Opportunities in a tough market

Switzerland, a country that is used to coping with economic difficulties better than most, has had a painful year. Many associate the past twelve months with failing businesses, struggling financial institutions, tumbling equity markets and widespread disillusionment among private and institutional investors, especially after the fall from grace of Martin Ebner's investment empire.

But the crisis has also had its beneficiaries. The buyout market is one of them: more corporate distress has generated investment opportunities, and whether or not the country's problems are going to continue, buyout practitioners are confident they can look forward to a good next year also. Activity looks set to remain strong as more distressed companies in need of cash are turning to private equity firms in search for financing solutions.

?Swiss banks may be more cautious days but they haven't stopped lending?

A recent preliminary survey of buyout activity in Switzerland by the Centre of Management Buyout Research (CMBOR) shows that in the first eleven months of the year, the sector has been unusually active, with 18 transactions worth a total of more than $1bn and already up 50 per cent on 2001, at $712m. Some of these deals have come about as a result of the country's uncharacteristically long list of unsettling events, most notably the collapse of ailing airline Swiss Air.

Swiss Air has been the source of two of Switzerland's largest deals this year, the €393m management buyout of Swissport, the airport ground handling business by UK buyout house Candover, and the purchase of SR Technics, the aircraft maintenance unit, by private equity funds 3i and STAR Capital Partners, for €425m. It continues to be an obvious source of deal flow for the pan-European buyout house, with companies such as catering business Gourmet Gate, which is at an advanced stage of negotiations with US buyout house Texas Pacific Group, private jet maintenance and service company, Jet Aviation, currently in talks with 3i, and low cost airline, CrossAir, up for sale.

But Swiss Air is not alone in attracting private equity houses with money to spend. There have been signs that debtridden Swiss engineering firm ABB, which has already disposed of its structured finance and equipment leasing unit to GE Commercial Finance, part of the GE Capital unit of General Electric, is planning to sell its building systems arm piecemeal. The company is also disposing of a large part of its property portfolio and expects to receive a further $200m from the sale of its metering business. Another struggling Swiss contender is technology firm Ascom, which is reportedly keen on making disposals in its telecom, media and technology business to help pare back its debt.

Deal flow
Private equity funds are also hoping for rich pickings from Switzerland's financial institutions divesting equity holdings in order to improve return on capital and to focus on core operations. Among the most high-profile transactions in this area has been Swiss bank UBS's spin-off of a large stake in Hirslanden, a hospital chain, to pan-European buyout firm BC Partners. In other parts of the economy, financial sponsors are now keeping a close eye on large groups such as drugmaker Novartis, engineering group Sulzer, and chemical firms Clariant and Syngenta to see what opportunities may present themselves.

Observers predict that corporate sellers are going to provide the buyout market with significant deal flow for some time. Eduardo Bugnone is chairman at Southern European buyout house Argos Soditic, which has an office in Geneva. He says: ?Large companies pressing ahead with their divestment and restructuring programmes have traditionally been an important driver of deal flow in Switzerland. We have already seen the first wave of restructuring spinoffs. What we will see next is that deal flow in the middle market will increase substantially as companies begin clearing up at the lower end.?

BC Partners' recent decision to set up in Switzerland is evidence of European financial sponsor's interest in the market. The pan-European buyout firm has plans to open an office in Geneva in the first quarter of 2003. Other firms to have opened offices in Switzerland over the past two years include 3i, Apax Partners and CVC Capital Partners.

Alongside the pan-European firms stepping up their efforts in Switzerland, there are local players that are active, particularly at the smaller end of the market. Family-run businesses have traditionally been an important source of deal flow for the Swiss buyout houses, but doing deals in this segment of the market can be a difficult. As Bugnone points out: ?What is clear is that it is more difficult to buy businesses off families in Switzerland than it is in Northern Europe. Generally, this has a lot to do with the level of advice given to vendors. But those businesses in serious trouble will still come to the market.?

Prices are moving
The challenge for buyout funds operating in Switzerland will be to convince owners of smaller and mid-market enterprises, which make up the backbone of the economy and account more than 80 per cent of GDP, of the merits of seeking private equity backing. ?What will drive the number of transactions in Switzerland is the broader know-how in the market place that an MBO is an interesting option for succession solutions and spin-offs. We therefore strive to increase the water level in the lake while tailoring transaction structures to satisfy the vendors' very individual preferences,? explains Tobias Ursprung, investment director at Zurich-based Capvis Equity Partners, which has been investing in Swiss buyouts since 1990.

?Troubled businesses will come to the market?

There is another, more ambivalent factor affecting deal flow in Switzerland: price. As Ursprung's colleague Rolf Friedli, a partner at Capvis, points out, sellers are slowly adapting to the change in valuations, and private equity houses are beginning to see more realistic pricing. He says: ?Two years ago, private equity houses were paying wild prices. Now, sellers have a more realistic idea of what companies are worth. This will drive activity.?

What is noticeable is that price adjustments are taking place mostly among distressed firms and family-run businesses. Corporate sellers under no particular pressure to improve their balance sheets that are nevertheless looking to unload assets that no longer fit their strategy don't appear to be willing to compromise much on valuations at all quite yet. A recent example was Swiss drugmaker Novartis' decision to postpone the planned sale of its health food and sport nutrition businesses, after sufficiently attractive offers had failed to materialise.

?I think we will see a further economic decline next year,? predicts UrbanSchwerzmann, vice president of corporate finance at Global Capital Finance, an investment banking boutique operating out of Zurich. ?If we are talking about family owned businesses or sales of businesses in order to create liquidity as seen with ABB, then entry prices will go down. If it's a strategic spin-off such as the sale of the Swiss flagship brand Ovomaltine by Novartis to British Foods, then that is more difficult.?

Lenders are cautious
Nevertheless, it is still early days for succession sales and price adjustments and it would be wrong to expect a sudden flow of deal completions any time soon. There is a small but compelling list of reasons why deals are still difficult to complete in Switzerland.

One significant obstacle affecting buyout houses is that lending banks are operating with extreme caution. Local debt providers, principally Credit Suisse and UBS, which together account for around 45 per cent of total lending in Switzerland, are less inclined to supply finance to a deal at present. Market participants report that lenders are putting pressure on businesses to repay debt and are reluctant to arrange new credit lines in a bid to reduce their overall exposure to corporate loans.

The current weakness in the Swiss banking sector presents non-Swiss players with the opportunity to win business in the region. Schwerzmann at Global Capital Finance predicts that the market share of UBS and Credit Suisse in the debt market will go down relative to foreign banks. ?It is obvious that they built up their loan books considerably over the past two years without really syndicating. Now they are starting to realise that they need to scale that down.? Among other firms Schwerzmann cites as still active lenders in the market are BNP Paribas, Royal Bank of Scotland, Bank of Scotland and Deutsche Bank.

Josef Stadler, head of investment banking at JP Morgan in Switzerland, is less confident that the balance of power is indeed shifting. ?Is there an advantage to us? This remains to be seen. Swiss competitors may be more cautious these days but they have not stopped lending. But it does look as though they generally apply more conservative loan to value ratios in the current LBO environment.?

To the buyout community, it won't matter to what extent foreign lenders will be able to grab market share in Switzerland, as long as leveraged finance remains available one way or another. What they want to see is corporate restructurings, family owners working through succession issues and attractive asset prices to further drive the buyout market going forward. 2003 could be successful year for the industry.