Large leveraged buyouts in Europe keep getting larger, and they're getting all the newspaper coverage too. With KKR's and Wendel's acquisition of Legrand back on track at the time of this issue going to press, Europe's first €5bn leveraged deal looked set to complete. But, while the average size of European buyouts is increasing, it is easy to forget that the vast majority of deals get done away from the headlines, amid the relative peace and quiet of the mid-market.
A quick look at the numbers confirms that the European buyout market is firmly built on the mid-market segment. According to data published by the European Venture Capital Association for 2001, buyouts accounted for nearly half (45 per cent) of the €24bn of total capital invested in Europe, and 10 per cent of the number of deals. On average, €11m of equity was invested in each deal, equating to a typical transaction size of between €20m to €30m using today's more restrained debt-to-equity multiples of around three. Even when, in the first half of 2002, several big-ticket LBOs closed on the continent, the average equity investment still stood at a mere €20m, with the average transaction value not exceeding €50m.
The European mid-market has also become one of the most popular areas in private equity for general partners and investors based throughout the world (and the US in particular). As the top-end of the buyout market becomes increasingly ? some say excessively ? competitive, midmarket funds are undergoing something of a resurgence, with new managers moving into an environment that previous incumbents had earlier abandoned in pursuit of bigger funds and deals. Investors in the asset class are also keen on the segment, attracted by high levels of actual investment in this current year, strong realisations and substantive cash distributions coming back to limited partners. And the outlook for 2003 seems even more encouraging.
Where is it?
Demarcating the mid-market is by no means easy, and practitioners' opinions as to its exact dimensions vary considerably. However most observers would probably accept a definition based on underlying enterprise value, or transaction size, of €20m to €200m. The majority of funds that are raised to invest in these deals also tend to be capped at €200m to €400m. There are of course exceptions: some of the very large pan-European vehicles such as funds managed by Bridgepoint and 3i have billions of Euros under management, but country-specific or regionally focused funds that are often looking to invest around €25m per transaction can manage less than €200m.
Fabio Lorenzo Sattin, chairman and chief executive of Milan-based Private Equity Partners, says it is important to keep a lid on the amount of capital raised for a mid-market fund. ?We capped our latest fund at €200m even though we could have raised a much bigger amount. If you have too big a fund, there is the pressure to invest a lot of money.? General partners operating in the mid-market say they try and avoid this kind of pressure, because having to manage too much capital and too many limited partner relationships can get in the way of the main business of investing in profitable deals.
Running a large fund also means having to invest in big and more mature businesses, which for a private equity buyer tend to be more difficult to control than mid-cap entities. In a larger and more mature business, the structure of the company, its management systems and procedures are a good deal more ingrained than in a smaller one. This means that the private equity owner is less able to make an impact on the actual running of the business. Given that exercising this kind of control over an investment is the key mechanism for mid-market private equity investors to add value, the attraction of buying majority positions in smaller companies is obvious. Richard Green, joint managing director at UK mid-market specialist Kleinwort Capital said in a recent interview with PrivateEquityOnline: ?It's far easier to have an influence over a mid-market company.?
Paris-based Antony Acciarri of Electra Partners, a pan-European firm focusing on larger mid-market transactions, comments: ?Our interest in the mid-market is that we think we can find businesses where we can add more value than just financial engineering.? And as Jim Clark of Cabot Square Capital puts it: ?Your influence within the business is so much greater in a mid-market deal ? it gives a better ability to make the right decisions in a timely manner, which is very important.?
According to Mounir Guen of placement agents MVision, which recently helped French newcomers Chequers raise a €300m mid-market fund, this kind of influence can have a dramatic impact on a portfolio company and as a result on the fund's ultimate performance. ?In a larger company it's about backing management, supported by a strong board, providing funds and letting them execute. For smaller companies this is not usually the case ? for a mid-market private equity sponsor, fixing management issues alone may be enough to earn two to three times their money.?
Buying one thing, selling another
Private equity houses investing in mid-market companies are essentially ?intermediate? owners of these businesses, helping them to undergo significant change driven by often highly focused development strategies. As Sattin says, ?what you're eventually selling is different from what you've bought.? He points to an investment in an Italian logistics business, where PEP conducted no less than 28 add-on acquisitions, each small in size, which dramatically transformed the footprint, and the attractiveness, of the original investment.
Expansion into new markets is often key as well. ?The key to our strategy is to buy a business at a local price, grow it, and sell it at a continental or even global price,? says Kevin Reynolds, managing director with responsibility for the UK market at Bridgepoint.
Mid-market companies that are acquired also tend to provide a wider range of exit options, and allow the next owner, which can be another financial investor, to continue to develop them. And because the portfolio companies are smaller, selling them to trade buyers also remains feasible even in a depressed M&A market such as exists today. ?It's easier for a corporate buyer to write smaller cheques than larger ones, so today exit opportunities are still ok,? observes Guen.
Generating value and subsequently realising it doesn't necessarily involve a buy and build approach, though many successes have resulted from this strategy. Most managers are keen to help implement strategic and operational changes to the existing asset rather than simply injecting capital in order to grow by acquisition. ?Our approach is about finding and driving scalable platforms for growth. The question is how to create a business that somebody else wants to own. Equally, and more importantly, it's about doing better what the companies already do,? says Clark at Cabot Square.
Conni Jonsson, managing director of EQT in Stockholm, a firm that has grown its funds under management hugely over successive funds but which still has its heart in the European mid-market, is positively against development through acquisition. ?There is no one thing that is so hard to execute as a successful merger, though with our industrial experience and network we think we are well positioned to manage a buy and build strategy. Ideally though, we buy a company that can grow organically.?
This prompts the question of how and where mid-market funds find their investment opportunities. Much of the deal flow comes from the general partner's often deeply rooted local network of personal relationships. But there is also an ever-present ? and growing – advisory community: few transactions are done with buyers and sellers interacting on a genuinely exclusive basis.
In the UK, where the buyout market is more active and mature than anywhere else in Europe, intermediaries are particularly influential. ?A very significant proportion of deals, 75 per cent or more, come through intermediaries,? says Hugh Lenon of UK-focussed Phoenix Equity Partners. Graeme White, head of Barclays Private Equity, which invests in several European markets, echoes this point: ?In the UK it's now unusual not to have some kind of auction. On the continent, it is more relationship-driven ? there are deals where we have gone in and there has not been an auction situation.?
Another key issue for mid-market operators is differentiation. Whether they operate as single country investors or on a pan-European basis, managers often have team members who specialise in just one industry. Having a number of such specialists make up their teams, some houses target a range of preferred sectors. Kleinwort Capital for instance makes a point of advertising its interest in four, and only four, sectors. Single-industry funds however, which do already exist in the United States, have not emerged in Europe yet.
Investors in private equity, to the extent that they are making allocations to the asset class at all at the moment, have an appetite for both country specialists and pan-European mid-market funds. John Snook of Close Brothers Private Equity, which concentrates on the UK market and closed its sixth buyout fund last February, says the message from investors is extremely positive: ?They tell us, ?we look forward to your next fund, but don't you dare raise a large buyout fund!?? More recently, the Chequers fund closed not only €100m above target (at €300m) but also quickly: allocations had been fixed in April this year less than 12 months after its launch, although legal work meant that the final close was not announced until October.
Investing in both types of midmarket fund gives the benefit of diversification. ?Some limited partners start with fund management groups they like, some start with the country they like,? says Phoenix' Lenon, ?at the end of the day, they need to like both the group and the country that a GP invests in.?
European Buyouts: Value Ranges – Number Each Range
|Less than €5m||124||184||189||172||204||168||171||185||218||154|
|€5m – €10m||255||170||86||117||146||145||80||111||155||99|
|€10m – €25m||38||48||44||42||62||71||77||63||26||21|
|€25m – €50m||22||28||35||41||44||64||54||40||36||18|
|€50m – €100m||9||12||19||31||28||39||48||32||25||17|
|€100m – €250m||9||11||2||14||20||33||47||32||23||21|