Italy: a late starter accelerates

Italy would provide an excellent case study as to the speed with which a private equity market can evolve. From its origins in the early 1990s, the Italian market has stormed into third place in Europe with some €2.6bn of private equity investment in 2002 according to AIFI, the Italian venture capital association, albeit still less than half the amount of either the UK or second placed France. Given the fact that Italy and the UK are roughly similar in terms of GDP, population and numbers of companies, the potential for the market is obvious. AIFI says that in 2002, the level of private equity investment in Italy stood at a 0.209 per cent of GDP compared to 0.626 per cent for the UK.

As in Spain, the largest potential for private equity lies in the huge number of medium sized companies that are situated predominately in the northern end of the country. “This is the core of the private equity market here,” says Fabio Sattin, chairman and CEO of Milan-based Private

Equity Partners “Not investing in this segment means not being a consolidating player in Italy.”

But persuading owners of these companies, many of which are still family businesses, to relinquish control can be difficult. As in the fashion industry, Italy is more used to creating trends than following them. Terrence Tehranian, a partner at London-based GMT Communications Partners, says: “Surprisingly, Italy is different from Spain, which is less parochial and more open to outside influences such as private equity.” Tehranian also cites a number of other reasons why it is, in his view, hard to do business in Italy, including the relative lack of development in financial reporting and corporate governance.

It is therefore unsurprising that not everyone is thriving in Italy. Part of the message about private equity Italian-style is that local knowledge only becomes really meaningful with local connections. That need not mean you have to be a home-grown private equity firm though. In 2002 a University of Bocconi study identified a tiny band of leaders amongst the approximately total 100 or so private equity players in the market. These included BC Partners, BS Private Equity, Investitori Associati, Permira, 3i and Private Equity Partners (PEP). “The top five do 50 to 60 per cent of the buyouts,” says Sattin, “and although new players are entering the market, we expect to see consolidation among the existing players as they capitalise on their experience—investors want to put money into the top names or not at all.” And while the headline numbers for aggregate IRR in Italy may look large – Sattin cites 22.8 per cent for development capital in 2002 – they are averages. “There is a huge difference between what the good and the bad players are getting,”

Three levels
The Italian private equity market operates on three levels. For large companies, those that are roughly €200m in enterprise value plus, there are the big international names that are bidding in big ticket auctions and looking for big industrial spinouts. Clearly, this space is the most competitive. Two of Europe's largest buyouts have happened in Italy this year; the €1.5bn buyout of Fiat Avio by the Carlyle Group and Finnmecanica and the massive

€5.6bn buyout of Seat Pagine Gialle by Permira Advisers, CVC Capital Partners, BC Partners and Investitori Associati. Both deals are in the completion stage. Another large transaction which has reached the exclusivity stage is Doughty Hanson's €670m exit from FL Selenia, while UBS Capital's exit from Global Garden Products is said to be nearing exclusivity too.

Below the radar of most of the large players lies the Italian mid market, comprised of companies with an enterprise valuation of €30m to €200m. It is deals in this range that arguably drive private equity in Italy; according to M&A data provider Mergermarket, the greatest volume of deals in Italy has been between €50m and €300m. Of 23 private equity backed transactions in Italy in the first half of 2003, only five were worth more than €160m and most were below €100m. This is where the greatest concentration of private equity players lies. These houses compete, increasingly at auction, for what are often family businesses. Since Italian private equity was relatively nascent at the time, it missed much of the private equity boom of the late 90s, meaning that many good opportunities remain. For the most part the players are independent names like BS Private Equity Group, Investitori Associati, PEP and overseas firms like 3i and Bridgepoint, all of which have established track records. It's also worth noting that the Italian banks and their captive funds cover this area too, as well as the upper and lower ends of the market.

There is a huge difference between what the good and the bad players are getting

At the lower end are the smaller I private equity houses as well as ^^ venture capital funds and regional and public players. It is here that the largest number of Italian private equity deals takes place. This is a strictly non-aucion space with the potential for lucrative deals for those that have access. “These can by juicy – they are very profitable, with low entry multiples, but you really have to be under the skin of the local entrepreneur,” says Armando d'Amico at placement agent Acanthus Advisers. This area is the stamping ground for small, local funds as well as the more flexible (or opportunistic) mid-market players like PEP and BS Private Equity.

This year, many of the smaller, specialised firms have seen more activity than the big international groups. This is thanks to their local connections and willingness to look at a broad range of deals. Bruno Castellini, a partner at law firm Freshfields Bruckhaus Deringer in Milan, says: “These firms have been more active, in terms of number of transactions finalised, probably because of their better knowledge of the local market and their willingness to do smaller deals than the likes of Carlyle and CVC.” BS Private Equity is an example of a house that has a longstanding appetite for these kinds of transactions. It did both the €200m buyout of plastic producer Radici Film from a family and the €30m MBI of scaffolding producer Pilosio from a vendor who faced succession issues.

On the other hand, according to AIFI, venture capital has been in a sharp period of decline in Italy as it has elsewhere. “There has been very little investment in start-ups, which from our perspective is almost dead as a market,” says Freshfields' Castellini. Instead the majority of transactions have come from later stage investments in traditional cash generating businesses. And although there has been a lot of talk of PTPs following Permira's buyback and delisting of yacht manufacturer Ferretti last year, not much has happened by way of transactions. This may well be due to the unwillingness of investors to sell back shares at a substantial loss. “A tender offer without a substantial premium is unlikely to be successful,” says Castellini. Investors in Italy it seems prefer to wait for public equity prices to harden.

Market changes
Italian private equity should receive a fillip from a tax change that comes into effect in January 2004. It will enable Italian residents that sell their companies to private equity players not to pay tax, a so called ‘participation exemption.’ This is intended to help the restructuring of industrial groups in Italy and is similar to a German measure that boosted its M&A market several years ago. Italy has also recently revised its law on closed end fund structures to facilitate investment by Italian institutions. Effectively, this allows them to invest directly in Italian private equity without the constraints of traditional offshore structures. Guido Paolo Gamucci, a partner at Permira in Milan confirms that: “The new participation exemption story and the new fund structure are working and giving a boost to Italian investment into private equity.”

At present, private equity funding in Italy relies heavily on the banks, which according to AIFI provided 44 per cent of funding in 2002, followed by 17 per cent from corporate investors and 16 per cent from private individuals. Pension funds contributed a mere four per cent of the total. Although the potential for pension fund investment exists, the Italian pension industry is in its infancy. “There is little pension fund investment at the moment,” says PEP's Sattin. “They are a very recent animal and it will take time for things to change.” AIFI agrees, commenting that since pension funds do not have tight asset allocation constraints, they will over time become major players in line with other international markets.

One private equity fund keen to draw capital from the Italian pension fund industry is Clessidra Sgr. The fund, which is targeting a €1bn final total, is said to be seeking €700m from Italian investors. Given that the new firm is led by Claudio Sposito, the former chief of Italian premier Silvio Berlusconi's family holding company, it is safe to assume that most in the Italian investment industry will be familiar with the fund's story. There are those though who have their doubts about such an ambitious project. “How can they do it?” says one industry insider. “The idea of such a large first time fund is mind-boggling.”

Whether or not the fundraising is successful, there are doubts about how the money can be spent. “This will be a problem for Italy's reputation,” declares the insider. “How can the country absorb such a large fund?” Clessidra will have to compete with the established names in the mid-market and against the mega players at the larger end. “Italy must be the only place on earth where people with no experience in private equity can raise a fund,” the insider concludes.

Another Italian fund currently in the market is Cimino & Associati Private Equity (Cape), an established firm seeking a comparatively paltry €110m. Cape has been a nimble player in the lower end of the market and is said to have done 12 deals in the last four years and already achieved four exits. True to style the firm is accentuating its local approach (it focuses on companies based in the north east of Italy), as part of its fund raising story.

Despite some worries about how the capital in buyout funds will be effectively deployed, the overall outlook for Italian private equity continues to be positive. Most observers believe that investment in 2003 will at least match the level of 2002. Certainly those private equity practitioners on the ground are bullish. As Francesco Sironi, managing partner at BS Private Equity, says: “I am sure that we will see a large increase in overall market volumes this year and although this will be largely due to the big transactions, there will nonetheless be a healthy rise in the mid market too.”