Still life on a smaller scale

Over the past two decades, France has steadily gained ground to become one of Europe's most active private equity markets. In 2008, its investment level was second only to the UK across Europe [see chart on page 58]. It was also recognised last year as having the region's most attractive tax and legal environment for private equity firms by the European Private Equity and Venture Capital Association.

The country's private equity industry was given another vote of confidence recently with a study commissioned by the World Economic Forum and conducted by a team of academics including Harvard Business School professor Josh Lerner. As part of a larger global study of 4,000 private equity-owned and comparable businesses, the researchers looked at leveraged buyouts in France between 1994 and 2004. They found that “private equity funds act as an engine for growth for small- and medium-sized enterprises”, with evidence of growth in jobs, productivity, sales and assets within companies that had liquidity problems pre-takeover.

Perhaps unsurprisingly, the number of groups actively looking for French deals has been expanding. In addition to several hundred domestic private equity firms of all sizes, and the regional shops that have long considered France a key geography, an increasing number of global players are interested in French opportunities.

“France is a large economy, the second-largest in Europe and the fifth-largest worldwide, so there's no shortage of interesting companies,” says Christian Strain, a principal at Boston-headquartered growth capital firm Summit Partners. A well-educated workforce makes French businesses even more attractive, particularly in the science and technology sectors, he adds.

Summit completed its first French deal in 2007, with the purchase of a 20 percent stake in Vente-Privée, an online auction site for high-end retail goods at discounted prices. Summit, which normally backs founder-owned, high-growth businesses, has helped the company's five founders expand their platform to Spain, Italy, Germany and the UK. “So far it's gone very well and we're keen to find more companies in that mould,” Strain says. “We have a lot of interesting opportunities in the pipeline. We started well with Vente-Privée and our ambition is to continue to build a track record in the French market.”

Summit is one of many global firms looking to raise its profile in France. In March, for example, The Blackstone Group hired Gerard Errera, former secretary general of the French Ministry of Foreign Affairs and French ambassador to the UK, to bolster its deal flow. CVC Capital Partners did the same in November with the hire of former HSBC France chief Charles-Henri Filippi.

France's allure is not limited to the size of its economy and the education of its workforce. “The French market offers, in my opinion, better opportunities altogether than some of the other markets in Europe,” says Wladimir Mollof, president of Europe-focused fund of funds ACG Private Equity.

Mollof highlights an expected wave of non-core asset disposal by corporate groups. “There is a lot more to be done and, frankly, there are also some fantastic opportunities in quoted groups in terms of non-core assets, and even in terms of making bids [for the whole company], because the market caps are lower than the net worth,” he says.

Recent examples of such activity include French mid-market firm 21 Centrale's €20 million mobile media carve-out of Jet Multimedia's consumer facing arm in December 2008, and, in October, Advent International's €203 million deal for the French electronic payment arm of checking giant Experian.

Succession issues are also frequently mentioned as a potential source of deal flow, as aging managers are regarded as generally friendly toward private investors. “Many of these owners and managers – contrary, for example, to Germany and to a certain degree Italy and Spain – are accepting of investment funds, more so maybe than some of the other countries,” Mollof says.

One of the most attractive features about the French private equity market is the country's “capacity for expansion” via its large volume of small- and medium-sized businesses, says Charles Soulignac, head of Paris-headquartered fund of funds FondInvest Capital. In most cases, French companies are much smaller than comparables in neighbouring countries, he says. “In the past it was a negative point to have a small company in comparison with, for example, Germany, where the small and medium-sized companies are larger in size than in France. But in some cases it could be more interesting to set up and build up a company progressively in buying and adding other companies.”

Buying and building in the lower- to mid-market is the strategy of choice in France, where, like its US and UK counterparts, the private equity industry has changed dramatically over the past three years.

FALLOUT EFFECTS
Last year, Europe's buyout market plunged 60 percent in value, hitting a seven-year low amid the seizure of credit markets and global financial dislocation. France saw the value of its private equity deals fall nearly 74 percent to €7.2 billion invested in 134 deals, dropping drastically from the prior year's €27.6 billion invested across 229 deals, according to the Centre for Management Buyout Research.

“The world is totally changing for private equity,” says FondInvest's Soulignac. “The volume will not be the same that we have had in the past four years. Exits will not be the same, they will take more time. It is necessary to go back to the basics of private equity.”

Long gone are the days of firms fighting one another for mega-deals, as they did in early 2007 when PAI Partners prevailed over 10 other investors to buy the roofing business of cement group Lafarge in a €2.4 billion buyout. The Paris-headquartered firm beat rivals including The Carlyle Group, Bain Capital, Doughty Hanson and LBO France for that deal, which saw it take on €420 million in debt and pension liabilities.

“Everybody knows that this part of the business has disappeared,” says Gilles Mougenot, partner and cofounder of Southern Europe-focused mid-market firm Argos Soditic. Mougenot also believes the market will see the departure of pass-the-parcel deals, or secondary and tertiary buyouts that effectively had companies switching financial sponsors every two to three years. “Everybody has to accept that leverage is no longer the same as it was in the previous period,” he says.

Financing for mega-deals doesn't exist in the current market environment, agrees Elizabeth O'Reilly, head of investor relations for LBO France. “The French market today in terms of debt financing, it's essentially just the French banks [funding deals]. It will come as no surprise that anything above €400 million is just un-financeable,” she says. The French firm's mid-market fund, which has the capacity to do deals up to around €2 billion, was actively looking at five deals at press time, all of them under €400 million.

All market participants agree large deals are tough if not impossible to get done, while smaller deals now require a greater number of banks in the lending group.

“You don't have any banks making any commitments to syndicate in transactions,” says Toufic Abi Fadel, a transactions-focused lawyer in the private equity group at Paris-headquartered law firm Gide Loyrette Nouel. “For any transaction you have to organize a club deal – even for €50 million – therefore you need at least three banks to arrange a deal. The rates are much higher, the margins are almost double the level they were at the end of 2007.” Debt-to-equity ratios are now nearly one to one, as second lien tranches have disappeared, he adds. “Before, you could have financing representing 80 percent of the deal in a multitude of tranches.”

Valuation problems are plaguing the French market. There remains a large bid-ask gap between buyers and sellers, with multiples still hovering too high for many potential buyers' liking.

“What is very difficult for everybody [from small-cap to mid-cap players], is the fact that cash flow, the profit and losses of companies, are totally unpredictable,” says Mougenot. “If you ask people now – except for in a few limited sectors like defence, healthcare, energy – it's absolutely impossible to be sure your new forecast is a true one and therefore it's difficult for anybody in this market to say what the true valuation is for a company. You could restate your budget every month.”

Despite the changing landscape, there remain buoyant pockets in the French private equity market. Many firms, like 21 Centrale and LBO France, are hiring rather than firing. Some, like LBO France and ACG Private Equity, are hitting the fundraising trail. “Now is a great time to invest. Private equity vintages during and post-crises have historically been good,” says ACG's Mollof. “At the moment, funds can make interesting investments with less competition; there are too many funds that are too prudent, waiting. These are times to exploit opportunities.”

Many firms are, in fact, looking to take advantage of the downturn in various ways. In October, Argos Soditic led the management buyout of French technology security consulting firm Laboratoire d'Expertise en Sécurité Informatique. Argos partner Louis Godron told sister website PrivateEquityOnline that the company's business model would benefit from the worsening economic outlook. “Fraud becomes more prolific during hard times, so companies need to protect themselves,” he said, adding, “in these circumstances businesses, especially financial institutions, need to manage their risks even more tightly.”

DEBT FOR EQUITY
Some private equity firms are backing troubled companies needing to reduce debts in exchange for equity injections, such as Auto distribution, the debtladen French car part distributor, which received a €110 million cash injection from private equity firms Towerbrook and Investcorp.

Meanwhile, LBO France is poised to raise the country's first credit-focused private equity fund in May, having already hired a dedicated trio of executives to launch the investment strategy. It continues a trend set in motion by many US and UK megafirms, which have sought to capitalise on debt opportunities arising from global financial dislocation. Credit-focused and distressed debt funds are now being considered by many French firms, according to market participants.

Traditional French small-cap and lower mid-market funds have greater success at the moment, according to Fondinvest's Soulignac. It is not just because their deals are easier to finance, but “because they are investing in companies which have niche businesses”, while larger funds with a strict sector focus are more susceptible to market contractions and specific industry downturns.

“We've seen activity continuing in the mid-market,” says 3i France managing director Bruno Deschamps, who left Clayton Dubilier & Rice in summer 2007 to lead 3i's French operations. He estimates French buyout activity is down by at least two-thirds, but points to particular companies for sale today as well as an increased demand for minority stake deals. “We see an increased appetite for those transactions because companies are either unhappy with their share price or need to make acquisitions to benefit from lower multiples, so they are happy to find minority shareholders to co-invest. This model is clearly gaining momentum.” Development or growth capital deals are increasing, in part because private equity is now the only source of capital for some of these companies, says Mougenot. “The banks don't want to provide loans anymore, the stock market for this type of company has totally disappeared, so there are potentially on the table a lot of opportunities,” he says.

CONSOLIDATION PROSPECT
LBO France is two deals away from fully deploying its second small-cap fund, Hexagone II, and is currently raising a successor. The segment of the market where deals are €100 million or less is “very, very dynamic”, says O'Reilly. “Smaller players are more open to consolidation discussions. Prices even in small caps have come down. Equity debt multiples in the past [were] 3.5-4x, we're now looking at 2.5-3x.”

In March, the firm's Hexagone I and II funds exited train seat manufacturer Compin in a secondary sale to Barclays Private Equity. Compin is a good example of a French buy-and-build, says O'Reilly. The company had annual sales of roughly €50 million when LBO France first invested in it in 2005; by the time it was sold, it had added on three companies, set up a joint venture in China, and brought sales close to €130 million.

On the smaller side of the market is Avenir Entreprises, which invests development capital in high volume across France. Backed by CDC Enterprises and Oseo, the firm did more than 35 deals last year, making equity investments of up to €2 million for minority stakes in rapidly growing SMEs. It also makes mezzanine investments of up to €500,000. Avenir's director general Claude Sauvageot, says even though some LBO firms have lowered their sights in terms of deal size, they typically wouldn't invest in as many companies as Avenir. Nor would they likely hold them for as long – the firm, which bills itself as “patient capital”, sometimes holds on to investments for as long as 15 years.

Arguably some of the most patient capital in France belongs to its venture firms. “Venture capital has been in a less than easy situation over the las t few year s ,” Antoine Papiernik, Sofinnova Partners' managing partner, said in an interview with PrivateEquityOnline.

For Papiernik, the Paris-based firm's recent $700 million sale of medical device company CoreValve – generating the largest return on a single deal in the firm's 35-year history – represents a long-awaited vindication of the venture capital model, which has until recently been overshadowed by the faster, larger returns generated by large buyout groups. “It's been hard,” he said, “People called us fools and told us we were the ‘last of the Mohicans’ doing early stage investment (see p. 36).”

France has strengthened its startup scene by “allowing institutional and private investors to put pre-tax money in young companies and/or VCs and have the chance to receive possible tax-free gains”, Rolf Dienst, founder of Wellington Partners, wrote in a recent column for PEO.

Less reliant on leverage and large deals, venture firms also have the benefit of being slightly less affected by the current market climate than private equity firms, argue Guillaume Aubin and Charles Letourneur of Paris-based venture firm Alven Capital. VCs may gain from an economic downturn as unemployment rates rise, they add, because natural entrepreneurs made redundant will increasingly choose to start a company rather than job hunt in a dismal market. “Many success stories come out of crises,” they say.

LOOKING AHEAD
As in the rest of Europe, fallout from the credit crisis means the French private equity landscape could experience some fund manager consolidation and strategy shifts.

“It has happened in the US, it has happened to a certain degree in the UK,” says ACG's Mollof. “Some fund managers are going to disappear, because they won't be able to raise [new funds] in view of the performance they are producing. Some fund managers will regroup with other fund managers. I think really the fittest will survive, the fittest in terms of size and state of portfolios.”

Danny Truell, chief investment officer of UK charity the Wellcome Trust, was one of many voices that echoed Mollof's predictions at the EVCA investors' forum in Geneva last month.

“The boom had attracted a lot of tourists into the industry, both GPs and LPs, with limited understanding of what they were doing,” Truell said. “These tourists will leave, leaving the rest of the industry to go back to what historically it has been good at.” Where it has excelled, he continued, is in disrupting industries and empowering people while providing long-term capital.

The overwhelming impression one gets from the GPs that call France home, is that they intend on doing just that. Although the various market participants may have different ideas as to precisely where the greatest opportunities lie at present, they share the same optimism for the industry's continued growth.