Friday Letter: Diminishing due diligence

Deal flow has been described as the Holy Grail for GP groups, particularly for those operating in the ultra-competitive mid-market. Take the French private equity scene, for example. Here, perhaps more than anywhere else in Europe, identifying primary assets on a proprietary basis is becoming as much the stuff of myth and legend as the romantic quests undertaken by the knights of ancient Christendom.  

Back in 2004, figures from Paris-based private equity firm Chequers Capital revealed that 24 out of 59 buyouts worth more than €20 million completed in France that year were the result of one GP selling to another. Although figures for last year are not currently available, the trend seems to have accelerated. One mid-market firm on the ground told PEO during a visit to Paris this week that around 80 percent of deal opportunities coming its way at the current time are emanating from the portfolios of rival investment groups.

One classic example of asset recycling occurred in October last year when plastic pipe distributor Frans Bonhomme entered its fourth phase of private equity ownership when acquired by Cinven from an Apax-led consortium. Critics of such deals, including some in the limited partner community, accuse GPs of doing little more than play pass the parcel. There again, do the means really matter that much if the end conclusion is a lucrative return?

In the case of Frans Bonhomme, it is interesting to note that – according to close sources – the best return so far was made by the Apax-led third exit. Backers of that deal insist that compelling growth opportunities for the business remain, and appear convinced that the fourth set of return figures will set an even higher benchmark – perhaps prompting thoughts of buyout number five in due course.

Reflecting on the attractions of Frans Bonhomme going forward, Cinven partner Nicolas Paulmier cites familiarity with the asset as a key factor. Back in February 2000, the London-based LBO house had bought a 31.4 percent stake in the business alongside Astorg Partners and PAI Partners. This trio held the reins of the firm until 2003, when selling out to Apax and various co-investors.

One by-product of this ‘familiarity’ is a perceived ability to be efficient in the due diligence process – something gratefully seized upon by GPs in a ferociously competitive market such as France where speed and deliverability of funding commitments is becoming a vital prerequisite for success.

Traditionally, one might have expected the banking community to apply the brakes when a deal was progressing very fast. But if the bankers also know the asset in question very well, that isn’t necessarily the case either. Consider for example, Royal Bank of Scotland, which led the debt financing for Frans Bonhomme at a bullish debt to EBITDA multiple of 7.35 times. A source close to the deal says just a few weeks of due diligence was sufficient to provide RBS with confidence in an asset that it had supported in a variety of ways over the years. Confidence multiplied by 7.35 times in point of fact.

For providers of due diligence services to private equity groups, all this is bad news. One Paris-based banker says that until recently, the full gamut of due diligence services – including insurance, environmental, tax, legal and commercial among others – was brought to bear on transactions. But now, says the banker, the trend is being reversed. Serial ownership of businesses means there isn’t that much left that can be discovered anew between changes of ownership. As a result, overly detailed due diligence doesn’t seem that important anymore.