They are the new masters of the universe. Private equity firms, also called risk capital firms, are showing off their unprecedented power, making them the star guests at every major deal on the planet. No bidding process can resist them, as revealed recently when Cerberus in the U.S. acquired Chrysler for $5.5 billion. The biggest battle, however, is being fought in Spain, where two separate initiatives have whetted the appetite of the new kings of the market.
Iberia, the Spanish flag carrier and the largest European airline to operate in Latin America, is for sale. Several funds, including TXUS, Vista Capital, Ibersuizas and Quercus have all joined the process, which could wind up costing four billion euros. Tobacco merchant Altadis, a Spanish-French company, is also looking for a new owner. Although Imperial Tobacco quickly knocked on its doors, they could easily be closed to Imperial because of the interest shown by CVC Capital and PAI Partners, who are prepared to write a check worth $13 billion.
Spain’s previous record-high deals look small in comparison. In 2006, 712 deals worth a total of 2.815 billion euros were closed. In the first quarter of this year, the volume of investments doubled from the previous year, going beyond 1.1 billion euros, according to data collected by webcapitalriesgo.com
For the rest of this year, forecasts call for investment volume to reach between 1.8 billion and 2 billion euros. These figures do not even include the ultimate cost of the Iberia and Altadis cases. The Iberia deal could be completed by the end of 2007 or the beginning of 2008, because the key players in the game are showing an interest in speeding up the process. In the case of Altadis, however, the battle has only begun.
What’s behind the rise of private equity? “The growth in the last two years paints a picture so compelling that one could say private equity is becoming more and more important,” notes Manuel Romera, Director of the Financial Sector at Instituto de Empresa business school. Nevertheless, Romera says, “Even four or five years ago, private equity already had a significant influence.” Nowadays, its principal power stems from the fact that “it is doing a great deal to make the Spanish economy more dynamic.”
José Martí Pellón is a professor at the Complutense University in Madrid and one of the foremost experts on this subject. According to him, “the pattern of activity has not changed much since 2005. The scope of these extraordinary deals — such as Iberia and Altadis — reveals a total volume of investment that has a stable base supported by increasingly active investments in the ‘mid market,’ where investors contribute between 10 million and 100 million euros. There is also growing public support for investments in companies that are in the start-up stage.”
Martí notes that “risk capital in Spain has a history dating back more than 30 years. At the beginning, from 1972 to 1986, the public sector attracted development in this sector. Between 1987 and 1991, many private investors jumped in, mostly with foreign support, but the economic crisis put a stop to development in the sector. The new take-off stage began in 1997, and strong growth continued until 2000 because of the push toward ‘the new economy.’”
Throughout this process, Martí notes, “the mechanisms used for starting up a new company were becoming less and less important, especially during the years of Internet euphoria. Financing growth was the principal goal for [private equity] money. What has changed in recent years in Spain, especially since 2004, is the definitive growth of large-scale leveraged deals. Elsewhere in Europe, these sorts of companies have already been the major targets for most [private equity] funding for almost a decade.”
In Europe over the last decade, the private equity sector has raised 406 billion euros, according to El Pais, the Spanish newspaper. In 2004 alone, 27.5 billion euros in capital was raised and 90 billion euros was raised in 2006 in Europe as a whole. In the case of Spain, the inflection point goes back to 2003 when the first major operation was completed by a U.S. fund — Advent International’s acquisition of Parques Reunidos, a theme park company.
“By the end of the 1980s, American funds were already making timid approaches, but they began a strong effort to get into this market after they realized they could pull off large-scale operations [in Spain],” recalls Marti. In his opinion, Advent International, by taking Parques Reunidos off the market, “demonstrated that Spain also offered its share of attractive opportunities for investors. This deal was a foretaste of the much-discussed move to acquire telecom company Ono-Auna, in which four U.S. funds and one European fund participated. The confirmation that direct investments of about one billion euros were being put together — when the cost of the acquisition and [corporate] debt are both included — is the factor that limits more participants from entering.”
Until now, this sort of investment was limited to a mere handful of deals in which risk capital wound up keeping a company out of the stock market. This included the deal for Parques Reunidos as well as deals for the Cortefiel fashion group and Recoletos, a publishing company. Little by little, however, attractive opportunities are opening up in some companies that are not quoted on the stock exchange. That was the case with Avanza, the road transportation company acquired by Doughty Hanson, as well as in the current bidding for Capabro, a supermarket chain, which involves the Permira and Blackstone funds as well as French retailer Carrefour.
“There isn’t any particular sector that risk capital finds especially interesting,” notes Martí. “It is a question of size. It is about getting into companies that have a large scale of operations, since the main problem for risk capital in Europe is having enough scale so that it can leave easily either to place shares in the stock market, or to sell itself to another fund in a ‘secondary buyout,’” he adds.
That’s what happened with Parques Reunidos. Candover recently bought that company, the third-largest operator of recreation parks in Europe, from Advent International. Now Candover hopes to sell it again within three or four years after doubling its volume of business.
A Broad Market without Entry Barriers
Another factor favoring private equity in Spain is the broad range of companies and sectors. There are many opportunities both in terms of the number of business sectors and the size of the company. As Romera notes, “Foreign funds face relatively few difficulties because they want to buy the sort of companies that generate cash in a stable way while continuing to expand. They want businesses they can invest in, and then disinvest in after five or six years and get a very good return. This is what they look for. And if they find it in Spain, they go for it.” For the giant U.S. private equity firms as well as some European firms, he adds, “geographical diversification is becoming a more and more important consideration. They want to be in all sorts of markets and find different kinds of investment opportunities. They want businesses that continue to operate without too many complexities — companies that they can reform, restructure and improve from a financial point of view or from an operational or strategic point of view.”
Growing interest by international firms does not pose any threat to Spanish companies that want to do business. In many cases, Spanish firms target their efforts at other market niches, Pellón says. “Local firms are more focused on what is known as the ‘middle market.’ These kinds of operations require greater knowledge of the idiosyncrasies of Spanish family-owned enterprises and they contribute value when there is a problem about succession [of ownership] and there are conflicts among shareholders. There are also some deals where growth and concentration in a sector comes as a result of an acquisition. On the other hand, the growth in the number of Spanish [risk capital] companies is related to the tax incentives of Law 1/1999, which were maintained in Law 25/2005.”
In contrast, Romera believes that there is a process of convergence between local Spanish and international companies. “And I believe that they will increasingly collaborate [with each other]. At Mercapital or N+1, Spain’s leading risk capital firms, the important thing is to play the same way as the international risk capital firms play the game: Make an easy profit — which is easy for them, because they have good management — by using extremely strong leverage; use leveraged purchases in the form a management buy-out or a management buy-in; use a huge amount of structured financing, be extremely active in the world of corporate financing, and so forth.”
Romera’s argument is based on the belief that there will fewer deals that are either very small or very large in scale. The giant pie will be divided by companies that are in the middle market. “Deals worth between 10 million and 25 million euros, and even from 10 million to 50 million are more common now. Statistically speaking, they are becoming more important.” Nevertheless, Romera forecasts a significant change that will place limits on that process of convergence: growing specialization by sector. “Risk capital institutions are becoming increasingly specialized. Nowadays, not all of them are going into every sector. Each has its own specialty and the trend is in that direction, although this is not yet a well-established reality.”