Making the grade

The fact that there is no access to the stock market or bonds market, also the fact that some Spanish banks have incurred huge losses from investments in Argentina and Brazil, forcing them to look for liquidity by divesting of some of their industrial portfolios and non-core activities is producing some prime targets for private equity houses,” says Alejandro von der Pahlen, who has recently been appointed by Candover to originate deals for the firm in Spain and Portugal.

Interest in Spain has reached a peak in the last year with players such as Advent International, Bank of Scotland, Candover and MCH Private Equity all attempting to make a mark in a market that is expecting deal flow to mushroom in 2003. And established players have been boosting their teams in anticipation of a surge in activity. ABN AMRO, which opened its Madrid office last year, has strengthened its Spanish team with the appointment of Carlos Godina Queralt. Ashurst Morris Crisp also added to its Spanish team with state lawyer Gonzalo Jimenez-Blanco who joins from BT Ignite Espana. His appointment follows a strong period of organic growth for Ashurst’s Spanish practice, with the hire of Jesus Almoguera and his team of lawyers from Arino & Almoguera last October.

Status quo

The biggest stumbling block is not lack of opportunities, but convincing entrepreneurs to accept financing and getting the right valuation for companies. A recent example is Vista Capital, the venture capital fund owned by SCH and Royal Bank of Scotland, which was forced to drop its high profile EURO600 million purchase of Seur, a package delivery company. Valuation was the main issue.

Carlos Pazos senior partner at international law firm, SJ Berwin says: “The big challenge in Spain is to convince entrepreneurs that VCs are not just bankers, that there is value behind their contributions and it is not just money looking for high yields. It is a fundamental cultural issue it is a huge challenge to convince entrepreneurs how they can be much better off with VC investors.”

A major shake-up at the end of the 1980s and in the early 1990s with many companies up for sale meant the old breed of entrepreneurs in Spain died, says Pazos. It takes time for the new breed to grow up. It is for this reason that the market in Spain has not exploded like the rest of Europe. There are a lot more people looking to Spain with more interest for two main reasons, he says. Firstly, it has a very powerful mid-market sector formed by this new breed of entrepreneurs. And secondly, probably for the first time in its history, it is in a good position economically prices in Spain are selective and there are good companies with spectacular rates of growth. “I believe we are about to see an explosion of activity in Spain there have been a strong wave of foreign houses landing in Spain,” says Pazos.

But there is room for improvement. “It is abnormal that in Spain there is such a low level of domestic money going into funds compared to the rest of Europe,” says Pazos. The main reason he cites is that pension fund schemes in Spain are not as developed as some other countries. According to the European Venture Capital & Private Equity Association (EVCA) funds provided by domestic investors represented 66 per cent of the total, while 32 per cent came from other European countries and the remainder from outside Europe.

Spanish family-owned companies have traditionally been suspicious of private equity firms, but this is changing as the market matures. “Eighty per cent of buyouts in Spain are family businesses – this is the fundamental difference between Spain and other European markets,” says Gordon More of Bank of Scotland, who is heading the group’s Madrid office, which set up this year, with Juan Carlos Gabilondo. More says: “Quality of management systems and information is weaker in Spain you have to spend more time with the management. This is one of the difficulties of doing deals in Spain there’s a longer gestation period for a deal.”

He adds that it’s also an educational issue. “The motivator in Anglo-Saxon culture is to make management wealthy, while there is a more of a family tradition in the southern European countries.” But this is changing. In the past many Spanish companies didn’t trade outside Spain, now there are younger, more experienced managers who are expanding internationally and need extra financing.

Companies in traditional sectors with strong growth or consolidation prospects are the main attraction in Spain. Service-related industries are regarded as a good source of deal flow as is the entertainment sector and tourism. These industries are not as cyclical as technology. They have more of a steady cash flow and so there are good risk reward opportunities, says Jordi Vilanova of Granville Baird Capital Partners. “There are more and more [Spanish] family-owned companies who are becoming confident with this financing instrument. It’s a case of letting management know the risk rewards of MBO projects,” he says.

Most deal flow emanates from Madrid and Barcelona. For the smaller deals you have to look to Barcelona, which is rich in opportunities thanks to a strong university culture. If you want larger deals in traditional sectors, you look to Madrid, the Spanish financial centre. To facilitate links between the two cities, a project to launch a nationwide high-speed train network is underway with a Madrid-Barcelona line opening in two years.

The journey by train currently takes over six hours so most fly or even drive. Madrid-Barcelona will take about 2.5 hours and other journey times nationwide will be slashed as the government invests over EURO40 billion in an expansion of high-speed links and connections. The new network aims to replicate the success of Spain’s only high-speed rail link between Madrid, Cordoba and Seville.

PE & VC fund raising

There are mixed feelings when it comes to fund raising in the Spanish market. Excel Partners is currently on the fund raising trail, but in challenging market conditions has reduced it target from EURO400 million to EURO300 million. “It’s a difficult market , but we seem to be making reasonable progress. The interest is there, but it’s getting investors to sign,” says partner David Bendel.

For the moment, Excel is concentrating on its portfolio. Bright stars include the Real Musical group, founded in 1969, which comprises three companies, Real Musical SA, Real Musical Ediciones y Publicaciones and Real Musical Educacin, encompassing three business lines: distribution of musical instruments and publications, its own music publishing company and education. The group’s goal is to create a music hypermarket. “Spain has a tremendous culture and passion for music,” says Bendel. “The music industry in Spain is still fragmented and so offers huge potential. We will build this group through acquisition.”

Another hopeful in Excel’s portfolio is the firm’s 1999 investment in motorbike manufacturer Gas Gas. “For some reason, trial biking is immensely popular in Spain. This is a sport that offers opportunity for the whole family and most parents like their kids to come and join them,” says Bendel. Excel hopes for an exit next year via a trade sale or even a secondary buyout. Private equity houses like motorcycle businesses, says Bendel. Long before Excel placed its bets on Gas Gas, Texas Pacific Group and Morgan Grenfell Private Equity broke ground in the industry in 1996 investing $113 million for a 51 per cent stake in Ducati, the Italian bike maker. In 1999 the firms also acquired Italian scooter maker Piaggio.

There has been a wave of new Spanish funds launched in the last year such as Andaluca Capital Desarrollo, Agrolimen Inversiones, Caixa Capital Dearrollo, IE digitales, Invercartera Capital, Fonsinnocat, Rodania and Tormo Capital.

Catalan Bank Caixa Catalunya has boosted its private equity activity this year with several initiatives. In April it acquired a 45 per cent stake in Baring Private Equity Espana and agreed to provide a cornerstone investment in BPEP Espana’s future fund raising. Until recently the bank mainly invested in private equity via local fund managers including Catalan d’Iniciatives, Barcelona Emoren, Innova 31, Marco Polo, Invercat Exterior, Ged Iberian Fund, Nexus Capital and Webline Investments.

Most recently the bank has committed to invest EURO30 million in SMEs by 2006 in the northeastern region of Spain. The investment will be carried out through a venture capital company, Invercartera Capital SCR and will include ten SMEs. It will look to invest around EURO3 million per transaction in return for minority stakes.

A sign of a maturing market, there are also firms who are well into fund raising for second and third generation funds such as Espiga capital, Inversiones Ibersuizas and Talde.

Hoping for a year-end close is the third offering from Spanish investment boutique Riva Y Garcia. Sebastian Waldburg, director of the private equity department joined the firm three years ago to help set up the venture capital division, says fund raising has been tough and they have been marketing for a year and a half. The fund, named Spinnaker after a powerful yacht sail, has attracted EURO21 million so far and hopes to close on EURO30 million. The firm also manages Invercat, a EURO24 million start-up fund set up by the local government to target investments in Catalonia, and Webcapital, a EURO3 million seed capital fund.

For the moment the firm is specialised in early stage VC investments. But Waldburg does not rule out raising a buyout fund in the future once the team has gained sufficient experience in the early stage sector. “We could raise a buyout fund. The buyout market is probably the more traditional market for investment in Spain. It depends on what we’d be able to raise and whether we’d proved ourselves with our first funds. Our corporate finance experience would definitely stand us in good stead.”

The firm’s background in asset management and private banking is a unique aspect of the business and means the firm has a number of income streams which means you don’t expose yourself to so much risk, says Waldburg. “At the end for clients what you offer is an integrated approach it is a bonus for private equity firms that have corporate finance experience in-house.” Waldburg says the firm has very clear mechanisms in place to avoid any conflicts of interest.

A star on the fund raising circuit is Spanish domestic house Nmas 1. The mid-market fund, which has a target of EURO200 million, has raised EURO135 million so far from investors including General Electric, AIG, Axis Capital and two Spanish institutional investors. The team is anticipating an imminent final close. Paz Ambrosy, investor relations manager at Nmas 1, said the new fund will invest alongside the firm’s first fund, Dinamia, which is the only private equity fund quoted on the Spanish stock exchange. By increasing its fund under management Ambrosy says the firm envisages doing more deals independently and to syndicate less, a trend that is increasing among Spanish private equity houses.

Well-established Spanish player, Granville Baird Capital Partners has changed its investment strategy to evolve with the maturing Spanish market. Its EURO30 million Spanish fund, which co-invests with the firm’s pan-European funds was originally, focused on early stage IT investments. Now the firm is aligning its investment strategy in Spain with its other European offices and will focus on direct investments no lower than EURO6 million. It will target both expansion and buyout transactions and is also expanding to include a more diversified portfolio of industrial products, business services and healthcare.

Why the change in focus? Jordi Vilanova explains: “From an internal standpoint the history of Granville as a private equity player has always been positioned in the mid-market this is nothing new for us. At the time we set up in Spain early stage was the name of the game. For us this is a very natural evolution. We see the [mid-market] segment growing. Early stage is not a segment that is appealing to our investors.”

By leaving the early stage sector, Granville is making room for players such as Barcelona Empren, Riva y Garcia and Rodania, but there is still a gap for early stage funding in Spain. “The VC industry in Spain needs more support,” says Emilio Gomez of Barcelona Empren, which is currently investing a EURO7 million fund in seed and start-up situations. There are so many good ideas spinning out of the Spanish universities, but not enough cash to fund them. Gomez illustrates his team’s frustration. In 2001 Barcelona Empren saw 150 opportunities. On average out of every 100 opportunities around 30 per cent are analysed in depth, says Gomez. Seven per cent of the total are approved by the investment committee and only three per cent are finally closed.

Barcelona Empren is in a niche position it was one of the first firms in Spain to look at seed capital and technology innovation, but it has still not witnessed any exits. The Spanish mid-market may offer the perfect solution and maybe Barcelona Empren’s and other early stage portfolio companies will boost Spain’s secondaries market, offering players such as Granville and 3i an extra source of deal flow.

Svante Borjesson of early stage investor Rodania, says the reason for the lack of early stage funds in Spain is the risk factor. “It is a market development issue. It is very difficult to raise funds in Spain as pension funds do not commit to this asset class. I’m sure they will in five to ten years’ time, but not just yet.”

Banks cash in

While Spanish private equity houses have more money to invest and envisage leading more deals independently, an increasing number of banks setting up in the region are looking to syndicate deals as opportunity grows. With the likes of Bank of Scotland and Royal Bank of Scotland, which have both set up in Madrid in the last year, Spain is just starting to see the benefits of structured finance instruments.

Bank of Scotland’s Spanish office, located in the central financial district of Madrid, has been operational since May and offers a full range of corporate banking services including acquisition finance, corporate banking, real estate finance, infrastructure finance and project finance. The six-strong team headed by Gordon More and Juan Carlos Gabilondo has already written in excess of EURO100 million since its doors opened earlier this year.

Stewart Livingston, head of the European corporate business of Bank of Scotland, is confident increased competition among the banks will be beneficial for the marketplace and can only help in raising the profile of private equity in Spain. “One of the challenges in the Spanish market is syndication a lot of banks in Spain shy away from syndication. We expect to see some retrenchment of the Spanish banks.”

He adds that deal structures in Spain will become more sophisticated. “The new entrants in Spain are used to dealing with mezzanine. We are looking at a deal with a mezzanine structure right now. This is ammunition we’ve got in Spain and we know how to use it.” With the likes of Bank of Scotland, Royal Bank of Scotland and ICG, which is rumoured to be setting up in Spain in the near future, the use of mezzanine in Spain is bound to increase.

There are not many banks in Spain active in acquisition finance, but the presence of more private equity houses will encourage more banks to arrive, says former SocGen director Beltran Paredes, now head of Royal Bank of Scotland in Madrid. (Royal Bank of Scotland is also present in a venture capital capacity through Vista Capital, its joint venture with Santander Central Hispano.)

Paredes describes Spain as a fantastic place for mid-market buyouts. “There have been very few failures over here because the market is less mature and hasn’t over-extended with leverage as may have happened in more developed markets. We haven’t seen over-leveraged debt structures. We have had a very prudent market with reasonable multiples both with acquisition and leverage terms, very few mezzanine deals and no high yield. In addition, some of the most sophisticated instruments are still in the earlier stages in this market; for instance, convergence of securitisation and leveraged finance hasn’t happened here yet. But it will.”

Carlos Pazos of SJ Berwin agrees. “The traditional philosophy of Spanish banks has been old-fashioned you don’t think of Spanish banks when you finance a buyout.” Spanish banks are however becoming more interested in the high margins generated in this sector. “Initially they had initiatives investing from their own balance sheet captive funds now they are even investing retail clients money,” says Pazos. “There is more interest from banking executives who are leaving the banking sector to try their luck in the private equity market. They see private equity professionals as better paid and look at the returns and think I want some of that!”

Indeed this year has been a tough one for Spain’s banks. Argentina’s economic demise and recession in Mexico have left two of Spain’s largest banks, Santander Central Hispano and BBVA with problems. The crisis in Latin America has led them both to issue profits warnings this year. The two banks expect profits to shrink 10 per cent in 2002 and both institutions this year have undergone criminal investigations of their boards. SCH is contesting a judicial inquiry into the legality of some high yield deposits offered to clients in the 1980s. One magistrate alleges the bank falsified documents for clients to help them evade taxes. BBVA is also under investigation over $200 million secret offshore funds that were used to make generous contributions to the election campaigns of politicians in Latin America and to top up the pensions of directors.

As these banks struggle to come to terms with these and their balance sheet problems, a gap is left for both the smaller domestic Spanish banks and the pan European players. Redundancies at major Spanish institutions are unleashing a new wave of seasoned professionals for the likes of Bank of Scotland, which has been actively building its Spanish team. Bank of Scotland has recruited a purely local team targeting the Spanish business community, finance houses and local banks and has also recruited from French banks, which demonstrate considerable experience of working in the Spanish market. More said: “We saw a mix of people applying for positions. We are seeing more and more opportunities to recruit high quality people because of the high number of institutions that are being forced to cut staffing levels.”

David Bendel of Excel partners says: “The domestic banking sector is under huge pressure and so people like Gordon at Bank of Scotland will be very happy there is a great opportunity for [foreign] banks setting up here.” He adds that there is a severe credit squeeze among the Spanish banks. “Domestic banks are hugely busy rebuilding their capital after suffering huge losses in South America. They will therefore either have to sell assets or rebuild their loan books to increase capital.”

Seeking advice?

Around half of deals in the Spanish corporate finance market are completed without advisers but there are a handful of firms that have managed to establish themselves in this niche. One is Atlas Capital, a mid-market advisory boutique established by a team of 16 corporate financiers from PricewaterhouseCoopers in 2000. Headed by Leon Benelnas and Pablo Cervera, Atlas has since doubled its team. A high profile hire for the firm this year was the newly-appointed head of debt advisory, Javier Rodriguez Izquierdo, who joined from JP Morgan Chase in February this year. He has 22 years experience of the Spanish debt market.

The ability to offer debt advisory services independently is a great advantage, says Ricardo Levit of the firm. In Spain there is very little competition in this field, as the debt market is still relatively young. The reasons for the firms’ success so far is down to its local presence and the fact that 30 per cent to 35 per cent of Atlas’ mandates are from contacts made through its PricewaterhouseCoopers connection. The firm also has a good relationship with many of the large investment banks based in Madrid and players such as Goldman Sachs, Merrill Lynch and Morgan Stanley often pass the firm deals that are too small for them.

Recently Close Brothers increased its stake in the firm to 20 per cent. The idea is that it will be a long term ownership and will provide Atlas with a good network of corporate finance contacts. “The fact that we have this international link, plus the fact that we are based in Madrid and Barcelona in this sense, we are unique. We are totally independent we do not have any link with private equity firms nor do we manage any fund at the moment,” says Levit. But he does not rule out raising a fund in the future. “You never know what will happen, but the thing we value most at the moment is our independence.”

The deal pipeline in Spain this year has not been great. Most investors are concentrating on either fund raising or nurturing their portfolios rather than making new investments. Deal flow probably won’t pick up until the second half of 2003 predicts Levit. As far as mega deals are concerned, he says, they do not exist in Spain. The big ticket players are fighting for deals. Carlyle has been here a while and has seen a few opportunities but has not yet closed a deal. Even Apax has only closed one deal Jazztel with Advent International, which it bought and sold very well, he says.

One of the biggest Spanish deals of this year, but not without its ups and downs, is CVC Capital Partner’s acquisition of Spanish high-voltage cable network, Iberdrola. CVC Capital Partners had originally agreed to pay EURO577 million, but the government threatened to block the transaction seeing a clear preference for local carrier Red Electrica de Espana (REE), of which it controls 30 per cent.

Iberdrola has since amended the agreement increasing the price tag to EURO617 million to incorporate the company’s fibre optic network, which was excluded from the original deal. REE will now commit EURO10 million to the transaction, acquiring a 25 per cent stake in Infraestructuras de Alta Tensin, the company created by CVC Capital Partners to complete the acquisition of Iberdrola. Proceeds from the transaction will be used to help Iberdrola pursue its strategic plan of focusing on power generation, in the light of planned liberalisation of Spain’s energy sector.

There is a mixture of realism and optimism among the Spanish players. Gordon More of Bank of Scotland says: “You’re not going to get the Le Grand or NCP deals in Spain. Deal flow is slow, but has definitely picked up since the summer. This year for completions it will be poor, but 2003 will pick up.” Sebastien Chartier of Spanish corporate finance newsletter, Capital & Corporate predicts: “Next year should be a great year for investment. There is an overhang of funds the money has to go somewhere.”