As a fund-of-funds focused on the less glamorous end of the buyouts market, Access Capital Partners has managed to avoid much of the pain inflicted by the recession felt by some of its bigger rivals.
The small and mid-market buyout space has certainly not escaped the pressures of economic recession, with a renewed emphasis on operational involvement and banking relationships coming to the fore, but neither has it been crippled to the same extent.
Philippe Poggioli, managing partner of the Paris-based Access Capital Partners, speaks to EVCJ about weathering the storm and preparing for brighter days.
What is Access Capital Partners’ investment strategy?
Since the creation of its first fund-of-funds in 1999, Access has been dedicated to the selection of European small and mid-size buyout as well as special situations funds. Within this space, we always believed that selecting general partners focused on enabling growth in businesses with limited reliance on leverage would lead to a more sustainable return model across economic cycles. Recent developments in the market have made this selection bias even more relevant.
Access is active both on the primary and the secondary segments of the European small and mid-size buyout market. We have always had an opportunistic approach to the secondary market, using it proactively as a buyer when the cycle goes down and defensively as a seller when the cycle goes up.
Since the beginning of the year, in response to a very active deal flow, we have substantially expanded its secondary deal-making activity.
What is it about small and mid-market buyouts that is attractive?
Top quartile small and mid-market buyout funds have historically outperformed larger top quartile funds, displaying several structural advantages such as lower entry valuations, less historical dependence on leverage, and stronger possibility for fund managers to add genuine operational value to portfolio companies.
While the current debt shortage has brought deal-making activity in the larger buyout segment (those with an enterprise value of more than €250m) to a halt, the smaller end of the market (enterprise value of less than €100m), with its traditionally lower leverage ratios, is finding it easier to develop alternatives to the traditional debt/equity structure and continues, albeit to a lesser extent than before the crisis, to put money to work.
Access has recorded 25 deals in the first half of 2009 in its primary portfolio, which is fairly encouraging considering the market circumstances.
On the exit side, we believe that the small and mid-market is also likely to be better positioned to maintain an exit activity than its larger counterparts in the current climate. With IPO markets and secondary buyouts at a standstill, smaller companies offering good opportunities in fragmented markets for consolidation continue to appeal to trade buyers who seek to acquire key strategic assets.
How has the economic downturn affected the business?
The economic downturn is posing a serious challenge for existing portfolio companies which are suffering from reduced consumer and business spending, delayed receivables, lower earnings and stricter credit conditions. Weaker earnings have in turn started to impact portfolio valuations.
In Access’ portfolio, lower debt levels at acquisition and only marginal exposure to bullet repayments provide better protection against softer trading and tougher banks than in the larger buyout segment.
Besides, in order to secure the financial health of portfolio companies, Access’ GPs have been proactive about the bank relationship and potential leverage issues. Funds have selectively used some of their cash reserves to deleverage their companies and re-inject equity in order to reduce the risk of covenant breach.
GPs also work the assets harder, intensify operational support, and manage cash even more accurately. Operational support is becoming even more intense, with a stronger implication of operational partners and, above all, increased cost control.
For many of Access’ GPs consolidation, through add-on acquisitions, is also a means of strengthening companies, helping them to achieve critical size, and therefore, to resist the economic turmoil better. These add-ons are executed at more attractive prices than in the past and offer a possibility to restructure the debt on the new entity.
Access has recorded 20 add-ons in its primary portfolio since the beginning of the year.
There has also been an impact for us on the deal making side. Fewer deals have actually happened in the small and mid-market buyout segments in 2009 while hardly any deals have been completed in the higher segments of the market. Deals made in 2009 have been structured with less classic bank debt, equity ratios going up, increasing importance of mezzanine and almost systematic recourse to vendor financing.
We believe that deal activity could pick up towards year end/early 2010, when trading performance of target companies over 2009 becomes apparent. Until then, the lack of visibility on the economy, the scarcity of debt and the bid-ask gap should keep the market from really taking off.
Slower fund deployment in the primary small and mid-market buyout portfolio is compensated somehow by:
- faster deployment of the special situation/turnaround portfolio: the current economic climate has created opportunities for turnaround players, who now see increased supply of opportunities;
- faster deployment of the secondary portfolio;
- higher proportion of growth capital deals (ie little to no leverage, sometimes through strong minorities) in small and mid-market funds (given the current acquisition debt shortage)
How many private equity funds do you look at per year and how many do you invest in?
On the primary side, our visibility in the European small and mid-market buyout segment, as well as its proactive approach to deal-sourcing, has ensured a large deal flow of relevant fund offerings. This year has obviously been a weaker one in terms of primary new fund opportunities.
We meet virtually all European teams raising small and mid-market buyout and special situations funds (on average 80 per year), which translates into north of 20 detailed due diligence reviews and five to 10 new investments per year.
On the secondary side, 2009 has been a very active year with a strong deal flow and 10 transactions done so far.
What tips would you give to GPs currently fund raising?
We look for seasoned, experienced investment professionals that demonstrate:
- proactive sourcing;
- strong and sustainable track record;
- demonstrated operational added value: growth in turnover and EBITDA;
- pricing discipline;
- moderate leverage;
- high quality deal flow;
- realistic terms.
We would particularly insist on realistic terms as the scale had tipped very much in favour of GPs in the last few years and a better balance should be achieved going forward. The GP/LP relationship should be a fair deal.
What do you think are going to be the hot sectors in the near future?
We continue to focus on the small and mid-market buyout segment as we see no need for small to mid-market private equity to reinvent itself as the basic ingredients of future returns in this segment (disciplined pricing, moderate leverage, high quality management teams, hands-on involvement, operational development) will not vary.
We are currently taking full advantage of the explosion of secondary opportunities, triggered by an increasing number of liquidity-driven sellers. Access expects these favourable market conditions to continue may be over the next two years, but we also know that we will need to be disciplined and reduce our secondary activity when the market becomes hot again which will invariably happen given the vast amounts of capital raised by secondary funds.
We also believe that later stage investments and buyouts in the technology space is an interesting place to invest. The increased maturity of the technology sector has produced an increasing number of investment opportunities for growth capital and buyouts in the information and communications technologies (ICT), industrial technologies, medical technologies, clean technologies, energy and media sectors.
In light of the economic turmoil over the last two years, do you think we will see a consolidation of the private equity industry?
Portfolio companies, particularly from vintages 2006-2007, are undoubtedly facing hard times due to the economic slowdown, higher debt burden and delayed exits. The bad hit many portfolios have taken – and from which some of them will not recover – will probably lead to a wash-out among private equity players during the next fund raising cycle.
Although many funds of recent vintages may fail to deliver the expected returns, most GPs may still be able to steer through the turmoil and protect their existing portfolio while grasping new opportunities arising from the crisis.
The paradox of the private equity industry has always been that it is hard to raise money when it is actually a good time to buy, and, inversely, very easy to raise funds when the market is at its peak.
Good quality businesses will continue to attract buyout activity, so as we look ahead, private equity still stands a good chance to continue outperforming other asset classes as it has been doing in the past. It is healthy that fewer funds will be given the opportunity to raise capital as too many sub-quality GPs were funded in the recent years.
What’s your attitude towards European venture capital?
The structural problems of long realisation cycles and volatility in returns for early stage investing in Europe have only been intensified by the current crisis. The recession in the real economy is hurting technology businesses as much as traditional ones. The appetite of institutional investors worldwide for this part of the asset class is still not increasing, contributing to the shortage of funds available.
We learned our lesson some years ago and have not had a VC allocation since 2005. Instead we have focused on later stage and technology buyouts.
What issues do you think the private equity industry needs to be most concerned about in the coming months and years?
Under the tougher economic and banking environment, private equity fund managers’ aversion to risk shot up spectacularly. In the months ahead, GPs will be most concerned by existing portfolios. They will continue, together with management teams of portfolio companies, to revise budgets and forecasts, and monitor receivables and payables very closely to optimise cash. Many funds will continue to use their cash reserves to selectively deleverage some companies by re-injecting equity to reduce the risk of covenant breach.
GPs are also increasingly concerned about keeping up a quality relationship with the lending banks in order to avoid distressed debt buyers to cheaply acquire debt positions from banks in their portfolio companies.
GPs will have to ensure they are on the ‘A list’ of the lending banks to maintain a constructive dialogue and optimise negotiations.
Philippe Poggioli joined Access in September 1999. He has 14 years of private equity experience. He is a member of the investment committee and is responsible for investments and strategic development of Access. He serves on the advisory committees of funds in France, the UK, Italy, Sweden, the Netherlands, and Spain.
Before joining Access, he started the fund-of-funds activity of the European Investment Fund (EIF) in 1996. Prior to EIF, he was programme manager with the European Commission for six years, during which he concentrated on seed capital and R&D funding for small and medium-sized businesses.
He began his career with Technofi, a management consultancy company based in Sophia Antipolis. Poggioli holds a degree in finance, business and administration from Sup de Co Marseilles.