In Europe, PE managers find new means of survival

Helen SteersFaced with falling valuations and few options for raising new capital, European private equity managers have targeted family companies undergoing generational change and corporate consolidations across the continent to secure new deals. But some managers are struggling to keep existing portfolios afloat, and have asked investors to ‘recycle’ commitments into old investments.

Simon Mumme talks to Helen Steers, partner with private equity fund-of-fund manager, Pantheon Ventures.

Private equity managers in the European market have become more insular during the downturn, ensuring existing portfolio companies are not irreparably damaged by the arduous business environment.

Pricing of new private equity deals fell at a lag to the meltdown in public markets, but as liquidity taps closed, managers with capital to invest have targeted the mid-market rather than the mega leveraged buyouts of 2006 and 2007. Across global markets, $386 billion was raised in 2008, but in the first quarter of 2009, $27.3 billion was put up by institutional investors.

But the lion’s share of deals being done in Europe are being executed in the small and mid-market, and involve less than  €250 million. This includes growth capital deals.

However, successions among large family businesses and the corporate consolidation spurred by monetary unification across the European Union (EU) is a theme worthy of pursuit, says Helen Steers, partner with European-focused private equity fund-of-fund (FoF) manager Pantheon Ventures.

 Many of the mid-market deals surfacing in Europe are sales of family-owned companies set up in the years after World War II and are not being taken over by the current generation.

“This is a trigger for private equity buyouts,” Steers says.

Monetary unification across the EU has also generated deals for private equity managers. Before the formation of the Eurozone, dominant businesses in each country sought to become national champions in their respective industries. Now, each country aims to host European champions, giving private equity managers opportunities to buy companies that compete globally, or soon will, Steers says.

But most managers are concentrating on improving – or at least maintaining – the competitiveness of companies they already own. This involves reducing operational costs, making bolt-on acquisitions or, when stressful situations become desperate, asking newer investors to redirect their commitments to old investments.

“Where the managers run out of money in a previous fund, they have to look at all the ways they can generate cash. They can reduce the cash needed by reducing operational costs, and can ask investors to recycle some of the commitments they have already made into current investments. Or they can try to raise an annex fund.”

Earlier this year, private equity titan Kohlberg Kravis Roberts asked investors to pump as much as  €730 million ($1.03 billIon) into an annex fund to support struggling companies in its 2005 European buyout fund, which raised $4.5 billion, according to the Financial Times.

Annex funds resemble the attempts made by venture capital investors to raise fresh capital after the dotcom bubble burst and they were left short of cash to support their investments.

Steers says that drawing on newer cashflows to bolster current investments – which includes the use of annex funds, cross-fund investments and ‘recycling’ provisions – usually met resistance from existing investors in the funds impacted.

“They can make cross investments from their most recent fund into a previous fund. But as an investor we try to discourage that.”

Turning again to opportunities in the private equity market, Steers says that while managers have trumpeted the opportunities in the secondaries market for more than a year, ‘late primaries’, later-stage investments in primary funds that offer attractive discounts to investors, were also worth considering.

“You can buy that 20 to 30 per cent of the fund already invested at a great discount.”

In the secondaries market, there are plenty of opportunities, but deals weren’t being completed. “The prices being offered aren’t being taken.”

Similar to the tact taken many listed equity managers in the past 18 months, private equity firms have preferred companies less vulnerable to the economic cycle, such as health care, waste management and telecommunications businesses.

Despite European managers’ current focus on the small and mid-markets, there are far fewer venture capital managers on the continent than in the US. This is primarily due to cultural differences: Americans have a more relaxed attitude to bankruptcy than Europeans, and the NASDAQ provides US start-ups with a natural exit point.

Buyout funds are dominant among European private equity managers. According to Pantheon, for a five-year investment horizon beginning in December 2008, European buyouts were expected to generate a pooled internal rate of return (IRR) of 11.1 per cent against the 7.9 per cent from their US counterparts.

In contrast, European venture capital funds were slated to deliver a 1.5 per cent IRR, while US venture managers were expected to generate 6.3 per cent.