Review of 1999 Mid-market investors still searching for the exits

As the new Millennium crept ever closer, preparations intensified for the world’s biggest ever party. But Europe’s private equity community could have been forgiven for cursing the very notion of celebration. Throughout 1999, the Y2K issue had been like a cloud hanging over businesses everywhere. For venture capitalists, the risk of putting deals together in such uncertain times was not a risk worth taking.

With the benefit of hindsight, perhaps there was a little less to worry about than everyone had imagined. But the uncertainty did take its toll of mid-market players. While the LBO houses were in theory investing in companies sophisticated enough to combat any potential Y2K issues, smaller companies were clearly more vulnerable. Says Chris Harper, a director at IT sector specialist Granville Private Equity Managers (GPEM): “We knew Y2K would make it a difficult year. IT service revenues were falling away, and there was no visibility on business recovery.” However, he adds: “We are now working on those deals which fell over in the final quarter of last year. Confidence has come back quickly now that the period of uncertainty has gone without a glitch.”

Simon Wildig is a director at Close Investments (Close), which invested in eight deals last year with an aggregate equity injection of GBP40 million ($65 million) in traditional’ UK mid-market companies. He, too, noticed investment activity trailing off in the second half of last year. “It was pretty buoyant in the first half – PLCs were selling things, and that’s still the case. It was a bit quieter in the second half but since then it has quickened up again and there’s very healthy work in progress.”

Presuming that it is now business as usual’ in the buyout market, participants may now return to core strategic issues, having been distracted by the apparently reticent Millennium Bug. For most mid-market investors this means consideration of the pros and cons of sector specialisation and geographic diversification.

It has been noteworthy over the last year or two that the traditional’ mid-market, where investments in non-core subsidiaries of manufacturing companies are prevalent, has been neglected in favour of either larger deals or technology-related investments. Perhaps the most groundbreaking development was 3i’s announcement of its emphasis on technology – while the firm claimed not to be moving away from plain vanilla’ transactions, the implication was clearly that technology is where it’s at’.

But not all are deserting the mid-market playing field. Wildig is encouraged both by 3i’s move and by the enthusiasm of former competitors to migrate to the larger deal arena. “It’s leaving the market with less funders and hopefully we’ll get a bigger market share. It’s a great market to be in in terms of sheer volume, and there’s plenty of quality about. Some of the highly leveraged buyouts may not perform as well as expected, and you may find some firms refocusing back on the mid-market,” he says.

However, not all firms associated with the mid-market are quite so enthusiastic about its prospects. In the wake of the Ivory & Sime/Baronsmead break-up, the newly-formed Friends Ivory & Sime private equity (FISPE) found itself in a position to sit down with a blank sheet of paper and re-evaluate its strategy. It concluded that plain vanilla’ mid-market deals were unattractive and that the only viable way to create healthy returns was by way of sector specialisation and developing continental European partnerships through its parent company’s Eureko alliance.


Says Wol Kolade, deputy managing director at FISPE: “It has taken a long time to build an understanding with our alliance partners, including how and why we should come together. But the upside has been so great, we now see it as an absolute necessity.” Kolade claims that several deals in the firm’s current pipeline have a pan-European element directly attributable to the alliance. Of other mid-market firms which have maintained a generalist, UK-focused’ approach he opines: “I really don’t know why some of the competition is doing what it is. Firstly, you will struggle to put money out in the UK. And secondly, to create assets the markets want, you may have to go pan-European.”

Even traditional’ investors such as Close are considering ways of adapting strategically. Wildig concedes that Close, which is due to raise a new fund this year, is considering some kind of move into technology. In addition, and despite being of the opinion that if we are doing well in the UK, there is reason to move out’, he is not ruling out developing a continental European presence. “We have an eye on Europe, but it’s a case of one step at a time. It would be folly to go from a single office to being pan-European in, say, 12 months.”

There is a tendency among some mid-market players to see technology as a panacea. But even for those who have historically specialised in the sector, such as GPEM, it is difficult separating the good from the bad. “In the last 12 months we have been inundated with dot com opportunities,” says Chris Harper. “People have focused on what they see as easy money, and in reality there’s no such thing. We have taken a cynical view of a lot of them due to the issue of long-term sustainability and whether they can generate revenues.” GPEM’s approach is low volume and highly selective. However, Harper concedes that due to the weight of opportunities in technology, there is also scope for a volume player such as 3i to succeed with a portfolio approach where the flyaway successes will more than compensate for the failures.

The flight to technology’ has taken place against a background of an investor frenzy to buy up high-tech stocks combined with indifference towards small to mid-cap stocks. This has driven the likes of Close to seek alternatives to the stock market as a way of exiting businesses. For example, it recently sold heavy machinery supplier HM Group in a secondary buyout to Alchemy Partners, having recognised that there was little likelihood that the business would attract either trade buyers or sufficient support on the stock market for a flotation. While buying from another venture capital house was once anathema, it is becoming part of the landscape. Says Wildig: “Secondary buyouts have been forced on us a little bit, and there is a reticence to do it, a natural suspicion. But the venture capital world is a small community and you can find out a reasonable amount about companies before you buy them. If both sides are comfortable, it shouldn’t be a problem – it has become a fact of life over the last year or two.”

There has been some speculation by commentators that it will not be long before small to medium-sized stocks are back in favour again on the public markets. While that may be so in the long term, Europe’s venture capitalists see little evidence of it yet. “Traditional assets are not attractive unless they’re in a consolidating industry, and even then they’re not attracting sexy p/e’s. Even if there is a correction, I don’t see the situation changing, it only means people will become more discerning,” says Kolade.

All the while this scenario prevails, the opportunity will be there to continue the trend towards public-to-privates (PTPs) which first re-emerged two years ago, having initially been common in the 1980s. Of the eight investments made by Close last year, four of them were PTPs. An interesting variation on the theme was the stake the firm took in Hill & Smith, the rationale being to attempt to turn the company around with the option of taking it private if the strategy was not well received by the City.

Another way of countering the negative attitude towards smaller stocks is to use the initial investment as a buy and build’ vehicle to create a larger asset which will be viewed more favourably. Last year, for example, Close made its third follow-on investment in Gibbs Palmer, which enabled it to complete the acquisition of market competitor Nursery Supplies Bourne.

GPEM-backed Elan Computing was another company to be given financial muscle by a venture capital firm in order to strengthen its position in the market. In its case, a GBP14 million ($23 million) investment was sufficient to bolster its balance sheet and enable it to acquire struggling competitors.

Many mid-market investors will have breathed a sigh of relief that the turn of the year did not bring the anticipated chaos resulting from Y2K issues’. However, the new Millennium has brought in its wake serious questions. One of the most pressing is whether or not to jump on the technology bandwagon, which in some cases may mean abandoning – or at least giving less emphasis to – their traditional areas of operation. For those firms which opt to stick to what they know, can they generate sufficient returns to keep investors happy in an environment where the exit door remains firmly closed?

Top UK Buyouts completed in 1999

Target Activity

Zeneca Specialties Mnfr chemicals

William Hill Betting shops

Sears Shoe stores

Hillsdown Holdings Mnfr food; mnfr furniture

Ineos Acrylics Manufacture acrylics

BTR Paper Technology (Invensys) Paper industry equipment

Coral Group-UK Businesses Provide betting services

Inn Partnership Own and operate public houses

Money Store-UK Mortgages Mortgage Portfolio

Dynacast Mnfr engineered components

Greycoat Real estate development firm

Thomson Directories Publish telephone directories

PHS Holdings Investment company

Charter PLC-Special Engineering Manufacture rail track,

defence equipment

Earls Court & Olympia Exhibition management services

Norcros/Stormgrange Tiles, adhesives, showers

Mettis Group Aerospace components

First Leisure Corp-Nightclubs Own/operate nightclubs, bars

Rebus Group Provide computer related services

Lambert Fenchurch Group Insurance company


Equity arranger Value (GBPm)

Cinven/Investcorp 1300.0

Cinven/CVC Capital Partners 825.0

January Investments 548.3

Hines/McKinney, Hicks Muse 537.5

Tate & Furst

Charterhouse Development 505.0

Apax Partners 489.6

Morgan Grenfell Private Equity 390.0

Nomura Intl (Nomura Secs Co) 370.0

Cabot Square Capital 325.0

Cinven 322.0

Mercury Private Equity 282.5

Apax Partners/3i Group/ 220.0

Advent International

Charterhouse Development 215.0

Candover Investments 194.0

Candover Investments 183.0

NatWest Equity Partners Gp 171.1

3i Group PLC 170.5

Candover Investments 170.0

Warburg Pincus/General 168.3

Atlantic Partners,CT

DLJ Phoenix Private Equity/Candover 130.9

Investments/Electra Partners/

Advent International

Source: Thomson Financial Securities Data