When is big too big?

The news about the possible €11bn buyout of Grupo Auna broke at the end of last year. The acquisition of Spain’s second largest telecoms company by Apax, Blackstone, CVC, Carlyle and Providence Equity Partners would be the largest buyout in Europe, almost double that of the current title holder, that of Seat Pagine Gialle, which was bought in 2003 for €5.65bn by BC Partners, CVC Capital Partners, Investitori Associati and Permira. Tom Allchorne takes a look at the attractions of the mega-deal and asks when big is too big?

The sheer size of the Grupo Auna deal has caught everyone’s attention, but most don’t seem to feel that €11bn is any sort of limit on how big these deals can get. On the contrary, the general feeling seems to be there is no limit. If the assets are there, the debt is there and the equity is there, why not? “You’ve got to look at demand and supply,” says Charles Sherwood, partner at Permira. “Are there enough large transactions that would make sense to buy, and the answer would have to be yes.” Sherwood argues that what has driven private equity in Europe is industrial restructuring, where companies which have been run on national lines have become global groups. The assets were there to buy and the money was there to buy them. “None of that is anything to do with deal size. Just because the companies got larger, the logic doesn’t change.”

Going clubbing

For Sherwood, the constraint on deal size is not the opportunity but whether they can be funded. “Investors have been complaining that fund sizes are getting too big. The simple fact is that this isn’t true,” he says. “Fund sizes haven’t moved anywhere near as much as people think they have. They moved a lot from 1997 to 2000. Permira Europe I was raised in 1997 on €1bn, which was a lot at the time. When we raised Permira Europe II in 2000 on €3bn, it wasn’t regarded as anything extraordinary.”

So if the fund sizes have roughly stayed the same since 2000 but deal sizes have gone up dramatically, (the biggest deal at the time was the €3bn LBO of North Rhine Westphalia Cable), something has to give.

“That circle has been squared by clubbing,” says Sherwood. The forming of private equity syndicates is par for the course when bidding for mega-deals, but not everyone likes the idea of firms ganging up. “There is only so much doubling up that investors will tolerate,” says Katherine Belsham, assistant director at Intermediate Capital Group (ICG).

The problem with clubbing is that it becomes difficult to manage; certainly any more than four, and it’s five for the Auna deal, is going to be challenging. Gustav Öhman, partner and chief executive for Industri Kapital’s Western investment region, says: “The private equity governance model is more successful than the public governance model. With public companies the board has to guess what the stock market is doing. In private equity the owner is visible. The only job of a private equity firm is to make money, and the GPs sit on two or three boards for a living. If you then say there are two or three funds in there you dilute the strength of the private equity governance model.”

Problems may also arise if one of the funds wants to exit early. “This means you don’t get the home run you were after and also encourages short-termism,” says Öhman. “Private equity is about looking mid-term, but with clubbing, because you can’t predict what a fellow syndicate member is going to do, you take a more short-term approach.”

Slight return

Probably the most important issue when it comes to investing in private equity is exiting, and the size of the Auna deal raises good questions about how exactly you make money on such an expensive investment. With so many of the big boys on board for the Auna buyout, they can’t exactly expect to sell it via a secondary, and there won’t be many trade buyers out there wishing to pay tens of billions of euros for a company. The only realistic option is an IPO.

“Just because the companies got larger, the logic doesn’t change.”

As far as returns go, no matter how great an IPO might be, for an acquisition of €11bn, the return will not be spectacular. “Returns will be nothing like historical returns,” says Belsham “but the firms have accepted this and are going for the safer returns. They won’t generate massive IRRs or return multiples but they will generate a return.” A likely tactic, and as yet how much of the company each firm is planning to buy is unclear, but they probably won’t put in a lot of equity and then keep recapitalising it over the years to squeeze as much money out of it as they can.

According to Adrian Johnson, chief executive of L&G Ventures: “The message in all this is the tremendous growth in private equity. All these big boys have got bigger funds and are placing bigger bets. Private equity is becoming such a big part of M&A activity. I think while investors continue to invest in the asset class the sky’s the limit.”

The evolution of private equity into the mega-deal is part and parcel of the success of the industry’s big players. They raise a fund, make some good returns which means they are able to raise bigger funds and so invest in bigger deals which means they are able to raise even bigger funds and so on. Many of the mega-funds still have money left to invest and so it is inevitable that their attention is going to turn to larger assets.

Trade away

The absence of the trade buyer is an important factor in the growth of the private equity mega-deal. Öhman says: “I think we are in a pretty unique situation because the trade buyers aren’t there and the stock market is there, but the IPO market isn’t. Throughout the 1990s there were a bunch of assets that we were not able to touch because either the trade buyers would out bid us or the stock market would prove more appealing with its lower capital costs and no credit costs. Now the prices in the private equity market are at the same levels or above those in the public market.”

Debt is also continuing to be priced at very generous levels, and there seems little indication this is going to change. “Most commentators agree that the quantity of debt available is unlikely to come down,” says David Moreland, director, Close Brothers’ debt advisory group. “Certainly we don’t see anything on the horizon which will affect debt pricing. The only thing which could affect it is if a larger deal doesn’t syndicate; then the banks may become more reluctant to provide debt.”

Private equity has proved itself to the debt world that it is a safe bet. One fund manager was recently speaking to a banker about the high multiples currently being given for some LBOs: “The banker said he is quite happy about it because he has a motivated guy holding 25% of the equity who is a junior to him.” When it’s put like that, it is not hard to see why bankers hold private equity deals in such high esteem.