With the collapse of credit markets, firms are increasingly willing to tread into unknown territory to find new opportunities abroad. A PricewaterhouseCoopers report on private equity investment (citing Thomson Financial data) noted that international buyers accounted for 23% of all U.S. mergers and acquisitions in the first 11 months of 2007. These cross-border deals totaled $354 billion, up 73% from the 2006 full-year total.
“The U.S. is particularly attractive because the U.S. dollar is at an all-time low,” Greg Peterson, a partner in PricewaterhouseCoopers Transaction Services, stated in a press release about the report.
Opportunities for investment in Europe and Asia are equally abundant, say private equity experts. Although individual markets have their inherent challenges, adopting a global strategy may be one approach to weathering the current economic slowdown.
“There’s massive potential for private equity [in Europe],” said Vince O’Brien, director of London-based Montagu Private Equity and immediate past chairman of the British Venture Capital Association. O’Brien, who participated in a panel discussion with other industry experts from Europe and Japan at the 2008 Wharton Private Equity Conference, noted that an analysis by Montagu found the total of all private equity deals in Europe in 2006 to be $150 billion, compared with the $12 trillion to $13 trillion total value of European stock exchanges. “We’re actually a small portion of the European economic environment. In Western Europe, we do have a very attractive, strong private equity industry and I think there’s plenty of business to do, particularly in the UK, Germany, France and the Nordic countries.”
The London private equity firm 3i, with $16 billion under management, expanded in Europe 10 years ago and now has 60% of its assets outside the United Kingdom. In Asia, it is focused on India, China and Southeast Asia. Patrick Dunne, group communications director, said 3i views Asia as a “triple play.” First, Asia represents a chance to make high-growth investments, he noted. Second, 3i has learned through its European portfolio companies that firms in developed countries need access to emerging economies in Asia. Third, he said, Asia is a hot market for exits. Companies that expected to exit private equity ownership in 7 to 10 years are exiting after only a few years amid a “flood” of exits expected to continue in China and Southeast Asia in the next two years. “We have underestimated dramatically how quickly exits would come in Asia,” Dunne said.
UK investors often question whether taking a minority stake in a Chinese company is “sheer madness,” Dunne added, because of corruption and state intervention in markets. On the contrary, his firm has had more problems with flat-out accounting fraud in Germany and Italy than with any problem in China or other Asian nations.
“We’ve made mistakes along the way — some of them hugely entertaining, some less so — but in terms of potential, our continental European business is 40%, and I think Asia has the potential to exceed that quite soon,” Dunne said.
Hiroshi Nonomiya, representative director and managing director of RHJ International Japan in Tokyo, specializes in industries including automotive parts and financial services, as well as cross-border roll-ups. He said private equity opportunities in the Japanese market are growing as a result of spin-offs from conglomerates that have grown too large to effectively manage their subsidiaries.
The biggest challenge in developing private equity deals in Japan, he noted, is persuading CEOs to sell a business unit. CEOs and company presidents are typically capping off careers of 35 years or more and are not interested in upsetting the status quo with a private equity transaction. Compared with their counterparts in the United States and other countries, Japanese executives hold less equity in companies and have less to gain from a leveraged buyout. “In many cases, they want to spend those last two or three years peacefully,” Nonomiya said.
A Pan-European Approach
Colm O’Sullivan, principal with PAI Partners, a pan-European private equity fund spun out of French Banc Paribus in 1999, said his firm has investments spread across nine countries. More than half of the companies PAI looks at operate in more than one country and most are pan-European or global. “They often have assets in more than one market, but if they are in only one market, I can almost guarantee that over time they will become a pan-European company,” he said.
Since the introduction of the euro, consolidation in Europe has accelerated, O’Sullivan noted. Still, vendors, management teams and regulators can be very country-specific. A pan-European approach can give private equity firms the ability to both envision an opportunity and put it into motion. To do that, O’Sullivan’s firm maintains a matrix organization. “We look at assets right across Europe and across sectors,” he said, “and then we have local offices in Madrid, London, Munich and Milan where we try to have the local content, someone who speaks the languages who’s an insider in the market locally.”
This allows the firm to be aware of the regulations and intricacies of doing business in the country, he said. “But also we can see deal opportunities across Europe and opportunities to combine companies, or ways in which we can compete and learn lessons from elsewhere.”
That approach has provided PAI Partners with insights into France, for example, that not all competitors may have. “The external pessimism about restructuring and redundancies in France is a great barrier to entry to other people coming into our market because we can be more confident about what it will cost and how quickly we can do it in terms of restructuring, closing factories, etc. And so it gives you a certain higher expected value, because you’re more certain of the probability of success and what the costs are.”
The Challenge of France
Thierry Timsit, managing partner and cofounder of Astorg Partners, which specializes in mid-market buyouts in France, said France is often depicted as one of the most difficult European markets to address for foreigners. “We don’t speak English. We hate capitalism and globalization. We love smelly cheeses and our president [is married to] a top Italian model. This is not easy to address for Anglo-Saxon investors.”
According to Timsit, France has a large number of family businesses spawned by post-World War II entrepreneurs who are having trouble with succession plans and would like to find a way to liquidate at least some of their equity. Half of Astorg’s business is with family-owned firms, with owners reinvesting 25% to 49% of the firm’s value, he said.
Another strong market is spin-offs from large corporations that were created by the government from the 1950s through the 1990s and that are now being turned over to private investment. “That has created bread and butter for private equity players stripping out these large corporates,” Timsit said. He noted that it is more difficult to take public companies private in France than in the United States because of tax rules and other regulations. For example, to deduct interest on loans, private equity sponsors must control 95% of the target firm. In addition, conditional offers are not permitted.
Timsit acknowledged that French companies are required to offer rich benefits and protections to labor, but at least those costs are clear to acquirers, he said. “When you know that in advance, it’s not going to get any worse. The only way it will move is to get better.”
When it comes to deal sourcing in Europe and other developed markets, proprietary deals seem to be a thing of the past — or at least fraught with hidden complexity. “First of all,” Timsit said, “no deal is proprietary. I mean the only proprietary deal is the vendor. Anyone can claim they own the deal, but the real owner is the owner of the company.”
Where proprietary deals do exist, Timsit said, often complications exist, too. Timsit’s firm concentrates on “complex situations where we have conflicting shareholders or regulatory hurdles which are very French-specific, or virtually no free cash flow or very poor bankability of the deal. In these situations, you sometimes find a proprietary deal or deals where the owner is ready to talk to you without an investment bank.”
Even so, he said, the owner is going to talk to someone else to see whether he’s getting a fair price. “In that case, he normally continues with you if you’ve been fair,” Timsit said.
Montagu’s O’Brien said another sourcing strategy was to groom prospects. “All of our origination effort is actually targeted at the CEO of a large subsidiary who perhaps is running a good company and perhaps we think may be non-core one day.” The strategy has paid off a few times. “We’ve found CEOs, we’ve gone to vendors –usually private groups — and we’ve caught them at just the right time. They’ve said, ‘Well, if you can do it in eight weeks, you can have it.’ But it’s rare.”
More straightforward situations usually mean competition. “If you’re chasing plain-vanilla deals,” Timsit said, “it gets very much intermediated, and [there are] no proprietary deals.”
Effects of the Credit Crisis
The credit crisis is being felt differently around the world. In Japan, the impact has not been so harsh, because the economy did not participate as much as other nations in the recent boom, Nonomiya said. “Fortunately or unfortunately, Japanese banks were not so invested in subprime products.” Japanese banks are still aggressive in debt financing, but “if we look for much bigger deals with international banks, then we have limitations.” He noted that many Japanese companies are highly leveraged.
Timsit said European loan default rates are at historic lows of less than 2%, although the cost of debt is rising. His firm has financed two deals since the credit crisis erupted and the banks involved in those transactions have demanded more due diligence than they had beforehand. “It’s going to be a more lengthy process to get debt. The cost of debt is rising, but we’re coming from a point in Europe that was much lower than in the U.S,” he said.
According to Dunne, the contraction in credit markets has had a chilling effect on large transactions in Europe, but mid-market deals are still being financed. He said broader economic weakness that may result from the credit squeeze is a bigger concern. “The big influence that no one is actually near estimating is the macro impact of this. The price of debt is one thing, but actually two-thirds of the business is in earnings growth,” he said. “We’re more interested in the price of earnings than the price of debt.”