Thinking bigger

Since acceding to the European Union in 1986, Spain has become an economic success story. Through its efforts to modernise, the country has managed to reduce public debt, unemployment and inflation and posted reasonably strong annual growth rates. Although unemployment remains high by Western European standards at just over 11 percent, and despite the fact that the rate of inflation is currently above the European average, solid progress has been made, notwithstanding a painful recession in the early 1990s.

But has Spain's private equity community shared this increasing economic prosperity? Until recently, it was hard to give a positive answer. “Many people in the past have referred excitedly to encouraging economic traits in the belief that they would allow private equity to take off”, says Carlos Pazos, a partner at SJ Berwin, the London-based international law firm that launched its Madrid office in 1999. “But, until now, such forecasts have always ended in disappointment”.

Pazos says one reason why the market has been held up in recent years was the Internet bubble, which had a detrimental effect on prices as vendors placed “ridiculous valuations” on businesses – and not only those in the technology sector.

But much has changed since then. After the bursting of the bubble came the grave events of 11 March 2004, commonly referred to as the Madrid train bombings. The terrorist attack was then followed by the election victory of the Socialist party and a series of falls on the stock market.

In the Spanish business world, pragmatism rather than bullishness has become the order of the day. A changed and uncertain environment has seen corporates retreating into their shells, unwilling to gamble on expansion strategies. Private equity firms, meanwhile – loaded up with capital and opting to take a longterm view – have come increasingly to the fore as the most willing deal participants.

Indeed, thanks to some noteworthy recent transactions such as Permira's €685 million buyout of 600 Spanish retail stores from Dutch group Ahold, private equity has become – in the words of Pazos – “all the fashion”. The deal – which was the first completed by Permira's new Madrid team, led by former 3i executive Carlos Mallo – has received broad and extensive national press coverage, and made the front pages of financial daily Expansión and daily newspaper 5Días.

Unlike in certain other European countries, it seems that private equity's profile in the Spanish press has been raised in a flattering way: on the whole, capital inversión has been painted as a catalyst for the further development of the Spanish economy rather than a malevolent force working against society's best interests. As exemplified by the Permira investment, the main reason for private equity's attracting publicity is its coming of age, epitomised by an increase in high-profile change-of-control investments in a market traditionally characterised by small, development capital deals.

Suala Capital is one firm in the vanguard of this transition. Before joining the firm in 2001, chairman Carlos Guerrero was at Vista Capital, the private equity joint venture between Banco Santander Central Hispano and Royal Bank of Scotland. Although during his time at Vista, Guerrero had focused mainly on modest expansion deals, he gained first-hand management buyout experience when overseeing the sale of supermarket chain Superdiplo to Ahold for €1.2 billion in 2000.

Armed with Guerrero's experience, Suala Capital launched a €215 million fund in December 2001 targeting buyouts. The idea, says Guerrero, was to take over family businesses and create short to medium-term value through the implementation of “tough measures”.

This seemed necessary because, as several Spanish practitioners interviewed for this article argued, some of the country's development capital investors had failed to achieve good returns because, as minority shareholders, they were not in a position to exert adequate influence over management teams. “You need to be hands-on in this market in order to grow and professionalise businesses”, opines Guerrero.

Suala is currently engaged in the divestment of portfolio company Mivisa, a metal packaging business, which, according to the firm, is expected to deliver “in excess of” four times capital invested. With its first fund now around 60 percent committed, Suala is expecting to raise a successor vehicle in the second half of 2005. Partner Gonzalo Días- Rato says that although no target amount has yet been determined, the firm has around €400 million in mind – almost double the size of the current fund.

Numerous other private equity firms in Spain are also thinking bigger now. José-María Maldonado, director general at Bridgepoint Capital, says that when the pan- European investor opened in Madrid in 1992, it joined a fledgling development capital market in which the firm would typically invest around €3 million per transaction. There were just a handful of local and foreign investors in the country at that time, he relates. Then a number of financial advisers sprung up, keen to encourage family sales and corporate divestments, together with an influx of leveraged financiers offering debt finance. Maldonado says Bridgepoint now finds plenty of opportunities in its “sweetspot” comprising companies with an enterprise value of €50 million to €250 million.

Corpfin Capital, a long-established mid-market buyout house, is, like its near-neighbour Suala, turning its mind to fundraising. In Corpfin's case, though, such thoughts are rather more pressing. London-based placement agent Helix Associates is currently advising it on plans for a launch that was imminent at the time of this article going to press. In its case, too, sights are being set higher in terms of target amount, with a likely (though unconfirmed) target of around €200 million. The firm's current fund closed on €135 million in 2001.

Corpfin president Felipe Oriol estimates that deals requiring €10 million to €80 million of equity have numbered 30 to 40 a year over the last few years and are set to grow further. “We have reasons to believe the buyout segment will grow at a significant rate”, he says. “Spain is now where the UK market was in the late 1980s. The concept of the buyout was unappreciated by Spanish management teams in the past, but now they see their peers going through the process and read about it in the papers”.

Oriol adds that the emergence of a “new breed” of hungry M&A boutiques should not be underestimated. He says these houses are busy knocking on the doors of Spanish corporates, seeking to play a role in strategic development and inevitably sloughing off deals for financial buyers in the process. One of these is GBS Finanzas, Spain's first independent investment bank, which was formed in 1991. GBS partner Kevin Woods says deals are being originated for the first time by proactive management teams. “Companies have much more professional management teams now, which are prepared to put together business plans and approach financiers with a view to a buyout. That simply didn't happen five years ago”, he says.

In addition to family and corporate sales of non-core divisions, a third source of deals is becoming apparent in Spain in the form of the public-to-private. At the current time, attention is focused on the auction of public company Amadeus Global Travel Distribution, the Spanish travel agency partly owned by Spain's national airline Iberia. In a recent statement, Iberia chief executive Angel Mullor said the business had received expressions of interest from up to ten private equity firms. BC Partners, CVC Capital Partners, Permira and KKR are believed to be among those interested in striking a deal by the end of the year which could be worth as much as €5 billion.

Clearly, deals on this scale are an extreme rarity. Instead, it is public companies of a more modest size that are increasingly being courted. “There is a lack of interest from institutions in mid-market companies on the stock market, and they do not enjoy sufficient liquidity for there to be any sense in continuing to be quoted”, says Suala's Días-Rato. “If a business is worth less than €1 billion, the stock market is no longer the place to be”.

The first and so far only example of a public-to-private in Spain was recorded in December 2003, with the €165 million buyout of leisure group Parques Reunidos by US-based global private equity firm Advent International. Part of the reason for the lack of completions so far is that the PTP is not an easy process. For example, lawyers refer to the greater difficulty of squeezing out minority shareholders in Spain compared with other European markets. The best assessment one can offer at this stage is that the case for the public-to-private as a source of deals is unproven, but undoubtedly offers potential.

But with opportunities for deals on the increase, does this mean there is now enough sustenance for a hungry market? Yes, says Qualitas Equity Partners co-founder Eric Halverson – at least at the smaller end of the market, where Qualitas is currently halfway through investing a €60 million fund. “Relative to the size of the economy, private equity spending in Spain is among the lowest in Europe, and there is room for a lot more investment”, he says. He points out that around two-thirds of Spanish businesses have a total workforce of 500 employees or less, compared with around 35 percent in Germany and 30 percent in the UK. Hence, he argues, there is an abundance of assets in Qualitas' target market.

Domestic institutions are definitely more interested in private equity now

Eric Halverson

This is not necessarily reflected at the larger end of the market. Javier Loizaga, executive partner of Madrid private equity firm Mercapital points out that the level of capital available to be invested in transactions in Spain is around twice the available supply of deals. Mercapital, which closed the largest buyout fund ever raised by a Spanish private equity firm on €600 million in January 2001, recently completed the €200 million acquisition of United Surgical Products (USP), a private hospital network.

Conceding that the auction of the business was “very competitive”, Loizaga adds: “It's a burning hot market, because it's attracted so much attention. In many cases, you can have 10 to 15 bidders in auctions, and you have to find an angle that justifies the price”. In the case of USP, Loizaga maintains, this was provided by the firm's experience in having made a number of healthcare investments over the years, as well as having known the management team for a decade.

Clearly the level of competition is a concern, particularly at the top end of the spectrum. One may of course argue that the really significant aspect of this is that Spain simply hasn't seen this level of competition before. In more mature buyout markets, one might reflect, having to outmuscle a host of equally determined rivals to win deals is acknowledged as simply a fact of life.

But if competition is becoming an issue, it will be interesting to see what effect this will have on what is expected to be a busy fundraising market next year. In addition to the fundraising plans of Suala and Corpfin noted earlier, rival mid-market investor MCH Private Equity is expected to launch a new fund with a target of around €150 million by the end of this year.

While market vibes about all three of these firms seem positive, there is a feeling that any manager going to market can expect to find itself under the scrutiny of increasingly selective institutional investors. “Prospects for some of those raising new funds are tough”, suggests Christian Hoedl, a partner at the Madrid office of law firm Uría & Menéndez. “Certain funds need to specialise because I'm not sure they will survive in the long term as generalists”.

As a counter-balance to Hoedl's observation, market professionals express hope that a greater level of commitment can be extracted from domestic institutions. At present, Spanish pension funds and insurance companies only commit around 0.1 percent of total assets to risk capital, partly because of tight regulations governing their investment activities and also because of fears surrounding the level of risk they are exposing themselves to. This is slowly changing, says SJ Berwin's Pazos, and, given that banks might scale back in the light of Basle II – there is an argument that it needs to.

“Domestic institutions are definitely more interested in private equity now”, says Qualitas Equity Partners' Halverson. “Some of the more sophisticated Spanish investors have committed to previous funds raised by local Spanish firms such as Mercapital and Nmas1. Less experienced institutions that have a lot of capital to invest may go into funds of funds or invest selectively in club deals”.

Targeting these less experienced investors is the rationale for the launch of Altamar Capital, the first Madrid-based private equity fund of funds. Established by former Merrill Lynch corporate financier Claudio Aguirre, the firm is aiming to raise up to €250 million by the end of this year exclusively from domestic sources to invest in partnerships outside Spain

But if domestic capital is coming up for grabs, Spanish private equity firms are determined to get their share. Oriol says Corpfin is hoping to increase the amount raised within Spain to 25 percent of the next fund's total from ten percent in the current fund. “International investors will always appreciate local backers giving you their support”, he says. Loizaga, meanwhile, says that when Mercapital next comes to market – which will probably be in 2006 – he too would anticipate a significantly greater contribution from Spanish sources.

For Spanish GPs, domestic support on the fundraising trail would undoubtedly be a positive development. But if the aforementioned concern that supply of capital may be outstripping supply of investment opportunities is true, a wave of investment from a new source may not be the best thing that could happen to the Spanish private equity market right now. Perhaps the aim of Altamar to channel some of the domestic institutional money into international partnerships will do the Spanish market a good service.