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Market integration, the changing role of government, the Internet downturn, and other factors make for a volatile time in private equity investing in Europe. But one thing seems clear, according to participants in a panel on "Late Stage Private Equity in Europe": the number of deals in the pan-European arena will continue to grow.
Markus Noe-Nordberg, executive director of Goldman Sachs International, put the burgeoning deals into "three key buckets": deals driven by private companies' need for cash; deals resulting from Euro-driven M&A activity and accompanying antitrust scrutiny; and deals driven by the business sales resulting from increased conglomerate restructuring.
Abel Halpern, partner and managing director at Texas Pacific Group (TPG), set recent developments in the context of historical trends in a critical mass of private companies founded after World War II. Many of these companies became pan-European in the '70s and '80s and experienced tremendous growth. Now, he said, complexities have arisen with older CEOs retiring and many older children involved in the companies.
"These companies often have Byzantine corporate structures that are designed for nothing else than tax evasion," said Halpern, "and now as they try to expand throughout Europe and throughout the world, they find that they are prisoners of their complex shareholder structure and Byzantine corporate organization. Very often a private equity firm can come in and help them rationalize and correct some of the crippling structures that are preventing them from accessing capital."
Allen Haight, partner at Schroder Ventures, agreed that the businesses that emerged after World War II comprise a valuable market. He stressed the benefits of close contact with this older generation of CEOs. "Having people on the ground is very important to us in terms of spending time with the entrepreneur who is in his 70s and convincing him that we can help professionalize and get back on track."
Finding good deals
All of the panelists were clear that the key is to invest the money well. "Anyone can get money invested," said Noe-Nordberg. "I can get 10 billion dollars' worth of investment in a year, but it is probably going to be bad deals and a bad rate of return and that's not what the game is about. So there are lots of opportunities. The trick is finding the right one."
Haight expressed confidence in the market's absorption ability. "The 5-billion-dollar Euro fund we closed two weeks ago is already 25% invested. So the opportunities, the good ones, are there."
Halpern and Haight described different strategies for covering the European market. Schroder's geographic structure, said Haight, includes offices in the U.K., Germany, France, and Italy, allowing individuals in the regions to get in close and find the hidden opportunities.
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Halpern described TPG's alternative of maintaining one office for all of Europe, with professionals from various countries who can be "shot at the markets as needed" using networks and relationships built around investment players.
"Not having offices in the regions prevents an urge to invest by default," he said. "It is easy to invest. It is hard not to invest. Sometimes you have to be willing not to invest in a market for several years. If there is nothing good to do in Italy for four years, then we will do nothing in Italy for four years. However, if you have an office with five or six people in Milan who feel like they are not justifying their existence unless they are putting four or five million dollars to work a year, it is more likely that you will invest in something that you shouldn't invest in."
The Internet bubble?
All of the panelists distanced themselves from the more precarious layer of technology implementers. Their focus was on what makes things click and the advantages of having observed the situation in the U.S.
"We invest in technology companies where there is a technology," said Halpern. "Technology is moving at a pace that increases exponentially. So there's a lot of opportunity for big ticket tech investing, but that is very different from market development Internet investing."
Haight put it simply: "We capitalize on the picks and shovels, not the bubble stuff."
Noe-Nordberg said that knowledge gained from the U.S. had led to less exposure in Europe. "Because the U.S. is often ahead of Europe, a couple of the European guys got to watch the movie in the U.S. before they put too much money in companies in Europe. Therefore, you didn't have the great number of funds in Europe who had no experience in tech investing."
The panelists offered several answers to a question about the primary driver behind the increase in European private equity activity.
Noe-Nordberg commented on the increase in supply generated by big changes on the governmental level, such as tax reform, pension reform, and the Euro. Exactly how these influences will play out is unsure, said Noe-Nordberg, but he was confident that "any time there is a lot of change, there is generally a lot of opportunity for private equity."
Halpern stressed the demand for private equity investing caused by the trend of globalization. He sees a large supply of private equity money coming from the U.S. as its investment capacity grows. "A number of U.S. firms, mine included, believe that globalization is actually one of the most important secular trends in our economy. In order to have an investment company of scale, from being able to manage a portfolio of companies efficiently to being able to maximize the value of each asset in that portfolio, you have to be global."
Government's role in Europe
The panelists also discussed the challenges of what is commonly seen as a more intrusive regulatory environment in Europe. This, along with the need to manage pan-European deals across varied exchanges/agencies, means that interactions that are treated as a matter of course in the U.S. become extremely cumbersome.
In contrast to the industry's often begrudging attitude toward local involvement, Halpern stressed the intelligence of recognizing the varied community constituents involved in a deal. "There are always different sets of stakeholders with different concerns," he said. "I personally believe that a mistake that private equity people make all over the world is that they act like they have the right to do whatever they want to do because they are controlling the assets. They feel they have no accountability or responsibility to any community or any other group of stakeholders."
Halpern described TPG's approach. "We have said that there are people who may not have ownership rights in this asset, but still can ask us to be accountable to them; whether it be local community, labor unions, trade associations, or just one big powerful guy who lives next door. You have to deal with their needs, which are sometimes competing with each other. If you don't address the needs of all of those around a situation, you are probably going to have a train wreck.
"In the Bally deal in Switzerland, we had to reduce the workforce by 1,000," continued Halpern. "Because we were proactive and constructive in dealing with the labor unions and recognized that it was a problem that we had to solve jointly with the unions and with the local authorities, it ended up being a nonevent. Folks who didn't retire were all placed in other jobs. We spent a few extra bucks and took a couple extra months, but as a result we laid off a thousand people without it becoming a horrible, horrible disaster."
Pointing the way toward future growth
The panelists also addressed opportunities and strategies for future growth.
"Schroders and TPG and a number of other firms are much more theme driven," said Halpern. "We try to develop investment themes that are often pan-European and not so focused on geography. By doing that, we are able to find companies that would otherwise not have shown up on the private equity radar screen. CEOs who are looking for capital then know that you are the guy who knows something about their business.
"By being theme driven, you are able to generate an enormous amount of deal flow," he added. "Also, by being theme driven you are more able to take risks because you are comfortable buying a company that has issues—operational issues, management issues, fundamental strategic issues. If you feel comfortable about the business, you can do a lot of things that investment banks won't feel comfortable touching with a ten-foot pole."
Haight described a method his team used for beating competition in the traditional markets. His team, he said, essentially "crafted the competition" by creating a consortium with other similar private equity players to make the highest bid in an investment bank auction.
"[Using a consortium] enabled us to pay the highest price," said Haight. "Playing in that spot, we were able to see an opportunity and win an auction. [The other equity players] pay a strategic price for their third, we arrange it, and you've got a nice business."
There are a lot of different ways to classify the European private equity market players—by size, industry, country, office structure (local or pan-European), or whether they are affiliated with an investment bank. Noe-Nordberg stressed that, "at the end of the day, it comes down to the people that you have in those firms.
"I don't think that there is going to be one model that is more successful than another model," he said. "Although you can slice it in a lot of different ways, what it boils down to at the end of the day is the quality of the people that you have at those particular firms, and their ability to dig out those juicy nuggets."
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