Taoists believe that for each negative force there is a balancing positive force. So while the U.S. buyout market slowly makes its way out of this year’s slump, perhaps Europe is the yin for America’s yang. While the European market is by no means at a climax, it is marching steadily onward with growing funds, growing deals and multiple financing options to get those deals done.
In fact, deal sizes are getting larger, as are funds. While several years ago, deals in the EURO50 million range were on the large end for a European buyout, today it is not uncommon to see deals closer to EURO500 million and into the billions, sources say. Last year, European private equity firms invested at least EURO27 billion, according to Buyouts publisher Venture Economics, which is up from 1999’s EURO25.4 billion. Funds took an even greater leap. European funds raised EURO35 billion last year, a EURO10 billion increase from 1999, according to Venture Economics.
All that Glimmers Isn’t Gold
According to a poll by Cinven, a London-based private equity firm, and Mergermarket, an M&A research company, the deals expected to see the most growth are those between EURO850 million and EURO1.7 billion. (The poll’s respondents are made up of more than 150 managing directors at investment banks that specialize in U.K., French and German deals.) However, if that is what is expected, it is not what is currently taking place.
Most sources interviewed for this story, while claiming to see strong deal flow, say that senior debt in the European market is becoming tougher to come by, thereby affecting the larger deals. “The larger deals . . . have probably slowed down,” says Nigel McConnell, a managing partner at Electra Partners Europe, a U.K.-based firm. “I think a lot of that is being driven by the fact that debt at the larger end is becoming a little bit more difficult to get. In the middle market deals [around] EURO250 million to EURO300 million the financing market hasn’t really been affected at all yet, and so far the deal environment remains very active and doesn’t seem to show any signs of slowing down.”
But unlike the U.S., deals are getting done overseas, mainly because there are other financing options that are attainable. Most private equity professionals focused on Europe seem to hold onto hope that high yield will be there for their deal if they need it.
Giving European professionals a deal to rally around, Messer Griesheim Holding AG, a Germany-based industrial gas company, last month issued the largest ever single-tranche high yield bond issue by a European industrial and secured one of the largest leveraged Euro-loans this year. The financing is aiding the company’s buyout by Goldman Sachs Private Equity and Allianz Capital Partners (see story Messer Scores High Yield in Europe).
The Messer deal set out for a EURO400 million bond and came home with EURO550 million, although it received close to EURO2 billion worth of demand. “There was a general sense towards the end of last year . . . that going to the high-yield market was going to go well because there was so much appetite for non-telecom-business securities,” says Tom Siebens, a partner at law firm Milbank, Tweed, Hadley & McCloy, which represented Goldman Sachs in the transaction. “In the beginning of this year the high-yield market went into a slump and everyone began to wonder whether any high yield could do all that well. But by the time we went to market at the beginning of May things seemed to be roaring along, and obviously there was a huge demand.”
However, all recognize that technology and telecom companies are exceptions, and likely will not get high yield financing. “There appears to be a good market for mezzanine and high yield, at least in non-tech and non-telecom,” says Michael Goroff, a partner at Milbank Tweed in London who specializes in European M&A transactions. “I think you have to draw a distinction between telecom-related financing, which is difficult right now and has soaked up a lot of the capacity in the market, as compared to Old Economy.”
At this point, GPs interested in Europe are pretty confident that companies in traditional industries will be financed. “With industries being where they are, high-yield bonds start to look very attractive to investors,” says Electra’s McConnell. “It’s senior debt that’s driving [high yield] because the senior debt numbers are contracting compared to what you could get a year and a half ago.”
Although senior debt may be a little hard to come by, many sources say that subordinated debt is readily available for financing structures in Europe. “In Europe you still have a very strong traditional bank lending environment, where bank debt investorsare oriented toward taking pretty significant buy and hold positions and are anxious to build assets,” says Rob Redmond, the head of financial sponsor coverage at Lehman Brothers. “There’s also a stronger and more active mezzanine market in Europe, which comes in a couple different flavors. There are a number of different financing alternatives available in Europe which make deal-making a little bit more hospitable.”
In the past few years, it seemed that every large buyout firm in the U.S. was establishing an office in Europe, but sources say that phenomenon is now tapering off. There are still U.S. firms moving across the ocean, though most sources write it off as the evolution of the industry. For the most part, the firms that are active in Europe are those long-established in the region.
“The rush to organize and separately fund activities in Europe on the part of U.S. firms seems to have abated a little bit,” says Redmond. “[U.S. firms were] very active two years ago and now it seems like those that have made the decision to go are active. There are others who made the decision not to get geared up, and I don’t see any additional investments being made there.”
Redmond also says that some of the most active players are the firms that are not limited by a dedicated local fund, but those that are able to easily move money to where the opportunities are.
Warburg Pincus is one such firm. It invests out of the $5 billion Warburg Pincus Equity Partners fund and the $2.5 billion International Partners fund, both of which have the capability of investing in Europe, as well as other regions.
Many of the large brand-name U.S. firms that have carved a niche for themselves in Europe have made a practice of investing their Europe-specific funds alongside their general private equity funds and staying very active. Among those firms are Texas Pacific Group, Kohlberg, Kravis, Roberts & Co., Clayton Dubilier & Rice and The Carlyle Group, picking up Punch Taverns, Laporte, Italtel and Riello Group, respectively.
Most recently Hicks, Muse, Tate & Furst and Apax Partners acquired U.K.-based Yell, formerly British Telecommunications‘ international directories business, for GBP2.14 billion (see story, Hicks, Apax Take Yell BT for $3B).
The friendlier financing markets in Europe coupled with the increasing number of deals contribute to the appeal for U.S. players. Milbank Tweed’s Goroff says that the introduction of the euro made the European markets easier to tackle and thereby attracted more American firms. “There are great opportunities over here, and I think that the U.S. buyout funds have developed techniques and approaches to doing transactions which assume certain types of financing markets,” he says. “And those markets didn’t really exist to a sufficient extent in Europe until relatively recently.”
Goroff also notes that U.S. firms are now getting used to the complexities of European deals, most of which are multi-jurisdictional. “By example, Messer had operations in 62 countries,” he says. “You couldn’t have a company that size [in Europe] that just had operations in one country, whereas in the U.S. there are plenty of companies that size that just have operations in the U.S.”
Recent changes to the European markets, such as tax reforms and deregulation, are creating deal opportunities that did not exist before or were too complicated. The large conglomerates that have absorbed European businesses are now breaking down to become more focused, creating a windstorm of divested non-core assets that can be picked up by buyout firms.
Additionally, financial buyers may find that deals move a little smoother than U.S. buyers are used to. Lehman Brothers’ Redmond says he’s noticed that there seems to be a significant social penalty for not following through with a deal. “Once you’ve made an announcement and put something on the block, the auctions that typically develop are very visible, and there’s a consequence if those transactions are not completed,” he says. “There’s some reputational risk associated with going out in the market and then not getting it done.”
Other than finding senior debt for large LBOs, the biggest caveat tied to buyouts in Europe is the lack of exit opportunities. As in the U.S., buyers and sellers are not in full agreement on where the economy is going and therefore what an appropriate valuation should be, making sales difficult.
“There is very little in the way of exits given the relative youth sponsor portfolios and given that a lot of the acquisition activity’s been over the last two to three years,” says Redmond.
Additionally, the European public markets have been less welcoming than in previous years. According to Zephus Corporate Finance Knowledge, uncertainty about the European capital markets caused the number of initial public offerings in Europe involving private equity firms to drop by more than 26% in the second half of 2000 from the first half.
However, for those many firms that need to diversify their portfolios by shedding a few of the many technology and telecom companies collected last year, the secondary market is a viable option. Secondary buyout transactions are on the rise, according to Zephus. In the second half of 2000, there were 44 secondary buyouts. This is a drastic increase from the 27 secondary buyouts in the first half of 2000, which remained fairly consistent with the 28 deals and 29 deals of the two previous six-month periods.
Yet at this point exit strategies are not of immediate concern to most buyout professionals, likely because, as Redmond said, that step is still a few years off. In the meantime, LBO firms are more than happy to take advantage of Europe’s more appealing opportunities to put money to work.