In a European M&A market that has seen steady decline for the past three years, private equity has come to marked prominence, the result of an absence of trade buyers, an abundance of capital to deploy on the part of sponsors and a steady flow of non-core assets being put up for sale by big corporations. The result has been an increasing focus on private equity firms by M&A advisors, bereft as many are of their traditional fee avenues.
“With such a large volume of capital to invest, private equity firms have filled the void left by the disappearance of trade buyers,” says Peter Jacobs, head of private equity at PricewaterhouseCoopers. Markus Noe-Nordberg, a managing director at Goldman Sachs, shares the view. “The big buyout firms have very substantial cash positions, corporates have undergone significant restructuring and asset sales, and they are also less active in the bidding process for assets.”
M&A data over the past couple of years highlights the growing role of private equity in what has been a shrinking market. According to data published by Dealogic (see table), private equity-led transactions have accounted for more than ten per cent of all global M&A activity in 2003, up from just below nine per cent in 2002. At the height of the dotcom boom in 2000, the figure was just over two per cent. In the same year, according to Dealogic a staggering £3,583bn of M&A deals were done worldwide. That total had fallen to £1,411bn in 2002.
Private equity firms are clearly seen as prime movers in the ongoing reshaping of the European corporate landscape by the investment banks. “The European private equity sector is maturing,” says Naomi Molson, global co-head of Merrill Lynch's financial sponsors group. “At the same time though, it is increasing in size and importance. In 2001 we advised on the Yell deal, which was the biggest in Europe at the time at £2.14bn. Two years on and we have seen the Seat deal which was more than double the size. Nonetheless, there is still some way to go.”
The Yell transaction gives an insight into the sort of role the big investment banks are trying to play in private equity-backed M&A. “Merrill Lynch introduced Apax and Hicks Muse, not just to the deal but to each other,” Molson explains. “We were the sole M&A advisor on the transaction and also led the debt and high yield financings. Last year we participated in the financing of a bolt-on deal in the US and we were joint bookrunner on the IPO this year.” Even if, as one banker who preferred to remain anonymous puts it, “private equity firms don't pay well”, a full service arrangement such as that seen for Yell can provide a steady source of follow-on of fee generating activities, in an otherwise all too quiet market.
Until 2001, fees at the banks were driven by IPOs and trade sales but this has virtually dried up and private equity has stepped in
“The corporate market is very slow at the moment,” says a UK-based GP, speaking off-the-record. “This is mostly because of the struggle with earnings.” This lack of activity among corporate buyers has seen banks turn their attention to the financial sponsors market. All of the major names are competing for this business. “We are driven by what we can do for private equity firms,” explains Noe-Nordberg. “We try to provide a menu of options, whether it be advisory, co-investment, financing or take public advice. In an ideal world we would provide a full service to private equity firms, but we leave those decisions to clients.”
The readiness on the part of these investment banks to get to know the asset class has not been lost on the sponsors. As one private equity professional puts it: “You've got a situation now where the biggest investment banks are willing to work on a £100m deal. They wouldn't have got out of bed for that a couple of years ago.” Effectively, banks have had little choice than to follow the fees and if this means taking on the smaller mandates provided by private equity firms, so be it. As an indication of Goldman Sachs' heightened interest in the asset class, the bank has broadened its emphasis to incorporate work on more deals in the sector. “It's not just the top end deals that we look for,” declares Noe-Nordberg. “We also want to help mid-market firms as well.”
“There is intense marketing going on at the investment banks,” says one banking source. “Until 2001, fees at the banks were driven by IPOs and trade sales but this has virtually dried up and private equity has stepped in… they're pretty much the only game in town.”
Cross border counts
The reasons why private equity firms have risen to prominence in recent years are clear. Much larger funds, ongoing corporate restructuring and distressed sellers have all played a part, but there is also another important reason, according to Stewart Binnie, a partner at independent corporate finance boutique Augusta Finance. Binnie was previously the investment director of Schroder Finance Partners and a partner at Schroder Ventures (now Permira). “It always used to be said that private equity firms couldn't compete with trade buyers on price, but that has changed since private equity firms have enjoyed synergies from mergers across Europe that we hadn't really seen before.”
Binnie cites the example of Cinven and Candover, who merged BertelsmannSpringer with Kluwer Academic Publishers (KAP) earlier this year in two transactions with a total value of €1.6bn. In so doing, they created the second largest scientific, technical and medical publisher in the world, with total combined revenues of about €880m and EBITDA of €155m. “The firepower of private equity firms has increased so enormously that they are now in a position where they can bid for anything,” notes Binnie.
Speaking at the time, Brian Linden, director of Cinven, said: “The acquisition of Kluwer Academic Publishers gave us an initial position in the sector. Our intention at that time was to build a group with a strong global presence in the STM publishing sector and the acquisition of BertelsmannSpringer is the manifestation of this strategy.”
The Carlyle Group has deployed a similar strategy following the acquisition of Fiat's Avio aerospace unit, which was bought for €1.5bn in July. Edoardo Lanzavecchia, managing director of the firm's Italian office, indicated at the time that the firm was keen to develop Avio into a consolidation play in the European aerospace industry. This strategy was behind the acquisition of MTU, the aerospace unit of DaimlerChrysler, that created a pan-European business with an enterprise value in excess of €3bn. “Private equity firms are now in a strong position to complete cross-border deals, not least because many of them have experienced overseas expansion themselves,” says Jacobs of PWC. “It's a natural next step. Why limit yourself to local transactions?”
Almost inevitably, cross-border deals are more complicated than domestic transactions (e.g. multiple jurisdictions, fiscal regimes as well as broader cultural issues), but problems can be overcome. “Banks are definitely most comfortable lending in their own jurisdiction,” says one bank source. “It can be difficult to raise financing for an international transaction. But really, the biggest obstacle for pan-European transactions is ensuring the deal makes sense.”
Fundraising offers the best guide to what will happen to private equity's role in European M&A – and funds continue to get bigger
As private equity firms expand into larger, pan-European deals, advisors are seeking to ensure that their service fits the bill. “Private equity firms are crucial clients because they are buyers and sellers of assets across the continent. We're focusing on our pan-European capability as a distinguishing feature,” says Jacobs. “As firms seek to create businesses of scale, there is a greater need to expand across Europe.” This has lead some practitioners to mark out two very distinct types of adviser: the pan-European specialist who wants (and needs) the large, cross border transactions capable of delivering sizeable fee income and the local, niche player who makes a virtue of working within a particular market or sector. Unsurprisingly, this latter type rarely makes the league tables when transaction value – or even volume – is involved though.
The advisor rankings from Thomson Financial for European private equity see Goldman Sachs in top spot, as is the case for non-private equity transactions, advising on ten deals in 2003 with a total value of $16.7bn (see table). “Goldman Sachs is always up there,” according to one London-based GP, “but they prefer the really large transactions.” UBS, ranked fifth overall for European MA& advice, is just behind Goldman Sachs with a total of $16.5bn. “UBS has had a much higher profile over the past 18 months and has enjoyed something of a resurgence,” the GP added. Citigroup comes in third, advising on deals totalling $13.2bn. “SSSB [as the investment banking arm was known until recently] specialises in the bigger, high-profile deals,” confirmed the London-based GP. BNP Paribas, ranked eighth, has been active this year, according to a Paris-based GP, “although fairly Franco-centric.”
Elsewhere in the market, much attention has been focused on the race to acquire UK department store group Debenhams. CVC, Texas Pacific and Merrill Lynch Private Equity are competing against Permira to take the group private, and both teams have been aided in their efforts by the PLC, with all sides receiving M&A advice from one of the major investment banks. “We've seen a new phenomenon in European public-to-privates with Debenhams agreeing to contribute towards the advisory fees of both consortia,” says Simon Tinkler, a partner at Clifford Chance. “Any reduction in the cost of launching an offer for a business should have a positive impact on the sale process and is likely to prove cost-effective for all concerned.”
When entering into an auction process, banks, in their attempt to land the best (i.e. winning) advisory mandate, are faced with a tactical dilemma. They are required to choose between aggressively backing one horse at the outset of the bidding process, or holding back until the later rounds when the situation becomes clearer but where the opportunity may have been missed. “You can argue both ways,” says Kamal Tabet, Global Head of the Financial Entrepreneurs Group at Citigroup. “You can select a partner from the outset and be very aggressive on the financing, but one rarely knows at the outset whether a sponsor wants to go all the way.”
Tabet believes that the number of buyout opportunities as a whole will diminish in the next few months; he also thinks that GPs appetite for new deals is being tempered by the need to exit some investments too. “We are seeing a lot of great ideas and pitches,” he says. “But the pipeline isn't great on the whole, partly because corporates have managed to clean up their act for the most part. Compared to two or three years ago, the supply has slowed. There is less on the block today and GPs are still having a difficult time exiting.”
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Tabet believes that this upstream problem for sponsors presents the greatest challenge for GPs moving forward: “The key requirement from [these funds'] LPs at present is a desire for greater liquidity, which is heightened by an improvement in the public markets.” In fact, any optimism regarding an up-tick in M&A activity should be checked with the news that deal activity outside the US is at its lowest level since 1997, according to Thomson Financial. Preliminary figures for the third quarter show that ex-US M&A activity has fallen from $150.5bn during the same period last year to $124.2bn.
The key question remains one of whether trade buyers are likely to return to the market and what effect that will have on private equity's role within European M&A activity. Will the financial sponsor coverage groups at the investment banks be less in the spotlight as senior bank management trawl for revenue? The prevailing mood would suggest that private equity will be a big part of the banks' M&A strategies for a long time. Even if corporate buyers become more active, it is not as if the private equity firms will suddenly find themselves frozen out of transactions. “Corporates are under pressure to ensure each deal makes sense,” says one banking source. “Private equity firms may find situations where they can acquire an asset and sell on the part of it desirable to a trade buyer. This can serve both sides well.”
Ultimately, private equity firms' ability to hold their own against listed companies when acquiring significant assets will be an important indicator of how the asset class has become embedded in the mainstream of European corporate activity. “Fundraising offers the best guide to what will happen to private equity's role in European M&A,” says Augusta Finance's Binnie. “And funds continue to get bigger.” In effect, private equity needs to hold its own against trade buyers when they return because the volume of capital raised will require them to do so. Opinions on when public companies are likely to come back to the M&A market are varied, with some analysts believing that the current stock market rises are a blip rather than a trend.
Additionally, a return of trade buyers is likely to be sporadic. “Trade buyers will return to the fray,” says Jacobs, “although it is most likely that different sectors will re-emerge at different times.” Expect the bankers to continue courting the sponsors for some time yet.