Change for the better

After years of rapid growth throughout the 1990s, 2001 will be remembered for a significant slowdown in the French private equity market. Performance data capturing the whole of 2001 is not available yet, but according to half-year figures published by the Association Française des Investisseurs en Capital (AFIC), the French venture capital and private equity association, new investment in France showed a 40 per cent decrease in the first half of 2001 against the previous year, from €2bn to €1.2bn. Divestments were also thin on the ground, reaching a total value of €762m.

Fundraising was faring somewhat better, experiencing a 16 per cent boost relative to the same period in 2000 from €2.15bn to €2.5bn. But the second half of 2001 is predicted to show a drop in volume of over 50 per cent relative to 2000.

Asked about the reasons for the recent decline, market observers point to the global economic downturn, the events of September 11 and poor performance of technology stocks. Says Hélène Ploix, chairman of AFIC: ?We are in the middle of a cycle. The first half of 2001 still showed positive signs, such as the number of funds created and the amounts of funds raised, but the end of the year was difficult: closings of funds produced no more than a third of the level that had been expected, exits were minimal, and new investments were mainly limited to reinforcing existing shareholdings.?

Corporates feed the buyout market
For the French LBO market, the second half of the 1990s was a golden age. Now things have changed, although deal flow in the first semester was still relatively strong and produced some of the biggest buyouts ever completed in France. According to LBO Net, there were 48 LBOs in the first semester, compared to 62 deals in the same period of 2000. However the second half of the year appears to have been relatively flat, reflecting the changing investment climate.

Among the most notable buyouts of the season was Carrefour's €920m spin-off of Picard Surgelés, the frozen food retailer, to a syndicate led by Candover. Corporate restructuring was, and still is, the main driver of the LBO market, where the big international buyout firms have a firm grip on deal flow. Other big-ticket spin-offs included the €890m joint acquisition of LMS by Advent International, the Carlyle Group and CVC Capital Partners, the €720m buyout of Cegelec led by CDC Equity Capital and Charterhouse Development Capital, PAI Management's buyout of Antargaz and CVC Capital Partners' €300m purchase of Aventis Animal Nutrition.

According to Dominique Oger, chairman at Atria Capital Partners, an independent mid-market LBO firm, corporates selling non-core assets will keep activity levels up, particularly in the mid-cap market. ?The loss of value of stock options in particular incites managers of subsidiaries of large groups to think spin-off rather than stock options from their parent companies. This generates a lot of opportunities,? Oger says.

Public to Privates (PTPs) are less visible, largely because current legislation requires buyers to acquire as much as 95 per cent of a target's equity in order to complete a delisting. Although reasonably strong in 2000, only a few such deals were launched in 2001. Among those to buck the trend was CLAM Private Equity, the private equity arm of Crédit Lyonnais Asset Management, which bought the quoted jewellery retailer Marc Orian for €102m.

Senequier: EBIT multiples were too high

Numerous buyouts are thought to have closed at exaggerated prices recently. ?Last year EBIT multiples were too high and didn't follow falling stock markets,? says Dominique Senequier, chairman at Axa Private Equity. ?Prices should come down this year, albeit slowly because of the mega funds raised in 1999 and 2000.?

Nervousness in the debt market contributed to the difficulties to get deals done, as indeed it did in other parts of Europe as well. The main players – Royal Bank of Scotland, BNP Paribas, Bank of Scotland and Natexis – continued to lend, whilst hitherto absent institutions such as Société Générale decided to return to the market. Others thought it wise to close this part of their business, following the events in September. ?After September, many banks chose to wait for 2002 before lending again, if only because they had made a lot of investments during the first half of the year,? says a senior French banker.

The banks that carried on lending took a view as well and drove up their margins significantly. Prior to September, these were at an historical low of around 150 to 175 basis points. Since September, lending fees have moved to a level that is much closer to the 225 to 275 basis points typically seen in the UK market.

Moreover, the change in climate has prompted senior debt providers to insist on lower levels of gearing, which in turn has given room to the mezzanine funds. Last year domestic specialists like Euromezzanine or IFE Fund, alongside international players including Intermediate Capital Group, Indigo Capital and Pricoa Capital, all benefited from this trend.

Despite the difficult market conditions, LBOs remain a popular way of selling companies in France, giving investment practitioners hope that the market will bounce back quickly: ?As far as management teams are concerned, LBOs, more or less unknown in France ten years ago, have become ideal for many of the more dynamic managers,? says Xavier Thoumieux, a partner at CDC Equity Capital.

Venture firms look to life sciences
Like their buyout colleagues and again in line with trends observed in other parts of the world, French venture capitalists have also taken a noticeable turn for the worse over the past 12 months. After the ?crazy years? between 1998 and 2000, 2001 has been tough on French houses, with only a modest number of first round deals, few follow-on investments and no IPOs at all. The majority of venture funds are concentrating on their existing portfolio: ?2001 brought home the end of the exuberance period especially in the venture capital area. Valuations of IT companies have crashed. Fund managers stopped investments in new companies and tried to manage their portfolios as best they could,? confirms Jean Daumet, chairman at CPR Private Equity, the venture capital arm of Crédit Agricole Group. Some even say 2001 may only have been the beginning of a deeper crisis in the French venture market: some portfolios are for sale including that of Bernard Arnault's Europ@web, and consolidation among investment teams is expected soon.

Schmidt: VCs will come out stronger from the current crisis

Such changes could ultimately be to the good, insiders believe. ?The French venture capital industry will come out stronger from the current crisis,? says Jean-Bernard Schmidt, chairman at Sofinnova Partners. ?Venture Capital is about managing risk: we can take high risks on individual projects, but we have to spread those risks over a number of projects, over several sectors and over several years. Those rules seem to have been somewhat forgotten in the past two years.?

Following the IT collapse, many have switched their attention to life sciences. As part of yet another global trend that has made its way into the French market, many local players are currently looking at this sector. Newcomers are keen to follow the example set by a number of established specialists such as Sofinnova Partners, Atlas Venture, Ventech and Auriga Partners, which for years have invested in both IT and live sciences. Their dual strategy is seen as an effective way of diversifying a fund's exposure to different types of risk in a number of different subsectors of technology investing.

What the Grande Nation's venture capitalists remain worried about is the prospect for exits. The past year demonstrated that with international stock markets closed, it will be difficult for French start-ups to really take off. ?We now need an European-level Nasdaq equivalent, be it called Nasdaq-Europe or EuroNext,? says Alain Caffi, chairman at Ventech.

But Caffi also shares Schmidt's view that the long-term outlook for the industry remains encouraging: ?Economic cycles will always have an impact on financial markets, and early-stage high technology venture capital is no exception. We must therefore include the macro-economic dimension in our fund management,? he says. ?But early-stage high technology venture capital can claim to be less impacted by short-term perturbations, since we basically are long-term investors betting on strong technical breakthroughs.?

Fundraising continues ? with or without French investors
Tricky market conditions notwithstanding, French firms recently succeeded in getting some significant fundraising efforts underway. PAI Management has launched PAI Europe III with a €1.2bn target, the largest buyout fund ever dedicated to French buyouts. Sources say the fund is likely to exceed its target. CDC Equity Capital has raised €360m towards a new fund for mid-market buyouts and is likely to reach between €400m and €450m later this year. Axa Private Equity raised €400m for a rival buyout fund, whilst also collecting €500m for investment in the secondary market. There it will face competition from Fondinvest, which has been active in the secondaries market since 1994 and in December announced a first closing for a new fund at €170m.

Drean: French GPs rely heavily on foreign sources of capital

A number of VCs have recently been raising money too. Sofinnova Partners, which has been independent since its foundation in 1972, received commitments worth a solid €330m for investment in IT infrastructure and biotechnology, while Auriga Partners raised €150m. Ventech II, sponsored by Financière Natexis Banques Populaires, and CDC Innovation II 2002 both raised in excess of €100m too.

In total, €2.5bn were raised for investment in France in the first six months of 2001, but everyone agrees that the final number for the year will be a far cry from the €5.5bn allocated to the French market in 2000, an exceptional year by any standard. Nevertheless, French firms in the first half of 2001 still managed to raise as much in they did in the whole of 1998, and five times the capital raised in 1995. These statistics illustrate just how quickly the market has grown in recent years. At the end of 2001, the French private equity sector managed portfolio capital in excess of around €20bn.

Such growth speaks of investor confidence in the market place, and yet both French and foreign investors face some difficult decision when trying to select the funds that will perform. ?Investors will probably have a tough job identifying the good teams to commit to,? says Agnès Nahum of Access Capital Partners. ?We believe that some of the best buyout and venture teams will continue to beat the other asset classes, and to outperform the MSCI and S&P indices French investor who understand the merits of the diversification need to be invested in the best private equity team, and they need to remember one rule: Selectivity is key.?

The trouble is that not many French institutions have come to appreciate what private equity can do as part of a diversified portfolio. In 2000, asset allocated to private equity in France represented only 0.38 per cent of French GDP, compared to 0.86 per cent in the UK. ?French institutions have been slow to seize investment opportunities in private equity funds. Local culture and the absence of pension funds may explain this. Independent French GPs were forced early on to rely heavily on foreign sources of capital,? notes Antoine Drean of Triago, the placement agent.

Nahum: disappointed with local investors

Nahum at Access agrees: ?As a fund of funds manager, we have discussions with a lot of French investors. We are quite disappointed to see that they invest very little in this industry,? she says. ?French investors have yet to come up with an optimised asset diversification to minimise their risks. Private equity is definitely a key element of such diversification, and the French market has very sophisticated private equity teams both in buyouts and in venture capital.?

Given the lukewarm response from French institutions, firms have been creative to tap other sources. Retail investors is one area where this has been working well. Fonds Commun de Placement pour l'Innovation (FCPIs), which invest in French start-ups and are open to private individuals offering tax breaks to those that invest, have been extremely successful. No less than 30 of these funds were launched in 2001, up 50 per cent from 2000, when 19 FCPIs received €500m.

The fact that fundraising has not come to a standstill suggests that market participants are looking ahead, whatever the current difficulties. And those who know the market well insist that there is more to come than simply gloom and doom. According to Hélène Poix at AFIC, ?the present situation still offers venture capitalists many quality opportunities: large funds are available for investment; valuations are back to reasonable levels; investment managers are more experienced and better able to help ensure that the investments they manage cope with the downturn in the economy.?

Gilles Mougenot, chairman at Argos Soditic, agrees that good things may well be ahead: ?Notwithstanding the current difficulties, a number of elements indicate that 2002 could be a favourable year: deal flow from sellers is strong; competition in the market for small and medium-sized transactions is likely to reduce; funds are available in abundance; and interest rates are at a historical low,? says Mougenot. Triago's Drean is also optimistic: ?Creative ways of investing are appearing in the market, sometimes inspired by innovations elsewhere in Europe or in the United States. France should be a fruitful ground for private equity players in 2002.?

Jean-Philippe Mocci is a journalist at L'Agefi, the French financial daily newspaper.