Accountancy firms’ corporate finance arms have enjoyed market dominance in all major European mid-markets for several years, but now their most famous offering private equity advisory work is mirroring the success of venture capitalists in mainland Europe.
It’s 15 years since the now big five set up their private equity arms. Some claim direct descent from the emerging leveraged buyout (LBO) market in the late 1970s. They began by offering tax and due diligence services, expanded into corporate finance advice, and now offer help to management buyout (MBO) parties from e-commerce to vendor due diligence.
“A few years ago, our corporate finance offering was a bit of a one-legged stool, just doing private equity work,” explains Martin Kitcatt, head of European private equity at Arthur Andersen corporate finance. “One of the ways to overcome the peaks and troughs [in the buyout market] is by adding more legs to the stool, such as public company work, sale mandates and PFI work. But our private equity revenue has grown year on year.”
Within the ebb and flow of bull and bear markets, these firms have taken the rough with the smooth. But in the past two years, several new factors have emerged to test the mettle of the big five private equity teams. These are the impact of US LBO houses in Europe, the development of financial sponsor groups at investment banks, and the pan-Europeanisation of prominent UK equity providers.
“The continental market is quite competitive,” says Peter Jacobs, head of PricewaterhouseCoopers’ European private equity advisory team, “but the intermediary network is less developed there. Through our relations with US and UK houses, we have had to meet the demand for advisory work across Europe.”
Paul Zimmerman, private equity partner at Deloitte & Touche, adds that his firm has helped open up Europe to the buyout concept. “We got into Europe early on through the venture capitalists who went into Germany and the Nordic region and partnered up with local firms. The culture of selling your business to a venture capitalist wasn’t entrenched.
Now that groundwork has been done, it is paying off in both volume and value of continental deals.”
Banks muscle in
Mandates of the big five have mirrored the surge in deal size in recent years, but big advisory work from US houses remains largely elusive. KKR, Hicks Muse, Blackstone, Texas Pacific and Carlyle all use banks on their European deals. And recently some of the London-based private equity firms operating at the larger end of the buyout market have been using banks on recent deals. HSBC Private Equity, for instance, has upped the ante to the $500m plus deal bracket this year, and used Merrill Lynch on its E760 million buyout of BBA group in July. CVC Partners appointed Deutsche for its purchase of Revlon, while Schroder Ventures mandated Chase for its buyout of Memec group from E.on.
Deloitte &Touche’s Zimmerman appears unconcerned about his private equity clients moving upstream. “Over the past 15 years we have grown up with the venture capitalists. A lot of HSBC’s people have been there for a long time. I just don’t see that if they go upstream they will drop us.”
Duncan Skailes, private equity partner at PricewaterhouseCoopers, adds: “There was a trend for equity houses to appoint banks for reciprocal business for when the banks are on the sell-side. With sector specialisation in the modern buyout, I think they now appoint whoever they feel knows about the kind of business they’re entering.”
Deloitte & Touche points out that it has just acted for HSBC Private Equity on its Formula One foray with Xtrac, while PricewaterhouseCoopers has two $1bn-plus UK buyouts to its name. Meanwhile, KPMG Corporate Finance acted for Mercury Private Equity on its first German deal, and for Alchemy on its failed bid for UK carmaker Rover.
Martin Aguss, head of private equity at Ernst & Young, says that while relationships are key to all advisory work, there are different drivers between advisory and tax or due diligence. “It tends to be personal first and foremost on the advisory side. On due diligence side it’s driven by the thinking of the private equity houses themselves. One or two houses like to have near exclusive relations with one law firm, and one accountant.”
So with banks gearing up to service the private equity community, will the bigger mandates dry up? “We’ve not had anyone pitching from a bank since last year,” says one London mid-market venture capitalist: “Our accountants are by and large more personable, and have proved they are capable on the larger deals.”
Eurovision or tunnel vision?
Europeanising franchises has been all the rage in London for around three years now. Countless UK financial buyers have stampeded into, particularly, Frankfurt hoping for a boom. The relationships between equity houses and the big five has largely remained intact.
“Everybody has been interested in the potential in Germany,” says Simon Creedy-Smith, head of European transaction services at Deloitte & Touche, “but the tax reforms should be balanced against the lack of good IPO exit opportunities. The non-tech IPO market has dried up.” Creedy-Smith points out that in 1999 German buyouts were actually down on 1998 figures. This was set against a backdrop of rapid expansion for the rest of Europe. But all firms concede that it’s early days in Germany, and that the UK dealmakers in Frankfurt and Munich have learnt from the overheated UK market of 1989.
But whereas some of their venture capital clients have paid lip-service to Europe and done little else about it, big five firms have committed huge resources between them. Deloitte & Touche estimates the UK market was worth E27 billion in 1999, while mainland Europe was worth EURO31 billion. Yet accountancy private equity teams have no more than half of their staff in continental Europe, and some considerably less.
The figures for next year are likely to be higher still, but all firms are reporting some difficulties in recruiting local hires, especially as investment banks are currently at the same stage. So firms are training staff internally, hiring ex-corporate people to improve networking and sector knowledge, and seconding UK nationals to the continent.
For banks, one option would be to poach from each other, but this approach is rare among the accountancy firms. Only a handful of the 1000-plus advisers have changed jobs this year and those that have have mainly joined venture capital firms to get into the direct investment arena. Examples include Michelle Newman, who quit Deloitte & Touche’s private equity team in April for Royal Bank Development Capital.
Conflict is a sore point in accountancy circles at the moment. In the US, the SEC has ordered the separation of consulting and audit businesses. Corporate finance departments are understandably
miffed, as they could face losing valuable mandates in Europe from audit clients. With audit clients including most of the big US private equity houses, chances of fostering further relations with them may diminish.
But conflict situations within corporate finance are common too and accountants, like banks, must manage them carefully. PricewaterhouseCoopers’s Jacobs explains: “When there are 20 firms in an auction, it’s impossible to choose just one client and forget the rest. Our clients understand that.” Andersen’s Kitcatt adds: “The key is to have strong relations with several houses, but not too many.”
Jacobs believes big five firms have an innate advantage owing to their size. During an auction, they can base separate teams in different offices to prevent breaches. As they have both more staff and more offices than most banks, they can represent more clients in any auction. In the communications age this may seem superfluous, but judges look favourably on active conflict management.
In the opposite case, the current co-investment tendency in private equity can pitch accountant against accountant. This is where relationships are tested, but the trickledown deals from any decent-sized equity investment are usually enough to assuage the losing party.
Advising management is the other key plank of big five private equity teams and this is where they excel. As an MBO is often a once-in-a-lifetime experience for the client, the expertise during negotiations, follow-on strategic help and general handholding’ is welcomed. But mid-market appointments are more often coming straight from the venture capital firm rather than management. PricewaterhouseCooper’s Skailes points out that many smaller modern deals now resemble institutional buyouts.
Management mandates come from all tentacles of these accounting empires. Whether management buy-in (MBI) programmes, audit and tax clients looking for vendor due diligence, or the deal origination groups, the private equity teams have access to management at all levels of the corporate world from e-entrepreneurs to veteran CEOs. Ernst & Young private equity partner Mark Hodgkins was appointed to advise Quantel’s management on its recent $76 million MBO from Carlton Communications. His name had been spotted by management in a rainmakers’ article in a UK newspaper. They wanted to arrange a buyout, phoned him and appointed him.
The other main offering of all the big five is transaction services. This is something of a staple route for accountants to enter the corporate finance market. It is a support service for MBOs offering financial due diligence, tax management, and occasionally sector reports. Regardless of who performs the advisory work, this service is now seen as vital by venture capitalists. Deloitte & Touche’s Creedy-Smith explains: “We operate in the mid-market alongside Deloitte & Touche advisory, but we are also in the big buyout marketplace too. But we aren’t abandoning the mid-market, because it’s an important part of Deloitte & Touche.”
Transaction services teams are keen to emphasise that this is not an add-on service but a standalone offering. Although they fall within the corporate finance departments, the majority of their mandates tend to come from relations with a different set of clients. But some VCs are keen on the one-stop approach. Last year PricewaterhouseCoopers managed the double’ on Candover’s Belgian buyout of Diamant Boart, providing both financial advice and due diligence reports. Elsewhere, on July’s $76 million Quantel buyout, PricewaterhouseCoopers did financial due diligence for LloydsTSB development capital, while Ernst & Young affiliate CIL provided market due diligence.
The acquisition of CIL has undoubtedly boosted E&Y’s presence in this lucrative if unsung offering. Aguss says Ernst & Young’s “integrated due diligence approach is a step ahead of the market.” On the upside, all the big five are leading a push into transaction services, facing competition from management consultants. Also, they are receiving big merger work. Deloitte & Touche prepared the ground for Vodafone/Mannesmann for instance. The downside is the growth of vendor due diligence. If the bidders are happy with the findings, there is less work for the transaction services team.
The mid-market may not belong to the big five yet, but Pricewaterhouse-Cooper’s mandate on IPC magazines the UK’s fourth largest ever buyout at GBP860 million shows that the top end is by no means exclusive to banks. For the moment, the European buyout market is proving fruitful, and with the average continental deal size at $100 million in 1999, the bulk of deals are in areas where these firms can feel comfortable. Accountants don’t have the mid markets sewn up by any means, but their boutique and small banking competitors are increasingly turning to niches where the big five aren’t strong enough. Accountants aren’t resentful of the competition, noting that there is plenty of work for everyone in the mid-market. And although their work is low-margin compared to advisory services, transaction services teams are establishing relations with new equity providers all the time. The splitting up of the firms could affect deal flow sources and that too will vary from firm to firm.