France leads Continental Europe

The French buyout market has been extremely active in the past two years and last year was the biggest such market in Continental Europe, ahead of the Netherlands and Germany. The current credit squeeze has meant that larger transactions are difficult to finance. The mid-market and smaller market, however, are still seeing activity.

Sami Rahal, managing partner at Deloitte’s M&A transaction services team in Paris, says that the credit squeeze is having a major impact on the market. “Unlike Spain and Italy, where the mid-market is bigger, France has traditionally had quite a few larger deals,” he says. “This means that, like the UK and Germany, France is being hit harder.”

According to AFIC, the French venture capital and private equity association, activity in the first half of 2007 was very strong. About €6.4bn was invested in the period, up 56% on the first semester of 2006. These funds were invested in some 800 companies, says AFIC, up 25% on the previous year. Of the total invested, the lion’s share was in buyouts at €5.5bn.

The total for the second half of this year will inevitably be much smaller, thanks to the current uncertainties surrounding debt finance.

Jon Harry, a private equity partner at law firm Lovells in Paris, says: “The credit crunch has had a big psychological effect on the market, with syndication problems at the bigger end of the market and some of the deals done in June to July facing problems.”

Despite this, firms that have invested in France have been generating increasing returns. An AFIC study published in September showed that the net IRR on French funds increased to 12.1% at the end of 2006 from 10.7% at the end of 2005. When it came specifically to buyout funds, the IRR was 18.7% at the end of 2006 and for development capital the return was 13.5%.

Part of the reason France has been so successful as a buyout market is the legal and regulatory environment. According to the EVCA’s third benchmarking study, published at the end of 2006, France was ahead of the UK and second only to Ireland in terms of a favourable legal and regulatory framework.

But these positive factors will not be enough to keep the market for mega deals going in the current climate. Although very large transactions are not really being done at the moment, there is still some scope for deals in the €500m–€1bn bracket.

Jon Harry highlights Astorg Partners’ €780m acquisition of funeral services provider OGF from Vestar Capital Partners. The debt financing for the deal has been committed to and fully underwritten by Credit Suisse. But Harry acknowledges that it was “quite a difficult deal to close” in today’s environment.

“In the mid-market up to €200m we’re not seeing the same kind of impact as for the bigger deals because there aren’t the same syndication conditions,” he says. “The banks are taking a wait-and-see attitude and not falling over themselves to lend. When they do start lending again, by next spring probably, there will be different conditions, especially as regards pricing and multiples.”

There are deals on the horizon, however. For example, Carlyle Group is reported to have mandated Deutsche Bank to explore sale options for packaging company Otor, which the buyout house acquired in 2000.

Otor is France’s largest producer of corrugated board and was acquired by Carlyle in controversial circumstances, thanks to protests from its original owner that he had been misled. Another company that could be on the block is the glass packaging and bottles subsidiary of Saint-Gobain, which could be worth several billion euros.

Deloitte’s Sami Rahal agrees that in the market up to €200m there is still significant activity in France, whereas in the €200m–€400m market some deals are being done. “But above €500m the market is pretty weak and people believe that there won’t be much significant change until Christmas, or possibly next spring,” he says.

There have been some larger deals closed since the credit squeeze. Earlier this month (October), buyout house Eurazeo closed its €2.3bn acquisition of ELIS, a leader in rental and cleaning of textile and hygiene services with revenues of about €1bn and 13,000 employees across Europe.

Eurazeo invested €393m of equity and Eurazeo Co-investment Partners €75m. Acquisition debt for a total amount of €1.85bn was underwritten by BNP Paribas. The company was acquired from buyout house PAI Partners, which bought the business for an enterprise value of €1.5bn in 2002 from BC Partners.

When ELIS was being auctioned in the early summer there was already some nervousness in the debt markets and some bidders dropped out because they couldn’t arrange finance at the price that PAI was asking for the asset.

According to some in the market, the deal ran into problems in its syndication. “The ELIS deal may have closed but I don’t think the syndication has been completed and the same is true of the OGF deal,” says one observer.

Rahal says that some private equity houses, such as 3i, are looking to take minority stakes in companies, given that asset valuations are dipping. Another trend is towards club deals among the banks, particularly when a business that the banks know well and are comfortable with comes to market.

“What we seem to be seeing more of is that instead of auctions taking place we’re seeing a private equity house and group of banks make a direct approach to buy a portfolio company from another private equity house,” says Rahal.

Buyout houses are reluctant to auction assets at the moment, for fear of not achieving the price they want.

“People don’t want to put up a company for sale and fail to get the price they’re seeking, because that tarnishes the company and makes it harder to sell six months later when the market may have improved,” says Rahal.

That’s why there has been a move towards direct approaches for specific assets, in which the potential purchaser puts an offer on the table. “I’m currently engaged on three such proposals,” he says.

Patrick Sayer, chief executive of buyout firm Eurazeo, says that for transactions sized between €500m and €1bn there is still liquidity among debt providers, often through club deals, as long as the asset being targeted is attractive. For deals over €1bn, liquidity is a problem because the syndication market for this size of deal is effectively closed.

Sayer adds: “Provided there is not a global credit squeeze, I think we’ll see the market reopen sometime in the first six months of next year as LBO financing remains a lucrative business for banks with a limited number of failures, but whether it’s the first or second quarter remains to be seen. The corporate market is still open and there’s still an appetite to do deals.”

On the ELIS financing, Sayer says that BNP Paribas “stood by its word” in holding on to the debt it underwrote but that there had been constructive discussions between the two parties, which resulted in a slight restructuring of the deal at no additional cost for Eurazeo.

Frederic Pinet, a managing partner at law firm Ashurst in Paris, says that he expects a return to how deals were being done before the fevered activity of the 12–18 months leading up to the summer.

“We were seeing sometimes quite aggressive legal documentation but I think we’ll see credit documentation that is more balanced,” he says. “When the market was so heated we had share purchase agreements with very limited warranties and more and more ‘covenant loose’ credit documentation, but things will be more balanced in the future.”

However, Pinet says he is not pessimistic about the market’s outlook, arguing that the US sub-prime market has no direct links to the French economy and that the fundamentals underpinning private equity activity in France are still present.

When it comes to the mid-market, deals are being done, according to Jean Eichenlaub, managing director at European Capital in Paris. The firm has closed three deals in the last two months – the buyout of insulated glass manufacturer Devglass, an investment in inspection devices designer Tiama, and an investment in hearing aid distributor Audika.

“There are fewer exits in the mid-cap sector than before but there’s still activity,” Eichenlaub says.

The mid-market has been less affected, he says, because the French banks that typically finance these deals have been less affected by the US sub-prime fall out than the large investment banks. He adds that club deals among French lenders have become more common, saying: “For example, we raised €40m of debt from Natexis and Banque Populaire for the Devglass transaction.”

Eichenlaub says that the three investments typify the kind of growth prospects that European Capital is seeking. Devglass makes dual-pane insulated glass, which he predicts will benefit from government incentives to reduce energy consumption, while Audika can take advantage of the growing demand for hearing aids from an ageing population.

Like others in the market, he expects fewer deals in the next few months and a calmer market after that.

“But we must remember that this comes after two fantastic years for the French buyouts market and so it’s not that surprising that we’re seeing a return to more normal levels of activity,” says Eichenlaub, adding that debt multiples have fallen from six to seven times before the summer to five to six times. “Sponsors are also putting more equity into deals,” he says.

Eichenlaub also argues that it is important to keep the current credit squeeze in perspective, saying: “The French economy is doing fairly well and is less affected by the US economy than many other countries, and the stock market in France has been very buoyant.”