VCs See Opportunity in Ailing Mediterranean Region

The Mediterranean economies of Greece, Portugal and Spain have been embattled, bruised and forced into using rescue packages since the credit crunch impacted the global economy in fall 2008.

One by one, they have had their credit rating slashed, their banks have begged for support, their unemployment figures have soared and their governments appealed to the International Monetary Fund (IMF) for emergency bail outs.

In the case of Greece, the IMF agreed to an unprecedented €110 billion ($153 billion) loan, while demanding austerity measures and a series of reforms to clean up the country’s murky financial waters.

In September 2010, the Portuguese government announced a package of deficit reduction measures, including a 5% cut in the public sector wage bill and an increase in value added tax to 23%, alongside a freeze on state pensions and reductions of up to 25% in social payments.

Spain had its credit rating cut from triple A to Aa1 in late September by Moody’s, following similar downgrades by Standard & Poor’s and Fitch, as Moody’s predicted growth of just 1% for the economy over the next few years. The Spanish government has promised to reduce its budget deficit from 11.1% of GDP in 2009 to 6% in 2011 and 3% in 2013.

In the midst of all this political crisis and economic despair, how has the venture capital and private equity industry fared?

“The crisis has worked very well for venture capital and private equity,” says Stavros Siokos, head of investment management at Pireaus Bank Ventures, the largest and most active VC fund in Greece.

He notes that two or three years ago, there was only one private equity house in Greece. Now there are five. It used to be a €200 million ($278 million) industry, now it is €1 billion ($1.4 billion), says Siokos, who points to a shift from loans to more equity investments taking place recently.

“Companies were used to getting cheap loans, they weren’t used to dealing with equity,” he says. “So when they couldn’t get loans any more, they came to private equity and venture capital.”

Today, the market is more local than it was pre-crash. Global firms such as The Carlyle Group were active in the mid-2000s, buying companies for up to €1 billion ($1.4 billion). Now, deals are smaller and carried out by locally based funds, since the large mega-buyout shops are more attracted by opportunities in Brazil, Russia, India and China, and company valuations in Greece have yet to fall dramatically.

“The market feels the lack of liquidity, but not yet the value,” Siokos says. “Private equity will come back when prices drop, but there will be different ones. It will be turnaround funds.”

Siokos points out that in the Greek economy, companies are now obliged to turn to equity providers, since the banks are both reluctant to lend and cannot move quickly enough to bail them out.

“If companies don’t give away equity, they will die. It is a matter of education, and of private equity houses understanding how to handle distressed assets. It’s not something that everyone knows,” Siokos says. “If you have a fishing company, you have to know the industry.”

Angels Taking Flight

Angel investors are another new phenomenon in Greek finance. Teresa Farmaki, CIO for private equity and venture capital at Piraeus Equity Advisors, has watched the angel sector sprout from zero in 2008 to an active and growing number today. Piraeus typically co-invests with angels 50/50, particularly through such vehicles as the Open Fund, helping investors, such as shipping company owners, diversify into new media as their traditional operations come under pressure.

“A lot of Greek investors have worked overseas and have seen mature, sophisticated investment operations. In the past, much of the funding for new businesses came from family and friends,” Farmaki says. “Information flow was lower and slower. But as the markets have developed and information flow has improved and become faster, everything else has improved. We’re still at an early stage, but it’s certainly a growth area. There are great opportunities.”

Meanwhile, European Union money has started to reach Greek venture capitalists in the past few years, including a €150 million ($208.6 million) joint EU and Greek New Economy Development VC fund (known as TANEO) that was launched in 2003. Another round this year will total €200 million ($278 million), providing 50% funding to upwards of 10 different venture funds.

Executives such as Siokos at Piraeus Bank Ventures are well placed to capitalize on current opportunities. Formerly global head of structured investments at Citigroup in London, he has put together a team of investors from Canada, Belgium, the United States and elsewhere. “This would not have happened in the past,” he says.

Climate Matters

For a growing number of VC-backed companies in Spain, the pleasant climate and environment is a key recruitment factor, according to David Carratt, managing director of London-based venture firm Kennet. The firm has invested in several Spanish-based businesses, including BuyVIP, a private online sales club with expected revenues of €95 million ($132 million) in 2010.

“Although they are based in Spain, VC-backed companies generally have quite a broad international perspective, so they’re not that exposed to the Spanish market,” Carratt says. “If anything, BuyVIP is seeing more demand, as consumers become more price sensitive.”

In July 2010, U.K.-based private equity firm Permira completed its first buyout since mid-2009 when it acquired Barcelona-based eDreams, the online travel group, in a deal worth between €250 million ($348 million) and €300 million ($417.8 million).

Among its investments, Kennet has backed TMC, a maker of a tech diagnostics system that sells in Scandinavia and the United Kingdom, and NTR, a software developer for PCs that is distributed in the United States and Europe, with only 25% of its business in Spain.

Both companies are located in Barcelona, purely because “it’s an attractive place to live and work,” Carratt says. He foresees further growth in entrepreneurs who make their money elsewhere, then move to Spain (or to Southern California) where the climate is better, recycling their money into the local area and starting up new operations locally.

“Italy is not so transparent and countries further east have less business infrastructure,” he says.

He anticipates that economic pressure may spur the Spanish government to accelerate some useful measures, such as diving online penetration, to bring forward cost efficiencies.

“And I think there is a long-term trend towards entrepreneurialism. Younger people feel that they’re more likely to do well by starting high growth businesses and relying less on traditional industries, such as tourism and agriculture,” Carratt says. “People are also less interested in cashflow engineering and more interested in organic growth. There used to be opportunities in arbitrage and leverage, but now there is big emphasis on profit.”

Looking on the Bright Side

Alberto Gomez, managing partner at Adara, one of the largest VC firms in Spain, agrees that the credit squeeze has several positive effects.

“What’s good about these times is that people have a tougher mentality. So there are very attractive opportunities for VCs to develop companies that are robust,” Gomez says. “Entrepreneurs in Spain will be more careful and efficient in terms of using capital. The potential upside will be greater.”

The depth of the recession in Spain has encouraged businesses to widen their horizons, according to Gomez. He cites Alienvault, an IT security provider that launched in Madrid, funded by Adara and others, and was initially focused on the domestic market.

“At the beginning of 2010, they looked at conditions here and decided to move to San Francisco, as they developed a more global view of how to sell to international markets,” he says. “Next year, Spain will be less than 50% of their revenue.

“The Spanish business is still growing at 20% to 30%, but if they had remained here they would be caught in a long payment cycle. Today, they are probably growing at 100 percent.”

Gomez argues that the demise of “get-rich-quick” schemes that characterized the Spanish property market has had a further effect on the VC industry. “It will encourage endurance and long-term commitment,” he says.

Firms such as Kennet have invested over the years in Spain and Portugal, recently selling Chipidea Microelectronica to MIPS for €147 million ($205 million), another multi-national operation that happened to have its headquarters outside the traditional centers of London, Paris or Munich. A smaller economy than Spain or Greece, there is plenty of motivation for Portuguese companies to operate globally.

At Espirito Santo Ventures, the country’s largest VC firm, Principal Jose Sousa argues that venture capital has an important role in helping the Portuguese economy to recover, through promoting exports and creating jobs. His firm has invested more than €200 million ($279 million) in its 10-year history, providing an alternative to family and friends that traditionally supported new businesses.