The waiting game

Although M&A advisers who focus on financial buyers haven't exactly been sitting around with their feet on their desks, it's fair to say that most have found time to sort out that backlog of paperwork. It has been pretty quiet time over the past six months. Not so much because there are no deals to work on, but getting them closed has proved nigh on impossible. ?The pipeline's chock full at the moment,? complains one, ?but there's not enough visibility for us to actually get the deals done.? Buyers are huddled in the data rooms and scouring the due diligence packs; sellers are slow to show and even slower to come to the table. And the advisers are trying to get everyone to the same place at the same time ? often without success. As one somewhat jaded adviser reports: ?There's still a serious dislocation of expectation ? and only time heals that. So I'm hoping things will be better in 2003.?

Merger and acquisition activity by private equity firms across Europe tends to ebb and flow under the influence of a number of factors, many of which ? according to the apologists ? have mitigated against there being a significant uptake in transaction volumes and value. The bursting of the technology bubble, September 11 and its destabilising effect on the world's economies, the depressed state of the public markets and the withdrawal of financing by wary banks that had moved into retrenchment mode are some of the most common causes cited. So is it going to be a quiet 2002? Although all of the aforementioned factors have cast their shadows over the market, there are good reasons to look forward to more deals reaching, and crossing, the finishing line.

More pain needed?
It's worth addressing the alleged reasons not to be overly exuberant first. Technology continues to struggle: companies are fighting to sustain, let alone build, revenues and the valuation models that seemed credible in boom times now get laughed out of the room. One consequence is that IT companies are being merged in an attempt to prop each other up but these are not the kind of deals to make the headlines, nor to make advisers or private equity firms smile. Says a practitioner: ?You're seeing some consolidation plays in micromarkets within the technology sector ? but it's tough going.? It's safe to assume therefore that the technology industry is still sorting itself as much as possible in private. In this context, private equity firms have little appetite to buy and can find little opportunity to sell their own portfolio tech companies.

Turn to more traditional sectors though and you encounter industries which are very much back in fashion. Just ask Michael Hough at corporate finance advisory firm Altium (formerly Apax Corporate Finance until their independence in 1999): ?We're finding hotspots across Europe in the services, consumer and retail sectors: there's clearly both demand and supply and private equity buyers are in the thick of it.? These are solid, reassuring businesses that have strong cashflows, coherent P&Ls and can withstand orthodox valuation models. Crucially they also can offer that other long-craved for ingredient: growth visibility. As Christopher Steane, managing director at ING Acquisition Finance remarks: ?In these more sober times everyone wants to have the comfort of a strong track record and strong prospects ? and the old economy companies can offer this.?

Much has been written about the economic impact of the terrorist attacks of 11 September last year, and plenty of people will tell you of M&A deals that were put on hold on account of them. But eight months on and their legacy seems less than one could have dared hope. A case in point is the state of the public equity markets: although their mood has been moribund, no European market has seen a dramatic collapse in prices across the board. One consequence of this is that some publicly listed vendors have not been obliged to initiate a rapid divestiture programme to assuage concerned shareholders' demands. Nor have they felt inclined to revise down their price expectations for those operations that are for sale. ?There is, as yet, the need for more vendor pain to encourage some pragmatic pricing and sales to get done? said one senior adviser.

Reasons to cheer
On the plus side though is the fact that Europe's economies have not gone into a profound decline and there are clearly some sectors (old economy for sure) that are showing clear signs of growth. Couple that with those sizeable publicly listed companies who have initiated divestiture programmes of non-core businesses and there are interesting acquisition targets for private equity buyers to be found. ING's Steane says there are pockets of activity in continental Europe, as markets such as Spain and France are becoming more and more comfortable with leverage.

Germany is another location that is often being referenced as a market where the restructuring process has begun and companies are actively pursuing the sale of businesses ? even through recent difficulties at a number of high profile transactions including Bundesdruckerei, Woolworths and Fairchild Dornier may well have had an adverse effect on vendor confidence in private equity as a financing tool.

Nevertheless there will be those that are determined if not desperate to sell ? and are thus highly attractive to financial sponsors. A related point concerns those major companies who themselves are keen to acquire competitors and who are therefore appearing on the European Commission's radar. The competition authorities have shown themselves to be both active and rigorous in scrutinising M&A proposals that they consider could be anti-competitive. And they are not afraid to block a deal if they remain unsatisfied, as buyout firm CVC found to its cost when it tried to acquire Austrian fibre manufacturer Lenzing to add to the fibre businesses of Acordis which the firm already owned. That the EC authorities should be taken seriously therefore is clear; that the stipulations they make provides interesting opportunities for private equity buyers should not be forgotten either though. That's why you'll find EC Competition Commissioner Mario Monti in our list of 50 most influential people in European private equity elsewhere in this issue.

As Christopher Bown, joint head of the private equity group at Freshfields Bruckhaus Deringer, points out: ?You're going to see a number of forced spin-offs driving deals and the private equity houses are going to be closely involved in this.? One striking example of a forced sale came when the EC told French electrical equipment manufacturer Schneider that its €4.6bn acquisition of competitor Legrand violated European anti-trust regulations and that it must therefore sell the business again. The result was a scramble by many of the leading buyout firms to mount bids for Legrand ? a process still moving towards a conclusion. The fact that a deal this size is even considered an obvious target for European LBO houses has struck many as a sign that good things are in store for those with plenty of buyout capital to deploy.

What about the banks: are they proving an inhibiting factor when it comes to mounting serious, big-ticket bids? Certainly private equity firms have remarked that the amounts of leverage that can be applied to a bid are lower, obliging them to increase the equity portion of a bid and depressing total bid figures also. Ask the bankers and you'll get a different answer: the right deal they say will still get the right financing (Cinven's purchase of NCP detailed below being a case in point). ?I don't think the financing market is constraining the market in Europe? says Steane at ING. That's not to say the bankers haven't learnt from past experience ? and become more cautious as a result. ?We're prepared to look at debt north of six times EBITDA today,? continues Steane, ?but we've learnt to look much more closely at multiples now ? and EBIT rather than EBITDA is often the preferable reference point.?

Michael Kershaw, managing director of investment banking at Dresdner Kleinwort Wasserstein, also points out that there's plenty of ?funny money? for private equity clients to draw on when funding acquisitions, i.e. financing alternatives such as PIK capital and warrantless mezzanine that are moving into the mainstream. ?As a result, the excuse that acquisition capital is in too short supply, which was probably valid six months ago, doesn't really work any more,? notes Kershaw.

A creative approach to making funding available is one way in which lenders can help stimulate M&A activity, especially when they are motivated by a strong commercial appetite themselves. Royal Bank of Scotland made headlines in May after its last minute decision to bridge Cinven's £820m acquisition of NCP, the car park business, which enabled Cinven to revitalise a bid that had looked dead in the water and clinch the deal ahead of heavyweight competitors Apax and BC Partners.

NCP was sold after what those involved in the deal described as the most competitive auction in Europe for many a year. Over 100 parties had shown an interest, partly reflecting the sustained scarcity of buyout opportunities currently in the market, but also underlining how irresistible NCP had looked to the LBO community. ?If you were to design the perfect buyout target, you'd probably end up with NCP,? commented an adviser, pointing to strong cash flows, a solid asset base, significant market share, high barriers to entry and significant potential upside through new revenue streams. The ?too-good-to-be-true? characteristics make it unlikely for a string of deals of similar quality to come through any time soon, but NCP could still turn out to give the market the sort of confidence boost that would stand it in good stead as it tries to build up momentum.

Pressure to invest
Just how many private equity firms requested a copy of the prospectus when NCP first came on the market demonstrates their growing desire to switch back into deal-making mode. As economic sentiment improves, general partner groups are becoming less distracted by needy portfolio companies and can free up resources that were previously tied up.

This is of course not an entirely voluntary process. Bown at Freshfields predicts that as 2002 draws to a close, limited partners will be feeling increasingly queasy at the prospect of GPs struggling much longer to invest the capital they have allocated. ?LPs will be looking to their commitments and asking some private equity firms: ?why have I got this money on short term deposit to service draw downs that clearly aren't coming?? GPs are going to have to evidence some real activity in their funds, especially as investors' annual allocation reviews are approaching.? Many expect LP pressure to increase further if by September 2002 activity has not improved dramatically.

Meanwhile M&A advisers are busy preparing contingency plans to present to general partners in case their bread and butter businesses continue to fail to pick up. According to Hough at Altium, such plans will be triggering less interest among mid-market players as their territory is showing strong signs of life: ?The last two months have been much busier, particularly in Europe.?

But those who do not concentrate on the middle market may have to look harder for places to put money to work. One area that investment banks and M&A advisers are taking more and more seriously is turnaround and distressed investment expertise. Corporate recovery is a buzzword, and houses such as Schroder Salomon Smith Barney and UBS Warburg, as well as financial advisers PwC, Ernst & Young and KPMG have recently moved to strengthen their capacity in this area. For private equity firms with an appetite for adventure, these are certainly relationships worth cultivating.