Secondaries fuel Italian market

The buyout industry in Italy has shown impressive growth in recent years and in 2006 a number of high-profile firms opened offices in Milan. There has also been a growing sophistication in how deals are financed, with more use of mezzanine and quasi-equity instruments.

Despite these trends, Italy remains an under-developed market considering its economic size. “In terms of private equity activity as a proportion of GDP, it is only 0.1% in Italy, compared with 0.3% for Europe and 1% for the UK,” says Marco Fumagali, head of 3i Italy.

There are a number of reasons for this, including the fact that the vast majority of buyouts are concentrated in the north of the country and particularly the area around Milan. The south remains a largely untapped market. There is also the continued reluctance by family-owned companies to sell to financial buyers.

“We’ve heard about succession issues at family companies for a long time and I think many companies are impressed with the multiples buyout houses are willing to pay, but perhaps they are holding on for prices to go even higher,” says Fumagali.

In 2006 equity investment in the Italian private equity market was up 22% on the year before, says Mara Caverni, a partner at PricewaterhouseCoopers in Milan.

“That rise comes on the back of increases in previous years,” she says, adding that there have been some significant deals in the early months of 2007. “I expect 2007 to be a good year, particularly as in Italy the first half of the year is traditionally quieter than the second,” she adds.

Caverni points to sectors such as financial services and the wine industry as being particularly attractive for buyout houses in the current climate.

She says: “In financial services, a lot of firms are eyeing the market and looking at what opportunities there are, even if they’re not yet at the stage of making acquisitions.”

The wine industry is attractive, she adds, because it is in the process of consolidation. “Major players in the wine industry realise that consolidation will be vital if Italy is to compete in a global market,” says Caverni.

It is the secondary market that has, in large part, been fuelling the Italian market in the past year. Among the major secondaries was last November’s acquisition by Blackstone of Gardaland, Italy’s largest theme park, from PE house Investindustrial and Banca di Verona.

Meanwhile, in December it was announced that Permira was selling its 80% stake in ferry company Grandi Navi Veloci to three funds led by Investitori Associati, in a deal valuing the company at nearly €700m. One of the biggest secondary transactions was Candover’s acquisition from Permira of a majority stake in yacht manufacturer Ferretti, in a deal worth around €1.7bn.

According to Fumagali, secondaries have been hugely important in fuelling activity at the upper end of the mid-market in Italy. He says there have been relatively few sizeable primary transactions since 3i’s acquisition of toy maker and retailer Giochi Preziosi in February 2006.

3i is thought to be considering listing 30% of Giochi Preziosi in an IPO that could value the company at about €1bn.

Privatisations are also likely to fuel deal flow. The government is in the process of selling a 39.9% stake in loss-making airline Alitalia. A consortium made up of Texas Pacific Group, US private equity house MatlinPatterson and Mediobanca is one of three groups likely to bid.

The TPG consortium is reported to have set aside €5bn to buy the company – €1.2bn for the bid and €3.8bn for investment in the airline. But it is likely to be a tough challenge for whoever buys the company, as they will have to accept conditions set by the government, including the guaranteeing of Alitalia jobs and the maintenance of loss-making routes.

Although secondaries are an important exit option for Italian investments in the current market, there are also opportunities for trade sales and flotations. Recent trade sales include the sale of engine maker Lombardini by BC Partners to a US corporate.

On the IPO side, Goldman Sachs Capital Partners floated Prysmian, which makes cables for the telecommunications and energy industries, in May. The deal valued the company at €2.7bn. Goldman Sachs bought the company from Pirelli in 2005 for €1.3bn.

Candover was one of the pan-European funds to open offices in Italy last year. Others included Cinven, Eurazeo and Cognetas. Private equity directors in Italy regard the arrivals as a vote of confidence in the Italian market. But it is not clear whether there will be enough deals to satisfy all the players.

One of the challenges is that the Italian market has grown in sophistication, both in the kind of financing available and the use by vendors of intermediaries.

Marco Franzini, a partner at law firm Simmons and Simmons in Milan, says that historically there was a clear split in transactions between the private equity investor taking 30%-40% and bank finance covering the rest.

“But we’re seeing more use of mezzanine and other hybrid financing instruments,” Franzini says, which enables purchasers to pay higher prices.

On the downside, he says, tax reform last year had a potentially negative impact on buyouts because it made the use of stock options for management less attractive.

But Franzini believes that the Italian culture of finding a way round problems means the changes are likely to be less damaging than they first appeared: “Italians can be very creative and can usually find a solution to this kind of problem,” he says.

The limited number of primary targets means PTPs are becoming more attractive, according to 3i’s Fumagali. Historically, there have only been one or two a year in Italy, partly because of their complexity.

But last week [May 16] Permira said it would pay US$1.06bn for a 30% stake in listed fashion company Valentino, beating a bid by Carlyle Group. The deal would value Valentino at €2.6bn (US$3.52bn). Permira is buying the stake from an investment vehicle run by the Marzotto family.

Marco Fumagali at 3i says that one factor that could make PTPs more attractive in Italy, compared with other countries, is that many listed companies are, in fact, controlled by a single investor or group. “Negotiation with one group can make it easier than where there is a large number of shareholders who need to be handled,” he says.

The acquisition of Valentino also illustrates the interest of private equity players in the luxury goods and high-end consumer market, which is one of Italy’s strengths. Italy has a lot of “quality of life” companies active in sectors such as fashion, cars and famous brand names, says Mounir “Moose” Guen, founder of placement agents MVision.

Guen says that Italian companies are often global leaders in a particular, niche product.

“It’s often very specialist, such as manufacturing glass bulbs to go inside TV sets or screws for the wheels in office chairs,” he says. Local PE firms are able to bring these kinds of specialist manufacturers up to a certain level, but it may require larger funds to really help them grow internationally.

When it comes to high-end consumer goods, Guen points out that some Italian companies are particularly vulnerable to competition from low-cost manufacturers in China, which might be able to copy designs.

“Some Italian companies have responded by moving production to China, while others try to make products that can’t be easily copied,” says Guen.

According to some buyout funds active in Italy, it is not manufacturing but the services sector that is particularly attractive. Palamon Partners, for example, focuses purely on services and Italy is its second-largest market for investment.

Stefano Bacci, a partner, says: “The Italian economy has traditionally focused on manufacturing but that will need to change because of competition from lower-cost countries. We see a lot of opportunities in services, especially financial services, because Italy is still under-developed in that area.”

Palamon has made two significant investments in the Italian financial services sector. The first was in Sigla Group, a consumer finance business, and the most recent was in Si Collection, a debt collection agency. Bacci says that Italy is probably where the UK was a decade ago in terms of the development of its financial services industry.

The firm brought in UK executives to advise on Sigla and help design loan products for the Italian market. As for Si Collection, Bacci notes that the Italian debt collection market is highly fragmented, with more than 200 operators, but is expected to experience rapid growth and consolidation.

But Bacci says that it is still not always easy to complete buyouts in Italy. “Entrepreneurs are still often unsure about what private equity is and their usual approach is to go to the bank for finance,” he says. “It’s only when they can’t get bank finance that they start to think about private equity.”

But things are changing, he adds. In the past, the Italian banks would have taken on both debt and equity in many cases, but today they recognise that it is more appropriate for private equity firms to hold the equity, while the banks limit themselves to debt finance, says Bacci.

He believes that future exits in Italy will come, in large part, from sales to international trade buyers.

“In sectors such as financial services, we believe a lot of international companies will want to be in the Italian market in the coming years, so our strategy is to create attractive companies that will give these corporates a foothold in the market here,” says Bacci.