Awaiting reconstruction

Spain was, not so long ago, the European Union's star performer on the economic front. With average annual GDP growth of 3.8 percent between 1997 and 2007 on the back of a boom in the construction industry, it seemed it was a market that could do no wrong. And then along came the global financial and economic crisis and the construction sector collapsed to rubble and ruin. The rest of the economy wasn't far behind – Spain now has 18 percent unemployment and the European Commission has forecast that its economy will contract 3.2 percent in 2009.

In Portugal, a much smaller private equity market, the economic picture has begun to improve. Following three consecutive quarters of decline, the country saw a surprise growth in GDP of 0.3 percent in the second quarter. Nonetheless, the Portuguese economy has had a tough time since around 2000 and did not share in the growth spurt of its larger Iberian neighbour.

Says Carlo Mallo, partner and head of the Madrid office at buyout firm Permira: “The financial crisis has slowed down the growth of the private equity industry in Spain and Portugal in the past couple of years but we believe that the market fundamentals continue to be as attractive for long-term investors like Permira as they were when we set up our office in Madrid in 2004.”

He adds: “The fragmented nature of the business fabric in the Spanish and Portuguese economies, with a predominance of family businesses and relatively under-developed capital markets, together with the need for some companies to reduce leverage by divesting non-core assets, mean that active investors with local knowledge and long-term capital will keep finding good investment opportunities in the region.”

VENDOR LOANS ONLY
But while the long-term fundamentals remain compelling, activity in the recent past has been subdued and looks set to remain so for a while yet. As with other private equity markets around the world, the credit crunch has taken its toll on banking appetite. “Vendor loans are the only way of closing deals now, ” says Javier Loizaga, chairman of Madrid-based private equity firm Mercapital. “That's one of the reasons buyout volumes have been so low.”

Deal flow has not dried up completely in Spain in 2009. Transactions completed during the year so far have included: London-based Palamon Capital Partners' investment in care services firm Grupo SAR (the deal value was undisclosed, but understood to be more than €200 million); fellow London-based firm GMT Communication Partners' refinancing of advertising firm Redext; and the acquisition by Barcelona-headquartered Miura Private Equity of Proytecsa, a specialist in the design, development, production and marketing of technology security products.

Nonetheless, despite the above examples, the statistics back up Loizaga's assertion of low deal volume. According to information provider Dealogic, the year to 24 August 2009 saw 21 deals worth €332 million completed in Spain. This compares with 34 worth €3.2 billion in the whole of 2008 and, at the peak of the market, 66 totalling €12.2 billion in 2005.

Beatriz González has a good insight into the private equity market in Spain as an investment director at Fonditel, manager of Telefónica's pension fund. She thinks the dire economic scenario – rather than the lack of credit – is the biggest drag on market activity. “In the past, Spanish GPs focused primarily on growth capital and so they are quite happy doing those kind of deals rather than ones that rely on leverage. They've never had an over-reliance on leverage, so they haven't made the mistakes that have been made elsewhere.”

The problem, she adds, is that Spain is a service-based economy which has come to be particularly reliant on sectors like construction and tourism. Having fallen such a long way, she predicts a “very tough” year for the economy in 2010 with any sort of recovery not expected until 2011. Unsurprisingly, therefore, she also expects GPs to sit on their money for a while yet. “No one is rushing to do deals,” she says, “because there is not a lot of visibility.

“But, despite the lack of visibility, GPs are starting to see value as valuations come down, and are very active in analysing deals.”

NOT MUCH DISTRESS
Loizaga agrees that the lack of visibility is a major issue, but also points out that some potential private equity targets in Spain are reasonably well capitalised. “There are not as many really distressed vendors as I thought there would be,” he says. “I think we will see more distressed sellers in the next six months from the banks and corporations, but because the Spanish economy has been so successful for the last 10 to 15 years, many of the family owned companies are sitting on piles of cash which they can live on through the recession.”

While new deal prospects are bleak, arguably the bigger preoccupation for GPs at the current time is stress in the portfolio. Says Philippe Poggioli, a managing partner at Paris-based funds of funds manager Access Capital Partners, which invests in funds across Europe: “Portfolio companies are suffering from the withdrawal of short-term finance. Companies are seeing overdrafts, leasing facilities and short-term credit lines being halved or pulled altogether. We have seen this in other countries, but in Spain the problem seems to be the most acute.”

Poggioli believes that the difficulties being faced by the Spanish market in general may taint Spanish GPs on the fundraising trail. “Even the most established groups would find it impossible to raise capital in today's market,” he says. “The country has been kind of ‘tagged’, so it would be difficult to raise anything from an international investor base.”

While it may be true that international LPs will look less favourably on Spanish GPs, González argues that local Spanish investors – which have the advantage of being able to stay closer to developments on the ground – will stay loyal. She points out that, around ten years ago, all investors in Spanish funds were non-Spanish – today, domestic LPs account for around 30-40 percent of the total capital of a typical Spanish fund.

She thinks that the importance of relationships will keep the money flowing into certain funds. “In other countries people talk about the importance of access to deals and proprietary networks and it may not be true, but in Spain it is certainly true.”

González also points out that a lot of Spanish private equity firms have been fortunate in the timing of fundraisings, with many completed during 2007 and 2008. The only problem for these funds, given the current deal-doing climate is what to do with all the money. With few prepared to look any earlier than 2011 for signs of recovery, a lot of patience may be needed – on both sides of the GP/LP divide.