Appetite Rises for European PE

The European private equity market appears to have performed a miraculous resurrection in the last six months.

At the end of December 2010, The Economist predicted dire consequences for the industry in an article called “The Lost Continent,” while it listed multiple reasons for acute pessimism across Europe, as PE funds shut down, announced drastic losses or struggled to raise new funds.

“European buyout firms battle to remain relevant,” it observed.

In evidence, The Economist cited the case of French firm PAI Partners, continental Europe’s largest buyout group by assets. The firm had acquired a controlling interest in French roofing giant Monier in 2007, but then lost control in June 2009 as creditors pounced. This contributed to a reshuffling at PAI, as two senior executives left.

However, PAI was back in the news at the end of May for different reasons, when the firm announced that it had sold electrical and mechanical engineering company Spie to another private equity consortium for €2.1 billion ($3 billion). It was the firm’s fifth sale of the year.

Under PAI’s ownership, Spie had increased its workforce from 23,000 to almost 29,000 and doubled its operational profit to €192 million ($272 million) in 2010. Alongside the sale of Italy’s Gruppo Coin and the U.K.-based Kwik-Fit motor servicing centers, Spie was an example of cultural and financial benefits that can accrue from private equity management, far from the gloom suggested by The Economist.

PAI now confidently predicts that it will raise a new €3 billion ($4.3 billion) fund.

It’s not the only PE firm in Europe that is gearing up to raise a new investment vehicle.

Altogether, there are currently 394 European private equity funds competing for €180 billion ($255 billion) in available capital. These include firms such as Montagu, which recently closed a €2.5 billion ($3.5 billion) fund, the largest of its type since the collapse of Lehman Brothers in September 2008.

In preparation for a new wave of fundraising, many firms are following in the footsteps of the rejuvenated French private equity firm PAI and unburdening themselves of assets that were initially acquired in the boom years of 2005 to 2007. For example, Permira has a queue of potential buyers in regards to portfolio companies in its 2006 vintage fund, despite modest IRR of 25% as of spring 2010.

We believe that, on the whole, institutional investors are not only holding their allocations to private equity steady, there is a long term trend towards increasing their allocation.”

Tim Friedman SpokesmanPreqin

Also of note is that exit activity is up across the continent. Disclosed European exit value reached $57.9 billion in the second quarter of 2011, double that of the first quarter and almost five times higher than the $12.7 billion registered in the same quarter of 2010, according to alternative assets data service Preqin.

Compared to worldwide activity, Europe posted the highest exit figures by value for Q2, dwarfing North America’s $23 billion, with Asia and the rest of the world at $2 billion. Not since the fourth quarter of 2006 has this relative proportion registered, demonstrating just how hungry European corporate buyers are for PE-backed assets.

“In recent quarters we have witnessed a surge in exit activity,” says Manuel Carvalho, Preqin’s manager in the private equity deals department.

Carvalho says that exit values are at record levels as fund managers take advantage of current market conditions to liquidate investments made during the buyout boom era and post-financial crisis.

“While buyout deal flow as a whole has rebounded from the lows seen in 2009, entry deal flow is still a long way from the highs seen in 2006 and 2007, with exits accounting for the largest proportion of fund manager activity,” he says. “However, capital is increasingly being returned to investors and this will be committed to new funds if investors intend to maintain their current allocations levels.”

Likewise, Preqin spokesman Tim Friedman says that European fundraising conditions for PE firms have been extremely challenging since 2008, falling to historic lows in 2010. But so far this year, there has been a remarkable turnaround.

“We believe that, on the whole, institutional investors are not only holding their allocations to private equity steady, there is a long term trend towards increasing their allocation,” he says.

In a Preqin survey of investors’ expectations at the end 2010, more than half said they planned to invest more capital in private equity in 2011 than in 2010.

That view is supported by such deals as Japanese Takeda Pharmaceutical Co.’s €9.6 billion ($13.6 billion) acquisition of European pharmaceutical company Nycomed in May 2011; Microsoft paying $8.5 billion for Skype Technologies; and Thermo Fisher Scientific’s $3.5 billion acquisition from U.K.-based buyout group Cinven of Swedish pharma company Phadia, all in the same month. Cinven, by the way, has its sights set on raising a €5 billion fund.

The boost in exits comes as exit opportunities fell dramatically in the wake of Lehman Brothers’ demise. This ensuing hiatus in deal activity clearly resulted in LPs reserving unspent capital, which is now pouring fourth, as strategic investors’ balance sheets have returned to health.

Europe’s private equity industry is still some distance from the go-go years between 2005 and mid-2008 … but reports of its imminent demise are premature, to say the least.

“There are more banks that are lending to the private equity community again and you also have a very buoyant high-yield debt market,” says Tim Syder, deputy managing partner at U.K. buyout firm Electra Partners.

Similarly, loan markets began to ease in 2010, according to Roland Berger Strategy Consultants in Munich, Germany, but banks remain wary of risks outside their comfort zone.

“Banks prefer borrowers they know,” says the consultancy. “Refinancing, corporates with strong credit ratings, secondary buyouts… If companies do not have bond market access, the low loan availability rate is an issue for them.”

Some market analysts already fear that borrowing is running too high, despite banks only recently becoming active again.

“The fact that a company can be acquired with a lot of leverage today does not mean that it will create a lot of value in the next five years,” says Joseph Schull, European head of the U.S. private equity group Warburg Pincus.

The average European debt to EBIDTA multiple for larger buyouts was more than 5x in the first quarter of 2011, still below the 6.6x European multiple reported in 2007, but a jump from 4.5x in 2009.

In its European Private Equity Outlook 2011, Roland Berger describes the “disastrous year” of 2009 and how 2010 was an improvement, but was “still challenging.”

“European PE activities started to regain momentum after a historical low in 2009 – PE investments increased by 52% compared with the previous year,” the report says.

It also warns that “European governments fuelled growth with deficit spending, which may hamper growth in the long run and put the stability of the European financial system at high risk.

For the private equity community, Berger believes that GPs “will have to rethink how they can meet limited partners’ return expectations in the future.” The consultancy argues that 2011 will prove to be a better year for PE firms, with more activity particularly in the automotive, capital goods, business services and consumer goods sectors.”

Europe’s private equity industry is still some distance from the go-go years between 2005 and mid-2008—and some would say, “Thank Goodness” for that, but reports of its imminent demise are premature, to say the least.