Deals further down the food chain

After several prominent transactions in 2002, investment activity in Switzerland's large-cap buyout market has slowed down. “The market for Swiss-based deals is still lumpy. It has been a difficult year, not a good market to get money invested”, complains a local financier of the past twelve months.

There have been exceptions. In January, Zurich-based midmarket house Capvis Equity Partners together with Quadriga Capital, the German sponsor, announced the SFr175m (€113m; $135m) management buyout of Zellweger Uster, a supplier of quality control systems to the textile industry. The vendor, Zurich-listed Zellweger Luwa, used the proceeds from the disposal to pay a dividend to shareholders and finance the take-private of the company in November.

Much later in the year in October, ABB, the still struggling Swiss-Swedish engineering giant, entered into an agreement to sell its oil, gas and petrochemicals business to a private equity consortium comprising Candover, 3i and JP Morgan Partners for up to €975m (the exact price is still being negotiated).

In November, 3i's Zurich team teamed up with management to acquire MIB Property + Facility Management from Siemens Building Technologies. The consideration for the Baden-based company with annual sales of SFr125m was not disclosed, but 3i said in a statement it was the largest MBO in Switzerland this year. Also in November, Apollo Management, Soros Private Equity and Goldman Sachs Capital Partners invested $350m of equity as part of a large financial restructuring for Cablecom, Switzerland's largest cable network.

Apart from these transactions though, larger buyouts have been thin on the ground. Practitioners talk of a market still slowed by buyer/ seller price gaps – even though these are reportedly narrowing – and the kind of competitive wariness that comes from there being a significant number of seasoned sponsor groups in what is a comparatively small market. Sourcing and then securing exclusivity in a transaction is not easy.

Small global leaders
This slowdown suggests that after a period of significant corporate restructuring activity mainly among Switzerland's large conglomerates in the aviation, engineering, chemicals and pharmaceutical sectors, the focus is now shifting to smaller entities looking to streamline operations and clean up their balance sheets. “Listed mid-size businesses with a capitalisation of between €1bn and €2bn are now looking to sell off non-strategic assets”, says Edoardo Bugnone, a partner at Geneva-based mid-market investor Argos Soditic. Others are expecting increased deal flow from mid-market companies when a change in generation obliges family owners to look at a private equity backed solution: “The Mittelstand is gaining momentum from succession problems,” says Michael Petersen, a director in 3i's Zurich office.

Whatever the drivers, financial investors as well as trade buyers are attracted to Switzerland's mid-market, mainly because it offers the prospect of investing in small but very high quality businesses that often are global leaders in their industries. To give an example: Auguste Betschart, managing partner at midmarket house Leman Capital in Geneva, says his firm is focusing on the country's ‘still extremely fragmented’ – and world famous – watch industry, where vertical integration is yet to happen and where family businesses in particular are considering their options for the future.

However, anyone familiar with private equity investment in continental Europe generally will not be surprised to learn that executing deals in the Swiss mid-market is difficult. Transactions can take years to come to fruition, and may well fail at the last hurdle. Vendors are often interested in discussing investment propositions but are rarely desperate enough to push for swift execution, which is one of the reasons why 2003 has been slower than some had predicted.

Also slowing down the transaction process is the fact that auctions have become almost inevitable. Says Markus Reich of 3i in Zurich: “Swiss vendors tend to approach the sales process with a somewhat exaggerated sense of perfectionism. As a result, buyers often have to go through an auction process, at least on a pro forma basis, even with smaller transactions where auctions make less sense.”

Moreover, although Swiss vendors are said to be generally comfortable with the private equity concept and open to considering its application, trade buyers often remain preferred partners. Where a private equity solution to a specific seller requirement is envisaged, vendors take great care to weigh up which buyer to enter into negotiations with. “Five years ago, sellers were mainly focused on price,” says Rolf Friedli, a partner at Zurich-based Capvis Equity Partners, the former UBS affiliate which in June this year closed its second mid-market buyout fund at €340m. “Today the whole package and the power to deliver count. Vendors want to know who they are dealing with.”

Some setbacks
Sellers also want to avoid the reputational fallout that tends to follow when a private equity deal ends in failure. Difficulties at a number of private equity backed Swiss companies have meant that private equity, although well established as a financing tool, has recently been in the news for the wrong reasons.

The forced restructuring earlier this year of Basle-based epoxy resins manufacturer Vantico, acquired by Morgan Grenfell Private Equity from Ciba Specialty Chemicals in 2000, is a case in point. Vantico, now controlled by New York turnaround specialists MatlinPatterson, ran out of steam after worsening market conditions had made the company's overleveraged capital structure too great a burden. Although Morgan Grenfell, which in late 2002 agreed to inject additional capital into the company in the hope of turning it around, still retains a small interest in the company, according to an investor in the fund that acquired the business, it is not expected to retrieve much capital from the deal.

Another private equity investment that has been making negative headlines for some time is Tornos Bechler, a tools manufacturer formerly controlled by pan-European private equity house Doughty Hanson. The firm raised close to SFr100m via an IPO on the Zurich stock exchange in March 2001. The business then became heavily loss-making in 2002 and lost over 90 per cent of its market value. Doughty, which sold a portion of its interest at the time of the IPO, remains a minority investor in the lathe making company, whose trading performance recently has been showing signs of improvement.

Whether these companies would have been faring any better had they not been subject to private equity investment is very much a moot point though. Local private equity professionals tend to take comfort from the fact that Switzerland has arguably seen less bad news than other maturing private equity markets in continental Europe, particularly Germany. “We haven't had a Fairchild Dornier or a Bundesdruckerei,” reminds a buyout practitioner, referring to two of Europe's largest private equity failures to date.

Looking ahead, Switzerland's indigenous buyout specialists as well as the pan-European houses that have carved out a presence here – such as Candover Investments, CVC Capital Partners, Apax Partners and Quadriga Capital – are optimistic that the market will continue to reward the efforts they have put in. These firms intend to play a meaningful role in the market going forward. The larger funds have no doubt that Swiss corporations will continue to sell off attractive non-core operations.

Others remain focused on midsize transactions. As the evolution of private equity markets in other parts of Europe has shown, bringing family-owned Mittelstand companies genuinely into play is no small challenge. Deep local networks and quality reputations – as well as a patient constitution – will be essential for investors who are serious about mastering it.

Although industry incumbents never fail to remind you that investing in Switzerland is a long-term game, private equity's appeal is not lost on Swiss finance and investment professionals. Many are still desperate to join its ranks: “We're receiving a surprisingly large number of job applications,” says Friedli at Capvis – which suggests that to many there is a great deal still to play for.

The expectation for 2004 (and beyond) is a pick-up in deal flow and investment activity. A number of Swiss houses, including Argos and Leman, did not complete a deal in Switzerland in 2003 (though both made investments in France), despite getting close on a number of occasions. They are adamant they will invest in 2004, and so are their peers. Expect to see a few major Swiss buyouts reach the market but a marked rise in smaller transactions next year.