The right market for the right fund

If one were to generalise about Italian private equity, platitudes along the lines of ?so far, so good? and ?room for improvement? would serve as fairly accurate, if facile, pronouncements on experiences to date in Europe's fourth largest market economy. However, as with all generalisations, these platitudes would struggle to reveal the interesting part of the story. For Italian private equity is a market in which the leading players are so dominant that they do not really need to worry much about deal flow, whilst others struggle to justify their existence, let alone their management fees.

The Italian private equity market began to take shape in the early 1990s when the major banks started to take an interest in Italy's small but growing alternative investment community. As the decade wore on, the number of firms operating in the Italian market grew as funds were set up to reflect an increasing interest in the asset class among banks and other investors alike. By 2001, the number of funds in the market had increased to 86, an increase of almost 300 per cent on the number a decade earlier.

?Most people would agree that there are too many players in the Italian market,? says Armando d'Amico of investment advisory firm Acanthus Advisers. ?Remove the pockets of excellence and you are left with a big list of average performers.?

Haves and have-nots
Part of what d'Amico has in mind when speaking of pockets of excellence is a group of ten or so firms that seem always to be involved in the most lucrative deals, whether in the mid-market or the larger buyouts. A recent survey of the top performers in Italy carried out by the Bocconi University of Milan produced a list of the usual suspects, led by BC Partners, B&S Private Equity, Private Equity Partners, Permira, 3i and Investitori Associati.

?The market leaders are typified not by their size, but by the experience of the managers they have doing the deals,? says Fabio Sattin, founding partner at Private Equity Partners. ?Entrepreneurs want to speak to successful decision-makers, which makes it vital to have your best people available in the Italian marketplace.?

The successful houses have long enjoyed high IRRs and benefited from long-standing relationships with investors built over a period of sustained performance.

On the other side are the more recently created funds which raised money in the late 1990s. The challenge facing up-and-coming Italian fund managers is how to penetrate the inner circle of the top performers. ?Firms to watch include Opera and Emerald which have both raised funds within the last 18 months,? says d'Amico. ?The jury is still out on a few of the other potential rising stars.?

Emerald closed in December 2001 on €215m. Opera was set up by Bulgari in 2000 and raised €225m to invest in turnaround and growth ? opportunities in the Italian luxury goods market. ?The Italian market can be difficult for newcomers,? says Renato Preti, a partner at the firm who used to work for BCI merchant bank Morgan Grenfell Private i Equity. ?It tends to be the i same people always doing the best deals.?

?There are too many players in the market?

The pre-eminence of the leading houses is particularly apparent at the top end of the LBO market, where the biggest deal to date was the E1bn acquisition in February of Danone's dairy and cured meat operations, Galbani, by BC Partners. BC Partners paid just over E1bn for Galbani, which included a €200m vendor loan note from Danone. In July, Permira tabled a €675m recommended offer for Italian luxury boat manufacturer Ferretti. The other two deals of note in 2002 are B&S Private Equity's €100m acquisition of olive oil firm Carapelli and the €460m cash and debt deal for half of Fiat's Teksid components business, which was concluded by a consortium of international firms including Private Equity Partners. ?All four deals are very interesting displaying very different characteristics,? says PEP's Sattin. ?None of them were completed for the sake of keeping busy. They each possess enormous potential.?

However, talk of potential leads one inexorably towards Italy's main promise, the mid-market. ?Although the financing is available, it is unrealistic, in the short term at least, to expect more than the occasional €1bn plus deal,? comments Fabio Sangiovanni, Head of Leveraged Finance for Royal Bank of Scotland in Milan. ?Italy's real growth opportunity lies with the enormous potential of its small and mid-market sector.?

Already the lion's share of transactions takes place at the smaller, family-owned end of the Italian market. One observer estimates that as much as 90 per cent of the deals completed in Italy last year involved companies with fewer than 100 employees. Reduced valuations have made this an increasingly appetising sector in which to become involved, although pressure on pricing has also deterred a number of potential vendors from coming to market.

Institutional investment lacks tradition
Barriers to entry also exist for institutions looking to deploy capital in Italian private equity for the first time. Practitioners say investors entering the asset class in the late 1990s and hoping to make hay in the sunshine of a booming global economy have not been rewarded. ?Unlike established investors who understand the nature of the markets, some late entrants tended to be more naïve, expecting quick and large returns,? says

Preti. ?These investors came too late and when the returns didn't materialise, there was a lot of disappointment.?

A dampening of expectations is not the only issue affecting the relations with the buyside. ?The Italian market lacks a tradition of institutional investment,? reckons Armando d'Amico. ?Many of the funds raised in Italy are established by the traditional banks attempting to get a toe-hold in the asset class. Foreign investors are sometimes put off by the notion that many of these funds are captive.? The statistics bear out a fundraising environment that is not market-driven, with around half of the capital raised by the large number of bank-controlled funds coming from the banks themselves. Only 20 per cent of the fundraising total came from foreign investors last year.

Italy, like everywhere else, endured a drop in both fundraising and investment in 2001, ending a ten-year period of growth. Funds invested totalled €2.18bn, a decrease of 26 per cent on the previous year's figure, according to AIFI, the Italian venture capital association. Nor was the decline in investment merely the result of lower valuations. The number of deals completed during 2001 fell by 24 per cent to 489. A similar downturn was reported in fundraising, which fell by 36 per cent to €1.8bn.

The challenge for venture capitalists operating in Italy will be to successfully engender a private equity-backed culture among the smaller and mid-market enterprises, which make up the backbone of the economy. Whilst many GPs speak of a growing range of opportunities in this market, others reason that more needs to happen. The largest deals will always generate enthusiasm, provided that the conglomerates are not frightened off by lower valuations and that the businesses on the block are not basket cases.

The plight of buyout firms could be significantly ameliorated by reforms being proposed by the right-wing government presided over by the business-friendly Silvio Berlusconi. Earlier this year the government announced plans to enable firms to raise leverage finance to fund transactions against target company assets, currently prohibited under Italian law. ?It is the mid-market deals that have the most to gain from an improvement in the regulatory environment,? comments Sangiovanni at RBS.

Looking to the future, the main area of interest may lie more in the evolution of the second-tier firms targeting mid-market buyouts than it does with the established houses. These firms will need to gain experience comparable with the top firms and hope for, and encourage, a sustained upturn in suitable assets coming to market. This should enable them to develop a niche position in the market. Says d'Amico: ?Vintages following a downturn are always improved so there is still scope for new firms that get it right to do well.?