Equity: A year of two halves for Euro buyouts

“The first half of the year was eerily quiet,” says Jonathan Russell, head of European buyouts at 3i. “There was a huge paralysis of decision making owing to the geo-political uncertainty. After the Easter holidays deal flow picked up and these transactions are now reaching completion.”

Stock market fluctuations in the first four months of the year, a steady stream of bleak economic figures and continued nervousness about war and terrorism made it a terrible time to do business, and this is reflected in the figures. Preliminary statistics from the Centre for Management Buy-Out Research (CMBOR) show the European buyout market dropped both in terms of volume and value in 2003. There were 333 buyouts completed in Europe for a total value of €35.9bn down from 536 deals valued at €43.9bn in 2002. Ben Harding reports.

Despite the downward movement in the headline trend, the average value of buyouts has risen significantly and now exceeds €100m for the first time; the mean figure now stands at €107.9m. Buyout sizes have gone up dramatically in the last five years from €39.1m in 1997.

While there are many reasons why deal sizes have been rising, the willingness of private equity groups to club together to complete mega-deals has certainly been a contributory factor. There were five deals in the €2bn plus range last year, each of which was completed by a consortium of two or more financial sponsors.

There is also plenty of cash in the coffers; estimates currently put the capital overhang in Europe at around €30bn. With very little corporate competition in the market for much of the year many firms viewed it is a good time to buy.

A relatively stable environment in terms of pricing also helped, although lead times were stretched and failure rates remained high. The widely reported ‘expectation gap’ in pricing does not seem to have been the inhibiting factor in 2003 that it was in 2002. By the start of the year, vendors had managed down expectations to more reasonable levels. Ian Taylor, head of the UK team at ABN AMRO Capital, says: “I don’t think pricing has moved much over the year, it has been fairly stable, but there are signs that people are starting to over-pay for some deals. This could certainly be a danger next year because there are a number of people in the market that need to put capital to work after a quiet 2003.”

The other factor driving prices is the re-emergence of trade buyers, Ian Armitage, chief executive of HgCapital, says: “Trade buyers weren’t buying last year, but there are signs now that they are circling the market and are becoming more competitive.”

Pricing has also remained buoyant owing to a fairly aggressive and competitive banking market. Steve Tadler, CEO of Advent International in Europe, says: “There have been some very richly priced deals recently that have been driven by a readiness on behalf of the banking market. This might be about to change; there are signs that some banks are losing favour with the leverage finance market, so we don’t think there will be as much dry powder around next year.”

Some of the larger deals recently have employed surprisingly aggressive leverage levels, Bain Capital used just over 25% equity in its €1.4bn purchase of Brenntag, equity for the recent Terreal and Materis deals amounted to about 28% for each while Frans Bonhomme was done with just over 24%. Total leverage levels have also been edging up with SEAT, the year’s biggest deal, at 6.7x EBITDA, Frans Bonhomme at 5.7X, Springer 6x and Terreal 6.4x.

A common feature in many of these deals is that they are strong secondary assets of a certain size that are well known by the banking community. Anecdotally, further down the market, deals have been a lot harder to finance. John Snook, managing director of Close Brothers Private Equity, says: “There is plenty of banking out there but at the smaller end of the market the banks are very cautious and conservative and are really very slow in making decisions.”

Finding the door

Holding periods for European buyouts have been getting steadily longer. Up to 1997, private equity companies held on to their portfolio companies for an average of 2.5 years. Last year, the figure pushed over the four-year mark. There are good macro economic reasons for this. Private equity firms do not want to keep companies for any longer than is needed because it clearly impacts on their internal rate of return. The main governing factor has been the collapse of the European M&A market.

According to Thomson Financial figures, the value of the European M&A market has fallen dramatically from a peak of $120bn in 1999 to $48bn in 2002 and just $34bn for the first nine months of 2003. Largely because of this shortage of trade buyers and the urgent need to put capital to work, CMBOR figures show secondary deals have become an increasingly important exit route. Of the 177 buyouts to have been exited in the first nine months of 2003, 44 were secondary buyouts and 50 went to trade sales.

Caroline Grounds, head of the private equity practice at Ernst & Young, says: “Over the last six months we have recognised that life for private equity houses has become tougher. Where in the past a fund would be looking to exit its investment within three or so years, it is now in for a longer haul as the traditional exit routes are not available.”

In the absence of traditional change of ownership transactions, people are looking at re-financing opportunities to make the assets sweat, a trend eased by a far more compliant banking market. Up until a few years ago banks were reluctant to restructure the senior debt at all, now they are willing to re-jig the whole capital structure allowing private equity firms to make valuable distributions to their investors.

Advent’s Steve Tadler comments: “We have four refinancings currently on the books. In the 1990s when public markets were strong, you didn’t want to constantly re-finance your company, now it has become far more necessary to have an efficient capital structure in order to try and maintain IRRs over longer holding periods.”

In some cases a dual strategy is employed, as ABN AMRO Capital’s Taylor explains: “What we have seen is businesses being put up for sale with refinancing as a fallback position. There are lots of people trawling the market to get the best deal on refinancing and this is especially true if you have a bank advising you on the sale of a business.”

Given the extended holding periods, it would appear some are holding off selling their best assets in the anticipation of better things to come, another factor in the increasing use of re-financings. Russell says: “There is always a temptation to sell your best companies in a tough market, because they are the easiest ones to sell. We have had some offers but have persisted until we feel we can get full value.”

There are some signs that a reversal in exit market fortunes may be not too far off. The IPO market is showing signs of life and, after nine months of growth, there is a greater confidence that some of the backlog of IPO candidates can be cleared in the next four to five months. “There are a lot of things being looked at and some of the European banks are starting to hire people to manage new issues, which has got to be a sign of confidence,” says Tadler.

This may be true of the London market, but the situation on the continent, where EQT recently pulled its high profile flotation of Dometic, looks bleak. “The UK market is open for flotations now,” says Gustav Ohman, a director at Industri Kapital. “On the continent it is a different story and, although there have been some successful capital raising exercises, there is little institutional demand for IPOs.”

If there is one thing that can been said about exits in 2003, it is that private equity companies have really tried to get on top of their portfolios; they have had little option but to. Most anticipate a better exit environment in 2004, as well as hope of a sustained IPO window, trade buyers are back in the market and it is thought secondary sales will increase as PE firms gear up to get back on the fund raising trail.

Fund raising

The ability to attract fresh institutional capital into the asset class looks like it is falling for the second year in a row, with

the figure for 2003 likely to slump well below the €28bn-plus that was achieved in 2001. There have been a few highlights; Permira’s record-breaking €5.1bn effort will flatter the year-end figures, and the well-documented institutional shift toward focused, country-specific vehicles served Graphite Capital and newcomers Altor well.

The main story in 2003 as far as fundraising is concerned has been one of increased differentiation. To be fair to those that have struggled, this is partially a matter of timing, but the more significant factor is the standard of due diligence being adopted by prospective investors.

Limited partners have become far more rigorous in their assessment of private equity investments. With less overall money to go round this has led to a surprising shakeout, with many of the established names in the European private equity firmament having real, and public, problems raising new funds.

Jonathan Blake, head of the private equity practice at law firm SJ Berwin, has a positive assessment for the year to come. “At the moment we are hearing an awful lot of people saying that they are going to be out in the market with new vehicles in the next 12 months. There are also significant new pools of capital to be exploited, specifically in Germany and France where the private pension fund market is beginning to be seen as an important new source.”

On the fund raising side, the important issues going forward are the development of a pan European fund structure and the implications of Basel II. A pan European fund structure is seen as important given the growing complexity of funds needing to accommodate investors from a wider range of jurisdictions. Initial lobbying has met with positive noises from the European authorities.

The latest Basel proposals have more worrying implications. The European Private Equity & Venture Capital Association (EVCA) has reiterated its concerns to the Basel Committee. According to EVCA, around 25% of the funds available for private equity investment in Europe are derived from banks, either through captive structures, or their investments in independent funds. The impact of any retrenchment by banks would therefore be significant and the current proposals would probably have that effect.

New entrants fuel the mid-market

It would seem that, given the well-reported flight to quality where institutions invest their PE allocation with established brands and long-term partners, new entrants would be detracted from entering the market. This has not been the case. During 2003, a surprising number of first time operators defied the tough market conditions and frequently embarrassed more established peers. Spin-offs often occur at the start of a new fund raising round, with fund managers unwilling to tie themselves in for a further ten years. SJ Berwin’s Blake says: “As entrepreneurial people it is only natural that spin-offs will continue to occur in what will be a very busy year for fundraising in 2004.” Anecdotal evidence from placement agents suggests negotiations are on going.

The rationale cited by most of these groups is that there is a void in the mid-market left by former incumbents moving up in deal size. Another common refrain is that these news funds intend to focus on operational factors, employing teams with predominantly industrial rather than financial backgrounds.

Many have been lucky enough to secure significant cornerstone backing, allowing them to get straight into the investment process. Stirling Square Capital Partners, Englefield Capital and Change Capital Partners all fit this bill. Stirling Square, which secured a cornerstone commitment of $250m from Citigroup, is managed by a group of experienced practitioners, the bulk of which spun out of Compass Partners. Founder Martin Calderbrook, ex Candover and Compass, said: “Now is absolutely the best time to be a new entrant in the European mid-market. We are bullish about the deal opportunities that we are seeing at good valuations, and are thankful that we do not have to dedicate the next 12 to 18 months to raising a fund.”

Englefield Capital secured €660m, also for investment in the European mid-market. The vehicle was raised in conjunction with Bregal, a subsidiary of Cofra Holdings, the Switzerland-based family holding company. Other investors include high net worth individuals and the general partners themselves. The venture is the brainchild of Dominic Shorthouse, who was one of three founding members of Warburg Pincus’ European operations in 1988. Shorthouse says: “We aim to be more operationally focused and less concerned with financial engineering than many of our competitors.”

Luc Vandevelde, the man credited with engineering the turnaround at Marks & Spencer, scaled down his efforts at M&S to concentrate on buying his own retailing companies when he launched Change Capital Partners. The fund secured a $300m cornerstone commitment from the Halley family, founders of the Promodes supermarket chain and holders of a 10%+ stake in Carrefour. Vandevelde was a protégé of Paul Louis Halley, one of the richest men in France and engineer of the merger of Carrefour and Promode. Halley died in a plane crash in December.

Other new entrants, such as Clessidra Capital Partners in Italy, Altor Capital in Sweden and Activa Capital Partners in France, have all enjoyed fund raising success by identifying a sweet spot in their respective markets and leveraging on the profile and contacts of their founders.

Clessidra, which held a €560m first close in October, is aiming to be Italy’s first €1bn vehicle with a final close pencilled in for Q1 2004. The status of former Morgan Stanley chief and Fininvest CEO Claudio Sposito was instrumental in attracting an impressive roll call of indigenous backers including: Fondazione Cariplo, Banco Nazionale del Lavoro, Banca Popolare di Lodi, Capitalia, Mediobanca, Telecom Italia and Unicredito Italiano.

Similarly Altor, which was founded by ex-Industri Kapital GP Harald Mix, managed to pull in €650m in just six months for its debut fund. The group managed to attract some of the biggest and most discerning investors, including: Adams Street Partners, Allianz Capital, Goldman Sachs Private Equity Group, NIB Capital Private Equity, Pantheon Ventures and Standard Life.

In France a group of well-known private equity practitioners have joined forces to create Activa Capital, a mid-market focused fund, that is well on its way to achieving its target of €150m. The founding partners, who between them share more than 50 years experience in French private equity, are: Jean Louis de Bernardy, former managing director of Bridgepoint’s French operations; Charles Diehl, co-founder of Barclays Private Equity France; his brother Michael, director of equities at UBS Warburg in France, and Philippe Latore, a director at Paribas Affaires Industrielle.

There is a flipside to all this, defectors usually leave at the start of their previous firm’s fund raising cycle and this can raise serious problems for the old firm. When Harald Mix left Industri Kapital to form Altor Capital Partners his departure was seen by many as a contributing factor in Industri Kapital’s subsequent lumpy fund raising.

3i is also currently engaged in a protracted fund raising exercise. It recently lost four senior deal doers; Tom Sweet-Escott, the director who secured 3i’s investment in Go, and Chris Graham, the head of the company’s media unit. They were joined by director Hugh Richards and Richard Campin, head of 3i’s French division. It is understood the four will look to start their own firm once the gardening leave is up at the end of the 2003. These new funds not only intensify competition for deals but also for institutional cash as the European private equity market limbers up for a very busy fund raising year in 2004.


In a new development this year, private equity houses have looked at their peers in the US and have started thinking about a broader product offering. Mezzanine is an obvious choice. EQT has joined its Nordic rival CapMan, which already operates the well established Finnmezzanine funds, and has created its own vehicle targeting mid-market Northern European deals as well as sponsorless transactions. Patrick Dumonk, who heads the independent mezzanine side of EQT’s business, said: “For us, the equity side of the deal flow is interesting and we have an advantage over traditional groups because we have the expertise in-house and are used to structuring these kind of deals. There is a strong industrial risk analysis capacity, which is not traditionally a feature of mezzanine providers.”

Other private equity firms that have been tempted by the mezzanine route include, Lloyds Development Capital, which has announced a formal allocation, CVC, which is apparently sounding out investors, and Duke Street, which already has a CDO capacity. Paradoxically, Legal & General Ventures, which has managed Mithras as a mezzanine sideline for some time, is now backing out and redirecting the capital toward its equity investments.

The idea is not new in the US, where equity houses have been looking to offer a broader alternative asset suite for some time, but in Europe the idea of equity houses getting involved in mezzanine has raised eyebrows. There are certainly potential conflicts of interest to deal with. It also seems to go against the much-vaunted ‘sticking to our knitting’ sales pitch. In the aftermath of the dot-com collapse, when some of the better-known buyout franchises strayed into pastures new, those that remained focused were keen to emphasise the fact.

Germany loses out to France

Duke Street Capital opened a Paris office in 2003 and in so doing represents something of a trend among private equity groups that were deserting Germany after a disastrous 2002. Doughty Hanson followed, scaling down its German operations and announcing a new opening in Paris under Yann Duchesne earlier in 2003.

Anticipated industrial restructuring, a glut of Mittelstand disposals and a favourable legislative climate had PE firms clamouring to get into the German market at the end of the 1990s. However, firms like Legal &General Ventures, Alchemy Partners and Duke Street felt the resultant deal flow did not justify a German office.

France, by contrast, enjoyed a record year in 2002, and many anticipate this success will be carried forward as companies like Alstom, France Telecom, PPR, Alcatel and Vivendi continue to restructure.

Alchemy Partners withdrew from Germany in October last year after polling its investors: 100% thought it was a good idea to close the office. The firm’s head Jon Moulton said conditions had been difficult for two years. There were only 28 buyout completions in Germany in 2002 and deal value declined by 50% to €5.7bn. By contrast, France’s market doubled in size.

Ralf Huep, general manager of Advent International in Frankfurt, said: “There are 10 to 15 sizeable deals in Germany a year and there are between 20 and 30 large buyout firms with a keen interest. There are also people out there who are prepared to accept lower returns in order to get a landmark deal done and make a name for themselves, this is obviously inflating prices.”

Although the market is over-fished at the top-end, Huep says the situation is slightly better in the smaller deal arena. Martin Block, a director at HgCapital in Frankfurt agrees that opportunity in the mid-market is picking up. “After a disastrous 2002, many left the market only for deal flow to pick up in Q2 2003. We are more positive about both the quality and quantity of deals we are seeing than we have been for some time. The fact that there is also less competition also doesn’t do us any harm.”

In terms of new players, the only growth areas in the German market last year were vulture funds such as Nordwind Capital and Capital Management Partners, preying on distressed assets, as well as restructuring companies like Alix Partners that have been assisting private equity groups with the more unpleasant aspects of portfolio management.

Worryingly, Jonathan Russell says the problems that hounded the German market may start to take root in France: “There is far too much money around in the French market, there is too much cash chasing too few deals. The market is at least as competitive as the German market was when people started leaving it.”