for businesses, so we are very careful about the businesses we back. We have to be sure we are only investing in companies where we can see the potential for earnings growth.”

Stefani adds that the current environment in many ways plays to Advent International’s strengths. The firm has just invested in discount retailer Stokomani. With its experience in the discount retail markets in the US and the UK, Advent was well positioned to acquire the business, he says. It had also identified the company as a target a long time ago and had been following it ever since. Advent’s international network also allows it to target some deals in which French or pan-European firms may not see value, he claims. “All areas of the market are competitive now – even the mid-sized and small buyouts segments,” says Stefani. “Buyouts have become like a commodity, so it takes a lot more work to get deals completed successfully. We like to target businesses where there is a strong international opportunity, to take advantage of our international firm. That makes the competition in the French market less of a factor.”

Gaillard agrees that getting deals to work in France is much harder these days. “It’s clear that funds operating in France are no longer going to be able to benefit from multiple arbitrage because the entry price is too high,” he says. “We have to be sure that we can add value to the business in some way, possibly through a build-up, especially a pan-European one. If we can’t identify ways to help management teams build value for the company, then we’ll abandon the investment opportunity.”

This may well mean that Axa slows down its investment pace. “We don’t think deal flow is that strong in France at the moment,” says Gaillard. “We are concentrating more on our existing portfolio companies, adding value and acquiring new businesses for them, rather than on new investments. We are also selling businesses – it’s a good time to be selling assets these days.”

Despite the high levels of activity in the market and the changes France has undergone in outlook, there are still plenty of barriers to private equity investment. It’s not so surprising that a high proportion of buyouts – just over 25% last year – are secondary buyouts. Part of this is because of natural churn in private equity portfolios, but also because of the difficulty that remains in getting other types of deal done.

There has been a large shift among corporate attitudes to divesting non-core assets to private equity players. Lafarge has become pretty used to doing this, for example. It sold Materis to a consortium of private equity players back in 2001 and has just sold its roofing division to PAI Partners for nearly €2bn. Glass manufacturer Saint Gobain has also recently sold Desjonquères to Cognetas and Sagard. But many other companies remain wary of doing this. “Large corporates – with a few notable exceptions – have never been very comfortable with the idea of spinning out parts of their business to employees,” says Elliston. “Some have even been pretty hostile to it. That is changing, but non-core divestments are still not a large part of the overall private equity deal flow here.”

Public to privates are also pretty thin on the ground, accounting for just 4% of buyouts last year, according to CMBOR figures. And it’s hardly surprising, given the obstacles to these types of deal. “One source of deals that you see in other markets hasn’t really taken off in France: take-privates,” says Pinkham. “There has been a lot of talk about them, but there are structural issues that prevent them from happening on a large scale. The tax advantages available on take-privates can only be had if you get 95% shareholder approval and, under French law, you are not allowed to make that a condition of the deal going ahead. That has stopped a lot of these deals happening. Unless this changes – and it seems unlikely in the current political environment – you won’t see a lot of these deals happening.”

Yet despite these issues, most in the market remain optimistic that buyout activity levels will continue to be high in France as long as the debt markets remain buoyant. “I don’t think there is a question mark over the quality of the portfolio of opportunities here in France,” says Activa’s Latorre. “It’s more a question of how banks’ appetite for lending will develop over time.”

So where will the deals come from to fuel that activity? The main hope continues to lie with family-owned businesses forced to face up to modern realities. “There is a huge stock of family-owned businesses that could go to private equity – there are opportunities across the board,” says Stefani. “We just have to take the time to explain to owners the growth opportunities and the prospect of liquidity. This is sometimes a long process and can take years to happen, but many of these families know that the economy is changing and that their companies won’t survive in the longer term as lifestyle businesses. They have to compete in the new environment if they want to maintain their businesses for future generations – private equity can help them achieve this.”

Striking behaviour

It’s become a popular hobby among certain parts of the media, the political establishment and unions to demonise private equity in many countries. Germany has famously had Franz Müntefering, at the time chairman of the Social Democratic Party, likening private equity and hedge funds to “swarms of locusts” and “anti-social radicals” intent on destroying the German economy. That was back in 2005.

Since then, the Department of Justice in the US has started an investigation into club deals and the possibility of price fixing among the larger buyout houses. And in the UK, private equity firms were accused of “mugging” public company shareholders following the take-private and subsequent re-listing of retailer Debenhams. More recently, UK unions have kicked up a storm about private equity, attempting to get the Government to review tax incentives available to private equity firms. The result has been that even the most publicity-shy figures in private equity, such as Permira’s Damon Buffini, have felt the need to defend the industry’s record for job creation and other economic benefits. And at the World Economic Forum in Davos earlier this year, buyout representatives present agreed to sponsor a two-year study into the economic impact of private equity – and all this while protestors picketed outside.

Yet in France, a country renowned for union activism, there has been little backlash against the recent success of private equity firms. This is despite the fact that this is an election year – you might have thought that at least some political figures would have something to say about the industry. Yet for now, at least, it seems as though the country is accepting of these new capitalists intent on transforming French businesses. Indeed, private equity has the support of at least one of the election candidates – Nicolas Sarkozy urged insurance companies to commit more to private equity when he was Finance Minister. Even Jacques Chirac has weighed in on this debate recently, on the side of private equity.

Part of this has to do with past experience. “There’s been a history here of development capital and minority investment by banks and so management and owners are familiar with the concept of private equity,” says George Elliston of Close Brothers Corporate Finance. “But LBOs, in which firms take a majority stake, are relatively new in France. Despite this, we haven’t seen the kind of backlash we’ve seen in other countries. The industry has done a very good job of promoting itself and communicating the economic benefits of private equity.”

That’s not to say there haven’t been any incidents. Back in 2000, when Texas Pacific Group took control of smart card developer Gemplus and fired some of its executives, the firm was accused of being a front for US security interests and of trying to steal the company’s technology.

And then in 2005, Butler Capital Partners found itself in the middle of protests and riots when it agreed to buy ailing ferry operator SNCM from the state. The furore was caused by the suggestion that the company was going to have to lay off 400 people. There have also recently been cases of the tax authorities challenging some of the management packages in buyouts that they consider to have been highly aggressive. And there is a French union-backed web site, set up by the CGT. Its aim is to inform workers and other interested parties about the ills of LBOs and “d’y metre fin” – put an end to it all.

Even with limited incidents such as these, some in the market believe the industry should take the lead in ensuring the wider public understands the role private equity has to play in the French economy. Advent International’s Pascal Stefani is one: “Just as in other countries, the industry is facing a communications issue. We have to be sure that we are explaining to the wider community how we do what we do and emphasise the fact that private equity creates jobs in the long run. The private equity industry is relatively new in France, so it’s natural that there is some education to be done.”

And it’s as well that market participants are not being complacent. The time for private equity to be pilloried in France may well come. “We’ve seen some remarkable sales over the last year or so, in which firms have made some very good profits,” says SJ Berwin’s George Pinkham. “That is a good thing, but it may lead to a political backlash at some stage – that generally happens when a group of people have been very successful.”

So what might trigger such a thing? “There has been a less overt reaction to this kind of success in France than there has been in some other countries, but these things can happen quickly,” adds Pinkham. “There have been a few articles in the press here recently about the pay packets and golden parachutes that management at large businesses have been getting. That’s not targeted at private equity, but it would only take one or two large deals to go sour for attention to focus more on the industry.