State of play

Government intervention in the economy – a topic raised with some frequency on a recent PEI trip to Paris – is seen as both a blessing and a curse. In socialist France, heavy state involvement has cushioned the country’s economy from the worst effects of the financial crisis. Unlike its neighbours the UK and Spain, France emerged from recession in the last quarter of 2009, recording GDP growth of 0.6 percent, in what economy minster Christine Lagarde described as a “satisfying result”.

The economic cushion that a socialist economy provides is not lost on the nation’s private equity practitioners. “France is a good place to be in a recession,” says Charles Diehl, a partner at French mid-market buyout and growth investment firm Activa Capital, who points to the protection afforded to employees and unemployment benefits as effective stabilisers during a downturn. The result of this, he says, is that even some consumer businesses managed to grow through last year’s downturn.

There is still week visibility of earnings.

Arnaud Leclercq

The flipside of the soft landing is a subsequent slow take-off. “The bad news is, the recovery will be sluggish,” says Eric Bismuth, president of mid-market investor Montefiore Investment. The thought is echoed by Jean-Marc Dayan, a partner at private equity firm Duke Street: “France has a greater ability to absorb, but less ability to generate growth.”

An ability to absorb shocks has not, however, meant that private equity firms in France have been able to go about their business as usual throughout the downturn. The lack of visibility on earnings and thus valuations has ravaged deal flow and GPs have faced similar difficulties in sourcing and executing deals in France as they have elsewhere in the world. The outlook – say insiders – does not seem to be improving in any meaningful way. “The quality of opportunity is not good at the moment,” says Anne Caron, a director with mid-market investor Gimv, which has had an office and team in Paris since December 2007. “It is a tiring market,” she adds, “because this is the third confusing year and we don’t really see the end”.

Caron’s colleague, Arnaud Leclercq, adds that he sees no dramatic change in deal flow from 2009’s figures. “There is still weak visibility of earnings,” he says. The expected stabilisation has not yet arrived.

The availability of debt has been less of an issue for the country’s predominantly mid-market private equity industry due to a combination of historically conservative leverage ratios – around 2.5x to 3x senior debt in a mid-market deal – and a banking sector that took less of a severe hit than its peers in Anglo-Saxon economies. “The world of debt finance has not strategically changed for mid-market players like us,” says Diehl.

As is the case in other markets, high quality investment opportunities are – in their scarcity – now commanding high prices. “At the year end, we saw a few high quality companies in the market, but as they were scarce the prices were stupid,” says Bismuth.

Gimv director Caron relates a scenario in which the firm was pursuing a growth investment opportunity – worth around €30 million – in the latter stages of 2009 and found itself to be one of a pack of 20 private equity firms in the running.

Sarkozy: Creating competition

While fierce competition for assets is not a uniquely French phenomenon at this moment in time, firms targeting the smaller end of the country’s private equity deal spectrum are coming up against a new, uniquely French competitor. The FSI (Fonds Stratégique d’Investissement) is a French sovereign wealth fund in all but name. The fund, which was launched in 2008 by President Nicolas Sarkozy, is mandated to make direct minority investments in French companies and has a pool of €20 billion at its disposal – including €6 billion in cash – making it one of the 20 largest sovereign wealth funds in the world. Its raison d’être is, according to its website, twofold: to promote the development of promising small- and medium-sized enterprises, which otherwise find finance hard to access; and to protect the capital structure of strategically important companies.

During 2009 the FSI invested €800 million in 21 businesses of various sizes. It is “aggressive and ready to invest”, says one mid-market investor.

It is not just the FSI competing with private equity firms, but a number of pools of state-sponsored money. “These new sources of cheap, active regional funds give entrepreneurs a lot of options,” says Gimv’s Leclercq.

Research commissioned by the World Economic Forum has shown that a moderate level of government intervention in the venture capital space is of benefit to the companies involved – they tend to perform better than either businesses with only private backing or only government money. “We are cautiously optimistic about the record and potential for moderate, well-designed government support for venture capital,” wrote the authors of the report, published in December 2009. The research focused on the benefits reaped by the investee companies and only examined venture capital. How government intervention affects private equity players competing for assets against government entities in larger deals is yet to be seen, but reports suggest that it will ultimately damage returns.

They make it harder for us to generate returns for investors, because they are less predictable in terms of behaviour and pricing.

Eric Bismuth

“State-backed competition has increased,” says Bismuth. “For very small transactions there have been fiscal incentives and state-subsidised funds paying stupid prices,” he says, referring specifically to smaller deals in the €5 million to €10 million range. The upshot of the state intervention is, he adds, a more difficult investment environment: “They make it harder for us to generate returns for investors, because they are less predictable in terms of behaviour and pricing.”

Elie Cohen, a member of the government’s Economic Analysis Council, in January said that with one or two exceptions the fund had “done the work of a classic private equity fund”. “If it is behaving as a normal private equity group then why does the government need to intervene? It is a contradiction,” he told the Financial Times.

The French state has always intervened to support SMEs indirectly via fund investments from the Caisse des Dépôts, a 200-year old public body mandated to make long-term investments in French businesses, says a Paris-headquartered fund of funds manager, but increased direct investment activity is competing directly with private equity funds.

Aside from complications arising from state-backed investment activity, the investment outlook is uncertain but improving. “We are more confident for 2010, more time has passed since Lehman providing greater visibility and now we’re in a better position to predict” says Duke Street’s Dayan, “even it if it is not good things”.

Bismuth cites the natural selection prompted by the crisis as being positive for private equity: “Prices remain expensive, but at least the crisis has been an acid test, so you know better what you are buying.”

Despite the “soft landing” experienced by the French economy, there is no doubt that local GPs – in the face of stiff competition from buyers both public and private –have their work cut out for them in finding and building value.