France maintains entente

France continues to boast one of the most active and competitive private equity markets in the world.

2006 saw another spate of big deals in the country. For the first time ever, there were more than a dozen acquisitions of French companies worth more than €1 billion ($1.3 billion), with Texas Pacific Group and AXA Private Equity's acquisition of broadcaster TDF topping the list at €6.2 billion.

“We're seeing a good level of dealflow, as large corporates re-focus on core businesses and the deals done in 2003/4, which have had outstanding results, come back to the market,” says Patrick Sayer, chairman of Eurazeo, a listed investment fund and one of the most influential LBO investors in the country. “At the same time there's more money ready to be invested, and funds are looking at larger targets. So the market remains buoyant.”

Unions tend to be quite pragmatic. They want to know that you will keep jobs and not destroy value

Jean-Bernard Lafonta

Looking at the list of firms involved in French deals last year, it is clear that local players like AXA, Eurazeo, PAI Partners and LBO France are now battling it out for assets with the international behemoths of the buyout world. Last year Kohlberg Kravis Roberts bought directories business Pages Jaunes for €4.2 billion, while CVC spent €1.8 billion buying truck hire group Fraikin from Eurazeo. Most of the big European and US funds now have a French presence, a reflection of its perceived importance within Europe.

“The market has been very active in the last year,” agrees Greg Revenu, a partner at French M&A boutique Bryan Garnier. “We've seen a number of very large transactions and the high end of the market is very competitive. Local players have raised significantly bigger funds and there's been competition from international players.”

STIFF COMPETITION
Of course, competition like this has its downside. With so many firms in the market, cheap debt readily available from local providers, and almost every deal going to a hotly-contested auction, the inevitable result is that firms are being forced to pay more for assets.

“Prices are rising because of competition and because of banks increasing their leverage – in some cases banks are financing deals at nine or ten times EBITDA,” says Dominique Megret, chief executive of PAI Partners.

Geoffroi de Saint-Chamas, head of leveraged finance for Royal Bank of Scotland in France, concurs: “It's a very good market. Leverage multiples have certainly increased over the last 12 months, particularly for the best quality assets.”

Proprietary deals are few and far between. “Competition is extremely strong and has increased significantly over the last three years,” says Megret. “Auctions are standard – there are very few negotiated [proprietary] transactions, and anyone that says they are doing one is probably lying.”

The problem is, there are not enough assets to go round. “There's a very large number of private equity firms hunting in France,” Revenu points out. “Most of the large corporates have divested what they're willing to divest, so there's not enough supply to meet demand.”

The reluctance to sell businesses may seem strange but, according to Jean-Bernard Lafonta, chief executive of Wendel Investissement, is typical of French corporations. “It's a French cultural peculiarity – when the markets are good, corporates like to keep their assets, rather than selling them as they would elsewhere,” he says.

This imposes a serious constraint on primary deal activity. So too do France's restrictive laws on public-toprivate deals, which require buyout firms to get 95 percent shareholder approval to take control of a company – a higher proportion than in other European countries.

As a result, the market is much more reliant on secondary transactions than elsewhere – as the list of the top deals of the year bears out. Opinion seems split on whether this is a dangerous trend. Revenu thinks it might be: “To some extent it is worrying that there are so many secondary deals. If funds are buying a company to optimise performance, then the second time round it's less about improving performance and more about increasing leverage. And that's a problem for LPs too, because there's not the same value as there is with new deals.”

But as de Saint-Chamas points out, it's not unreasonable to see more leverage in secondary deals. “These assets are well known to the banking community. Most of the primary deals completed over the past 2/3 years in France have overperformed their targets. This provides a greater visibility to lenders and allows for more aggressive structures.”

Sayer also seems sanguine. Preliminary data from AFIC, the French trade body he chairs, suggests that only about one in six deals was a secondary last year. This figure may come as a surprise to managers, many of whom speculated that the proportion was closer to one in three.

Megret believes it ultimately depends on the deal. “There are two types of secondary buyout: one, where all the work is done, so it's hard to increase the underlying value of the company; and two, when something has been done, but there is still a new story to be written – perhaps through acquisitions.”

MANAGEMENT HEADACHE
Secondary and tertiary deals bring with them another big headache for buyout firms: agreeing an incentive package with management. Management deals in France are now some of the most lucrative in the world. “Managers are now much better advised and are very good at negotiating their incentive packages,” says Chris Masek, a partner at Industri Kapital in Paris. “By our reckoning, management packages in France are better than anywhere else in continental Europe.”

The real issue, looking forward, is: what will happen when private equity starts buying the big household names?

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This problem is particularly acute in a market as competitive as today's, where firms are scrambling to differentiate themselves over rivals. Many believe management teams are getting too greedy – but the firms themselves are partly to blame. “Newcomers are trying to buy market share by offering increased incentives to the management team, because they have no other angle,” says one french manager.

“In secondary buyouts particularly, managers are playing a key role and asking for alternative packages, says Olivier Deren, head of private equity at law firm Paul Hastings. “It's sometimes unreasonable, and it could create pressure on the industry.”

However, Sayer believes these bumper packages are just a reflection of the industry's recent success. “It's fair to say that some tremendous deals have taken place, not because the package is that generous but because the rate of return has been far superior than initially anticipated.”

IMAGE PROBLEMS
But the problem for the industry is that these lucrative management deals can foster resentment among the rest of the workforce, or in the public at large. With its strong socialist tradition and heavily unionised workforce, France is often considered “a bad place to make money”, as one manager puts it. Suggestions that the industry is merely enriching a select few will not help its image.

“There is potential tension over the subject of LBOs,” admits Revenu, who notes the subject's particular sensitivity at a time when France is preparing for a presidential election later this year. “The concept is not necessarily well understood by the general public, and when people see managers in secondary and tertiary buyouts making huge returns with limited risks, that can generate a higher level of frustration at the lower levels. As we approach the election, this is an easy thing to leverage, especially for the trade unions.”

This issue has already caused problems for some firms. In 2005, when LBO France bought construction company Terreal from Carlyle and Eurazeo, workers were upset that management would receive all the benefits from the deal, and went on strike demanding a bonus. And there have been more recent signs of union activism, too. Last year, the French trade union CGT launched a spin-off called Collectif LBO, which aims to enlighten its members about the evils of private equity.

“The unions can put pressure on the industry by making noise in the newspapers, suggesting it is driven exclusively by profit and destroys jobs,” says Deren. “What they are saying is absolutely not true, but it has a psychological impact. It creates a climate where it could be difficult to complete certain transactions.

Yet despite this, the industry seems to have survived the last few years without any major political rows – unlike its supposedly less unionised and more right-leaning neighbour on the other side of the Channel. So what is France doing right that other countries in Europe are doing wrong?

SHARE AND SHARE ALIKE
One point to remember is that buyout firms in France are very used to dealing with the unions. Every transaction must be approved by a workers' council – which can potentially delay deals indefinitely if it sees fit to do so – so most firms have many years' experience in circumnavigating union objections. “That kind of opposition started a long time ago, so perhaps we're more used to it. It's less strong than it is currently in other countries, but it's still there,” says Megret.

Another key factor is that the industry in France has a compelling success story – and AFIC seems to be telling it pretty well. The trade body has recently published studies showing that private equity backed companies grow more quickly and create more jobs than the average company – a powerful counter to any external criticisms.

Of course, these studies are only powerful insofar as they influence the media agenda – an area in which buyout firms often seem uninterested. “The private equity industry as a whole would be well advised to talk more to the media and the unions,” suggests Patrick Petit, the founder of Paris-based placement agent Global Private Equity.

But in France, hostility to the industry in the mainstream media seems less pronounced than elsewhere. For example, AFIC's study received widespread and very favourable coverage in the press, including a front page piece in leading French business daily Les Echos- whereas the UK trade body's (very similar) statistics have been largely ignored by the media in Britain's recent furore. As Petit says: “In France there's been no big move in the media against private equity – perhaps because the industry is closer to the press, or because there's more of a consensus between all the parties involved.”

Observers believe criticism from the trade unions is probably less publicised than in other countries. As de Saint-Chamas notes: “Coverage of the industry tends to be more positive than negative.”

But perhaps the most powerful way in which the industry in France seems to have anticipated the debate happening in the rest of Europe is by allowing employees to share in the upside of successful buyouts. “France is a country where the social divide is felt very strongly, so I believe it is necessary to reconcile the owners and the workers of a business,” says Sayer. “That means we must make sure that the value created in the company in which we invest is shared with the employees – that the incentive packages are not just confined to the top managers but spread more widely, and to some extent offered to all employees of the company.”

For instance, to resolve the Terreal row, LBO France is widely believed to have paid out some kind of bonus to the workers – and although there were some mutterings at the time about “worrying precedents”, this approach is increasingly standard in French buyouts. Many believe that it needs to become standard elsewhere, too.

Indeed, extending the equity upside to employees as well as managers seems a natural part of the ‘alignment of interest’ argument so beloved of private equity. As Lafonta puts it: “It is important that all stakeholders can share in a fair way in the value creation. You must consider each time: how do you achieve a good alignment of interests? Because if you don't have that, the company is less efficient as a result.”

CLASHING SYMBOLS
Whatever the explanation, the French accord appears to be holding – for now. All the managers who spoke to PEI about this article played down any suggestion of tension with the unions. “Unions tend to be quite pragmatic,” says Lafonta. “They want to know that you will keep jobs and not destroy value. If you have a good and clear vision of the company and its strategy, they understand.”

In France, cultural businesses are the equivalent of defence businesses in the US

An open relationship is key, says Sayer: “Unions are not the enemy of private equity. We need to hold a common discussion and take the time to explain the facts – that workers can make more money and have better job security in a growing company.” Indeed, AFIC's approach has been so successful that it plans to share its knowledge with other European associations, according to market sources.

Of course, the accord could just be a function of the relative lack of maturity of the French market. Certainly some managers believe conflicts are inevitable as the industry becomes more high-profile. As Masek says: “The real issue, looking forward, is: what will happen when private equity starts buying the big household names?” This is not just a function of the size of the company but its symbolic value, he says – as witnessed by the recent tension over the sale of Editis, a French publishing company recently bought by Wendel. “In France, cultural businesses are the equivalent of defence businesses in the US,” quips one manager.

CAUTIOUS OPTIMISM
But these concerns are for the future. For now, most people in the industry seem optimistic about the environment for doing deals in France. “2007 will be a good year,” says Petit. “There are still blue skies ahead.”

Masek is inclined to agree with him. “The overall environment for investment is good – good managers, good companies, good local debt providers, and a decent tax structure.”

De Saint-Chamas says the first quarter has been very busy for RBS, which has picked up six new mandates. “The market has been active in every segment. Dealflow has slowed down slightly in recent weeks, but there are some interesting prospects coming onto the market.”

French buyout firms do seem to be doing a better job than most of their European counterparts at maintaining a good equilibrium between all the industry's stakeholders – managers, employees, politicians and the media. But as an increasing number of players, with even more money to spend, chase a limited number of assets in an already crowded market, many managers are reluctant to predict that this can hold indefinitely.

As Megret puts it: “We have always been prepared for a tougher tomorrow. So we're cautious when looking at transactions, we're cautious about valuations and we're cautious about how we manage our companies.”