Exits Perk Up European Private Equity

Europe’s venture business, dumped in the gutter during the tech bubble, has come back to the point where VCs are at least thinking about looking at the stars.

“I don’t think we’ve ever been busier” than in the last six months, says George Coelho, a general partner at Benchmark Europe, which recently closed on $375 million for Benchmark Europe II. Coelho says the climate for venture investing has improved dramatically in the last year, which is one reason why his firm raised its second European fund even though it has not yet had an exit from its first.

“There is a better climate, and part of that has been created by the fact that we’re starting to get an improvement in exits,” says Rod Perry, global head of venture at 3i. Perry notes that in the first half of 2004 there were 14 IPOs and an additional 80 exits through merger or acquisition.

This year’s most notable IPO was CSR (formerly Cambridge Silicon Radio), the Bluetooth chipmaker. While not yet on par with Business Objects – whose $2.2 billion market capitalization makes it perhaps the most successful European venture-backed software company – CSR’s IPO is “a landmark deal” for European venture capital, Coelho says. In addition to 3i, the company’s backers included Amadeus, Gilde Investment Management, Intel Capital, Mustang Ventures and Razorfish.

On the M&A front, the year’s biggest deal for a venture-backed company was Yahoo’s purchase of Paris-based Kelkoo for 475 million euros (or $589 million). Investors in the profitable online shopping service, which was founded in 1999, expect to see a return of about five times their money, according to the European Venture Capital Journal (a PE Week sister publication). Kelkoo’s backers included Banexi Venture Partners, Sgam (Societe Generale) and Innovacom from France, Netjuice and BBVA from Spain and Kistefos of Norway.

Other notable acquisitions of 2004 include the purchase of Germany’s Element 5 and Jamba!, and England’s Alphamosaic and KVault Software. Venture firms that cashed in on those deals include 3i, Doughty Hanson Technology Ventures, Earlybird Mosaic Venture Partners, Summit Partners and TTP Ventures.

With a growing number of companies exiting their portfolios, more European VCs have picked up the pace of new investments. There doesn’t appear to be an overall increase in tech deals, but one sector that’s strengthening is semiconductors, especially chips for portable devices. CSR and Alphamosaic are two of the key players in that space.

And, says Coelho, there is a “secret” European venture market driven by strong growth in consumer Internet plays like Kelkoo. “Europe does some dot-coms very well,” he says. Benchmark’s Internet bets include Betfair.com, a U.K.-based gambling site; Digital Island, the U.K.’s version Netflix; and yoox.com, an Italian consumer goods e-tailer. Coelho says the firm has passed on several richly valued German e-commerce ventures, which he thinks will be highly successful.

European private equity investment rose 27% from the first quarter to the second quarter, according to a report by the European Private Equity & Venture Capital Association (EVCA), Thomson Venture Economics (publisher of PE Week) and PricewaterhouseCoopers. During that period, early stage deals shot up 47% and buyout deals climbed 44 percent. The only sector to decrease was expansion deals, which were down 16 percent. The EVCA report indicates quarterly trends in European private equity. It does not show dollar amounts invested.

The EVCA report is good news for the VC segment. While European private equity overall had its second-best year ever in 2003, venture capital lagged. European VCs invested about 2 billion euros ($2.5 billion) in early stage companies in 2003, which represented about 31% of deals, according to the EVCA. That was down from 2.6 billion euros ($3.2 billion), or about 34% of deals, in 2002. Follow-on rounds attracted 6.2 billion euros ($7.7 billion) last year, down from 6.9 billion euros ($8.55 billion) in 2002.

The market for European venture capital is maturing, particularly in the United Kingdom, which typically generates close to half the venture activity in Europe. And there is a European discount, so it’s relatively cheap for U.S. VCs to buy into late stage deals.

3i’s Perry says success stories will help draw U.S. limited partners into Europe. And Coelho says he would be shocked if more large early stage U.S. VCs don’t follow in the footsteps of Benchmark and Accel Europe.

Others are skeptical. Steve Baloff, a general partner at Advanced Technology Ventures (ATV), which successfully made investments in Europe and Israel in the late 1990s, says he’s not sure it makes sense for ATV to start investing in Europe right now. He adds that it’s unlikely that his firm would invest in Europe unless it expanded and raised a European-specific fund.

Back in the 1990s, Baloff says, valuations in Europe were so low that it created arbitrage opportunities. While values remain lower in Europe than in the United States, he says the arbitrage potential is mostly gone.

Even those who are in the market say that it still faces challenges. Herman Daems, chairman of Belgian private equity firm GIMV and chairman of the EVCA says it’s too difficult for European companies to go public.

But in a global market, being international from the start may be a good thing. Indeed, there are signs that historic returns may begin to favor European venture capital. For instance, while Europe’s VCs haven’t performed well in the wake of the tech bubble’s collapse, they’ve been better than their U.S. counterparts. Jean-Bernard Schmidt, managing partner of Sofinnova Partners, argues that European companies had less exposure to the bubble, continue to have a lower burn rate and that will help them in the long term.

“It will show up eventually in the returns,” Schmidt says. “One may find that European VCs stack up pretty well against U.S. VCs over the next 10 years.”

This story originally appeared in Venture Capital Journal, a sister publication.