All the early indications are that 1999 will have turned out to be something of a landmark year for the private equity industry.
With less than a month to go before the New Year celebrations, the value of UK management buy-outs and management buy-ins for 1999 had beaten all records, already exceeding £15bn, according to early figures released by the Centre for Management Buy-Out Research, sponsored by Barclays Private Equity and Deloitte & Touche.
Based on recorded deals for the year to early December, the value of UK MBOs and MBIs had already beaten the 1998 total of £14.1bn by more than £1bn. Although the total number of transactions is down, average deal size has risen substantially, by 66% to over £35m. Bigger deals are again at the forefront and the number exceeding £100m has risen to 33, from 26 in 1998.
Tom Lamb of Barclays Private Equity commented: "Fears that Millennium Bug phobia would cause the market to grind to a halt in the 4th quarter proved to be unfounded." In fact, the final quarter is already 35% up on last year, and there are still 12 shopping days left until Christmas for those last minute private equity stocking fillers.î
Said Chris Ward, head of advisory services at Deloitte & Touche Corporate Finance: "£15bn of deals in this country alone is a staggering total. UK private equity houses have also aided and abetted the market growth seen in the rest of Europe."
The year certainly developed differently than expected. Market practitioners commenting on the wave of activity in the second half of the year expressed surprise to find deals still being announced in December. Most predictions had been for a deadly dull end of the millennium as activity wound down, not least because of Y2K concerns. Not so in practice. "Activity has confounded expectations," says Jonathan Russell, an executive director at private equity specialist 3i in London. "People are investing their socks off."
It will come as little surprise that telecoms in general and the Internet in particular are taking the world of private equity by storm. They have replaced pharmaceuticals and biotechnology as the stocks to be seen with. This must be seen firmly in context, however. "The bulk of the money going into traditional sectors far outweighs that going into Internet start-ups," observes Marek Gummieny, managing director of Candover Investments. The European Venture Capital Association, for its part, argues that the focus is shifting from buy-outs of established businesses to opportunities in the technology sector as IT firms have become bigger and more mature. In due course, it is perhaps worth adding, the start-up new media and e-commerce firms invested in by today's venture capitalists will be tomorrow's buy-out opportunities.
Entering the world of private equity can be like wandering into the realm of quantum mechanics, largely because the subject can be slightly difficult to define. "Some people use the terms private equity and venture capital almost interchangeably," says Steve Harmston of Bannock Consulting, a financial consultancy firm with a strong interest in this sector. "Strictly speaking 'venture capital' covers seed, start-up and early stage investment etc; the term 'private equity' includes these and buy-outs and buy-ins, Hence, venture capital is a subset of private equity. The phrase 'buy-out' is often used as a generic term covering management buy-outs, management buy-ins, buy and build situations, and other variants."
During the last three years, the UK and Continental European buy-out markets have been experiencing boom conditions, according to the UK's Centre for Management Buy-Out Research (CMBOR). In 1998, the CMBOR calculates that UK deal value hit a new record at £14.2bn while in Continental Europe a new peak of £12.5bn was reached. This market growth has been especially strong in France, Germany and the Netherlands. Both France and Germany saw buy-out market value in 1998 in excess of £3bn while the Dutch market topped £2bn. In Italy, however, deal value fell sharply to £390m.
For the first three quarters of 1999, deal value in the UK stood at £11.1bn, with the market on course for yet another record for the year as a whole. Across Continental Europe, the markets in France, Germany and the Netherlands continue to be highly active and may well exceed the 1998 level for 1999 as a whole.
Despite these huge recent increases, the main Continental European markets remain under-developed in comparison with the UK, says the CMBOR. UK market value in 1998 equated to 1.7% of GDP but French, German, Dutch and Italian deal values last year equated to 0.4%, 0.3%, 0.9% and 0.1%, respectively. The Continental European market, therefore, clearly continues to hold prospects for considerable further growth. This growth in part is expected to come from the spread of recent UK developments to Continental Europe, but also from factors specific to each country.
As analysed by the CMBOR, the major current developments in buy-out deals in the main European markets relate to: asignificant increase in large divestment deals; a notable increase in large buy-outs of privately owned businesses; the spread into Continental Europe of public to private buy-outs; growing privatisation buy-out pressures; the development of leveraged build-ups and the growth in secondary buy-outs.
Sherwood Dodge, managing director of GE Equity in Europe, identifies an increase in the number of investment houses as a further factor in the growth of private equity activity, citing familiar names such as Clayton Dubilier, Hicks Muse and KKR. GE Equity is itself a busy investor in Europe, aiming to provide what it describes as 'value beyond capital', that value being access to the resources (network, technical assistance, customer base, market intelligence) of its sister companies within the General Electric Group. GE Equity's E-Fund initiative, announced late in 1999, represents a commitment to invest $50m in European-based internet-related companies seeking early stage financing.
While the restructuring of larger groups is a well-established source of buy-outs in the UK, in Continental Europe pressures on groups to restructure have only recently become irresistible, continues the CMBOR. While there have been major divestments of foreign-owned subsidiaries as buy-outs, major divestments from domestic groups are only now becoming a significant feature of the market.
The rapidly developing German market saw several significant divestment deals in 1999 including Stinnes Reifendienst, a car service chain spun-off by Stinnes AG for an estimated DM 100m. In France, divestments accounted for over 40% of the market in 1998 with major restructurings becoming more widespread this year. In July Hicks, Muse, Tate and Furst bought out the champagne brands Mumm and Perrier-Jouet from Seagram. Also in the drinks sector, Barclays Private Equity France led the FF1bn buy-out of Grands Vins de Gironde from Remy Cointreau.
Local company divestments have maintained their traditional strong position in the Netherlands, says the CMBOR. The divestment buy-out of Acordis from Akzo Nobel for around NLG 1.8bn contributed significantly to Dutch deal value for 1999.
Buy-outs of family businesses have long been an important part of the Continental European market, until recently accounting for a larger share of the market in countries such as France (49% in 1998) and Italy (76%) than is the case in the UK (48%). However, although they have typically been associated with mid-market transactions, buy-outs of family firms have also come to involve very large businesses across Europe.
Going back to the future, private equity specialists report that they are being inundated with requests from companies describing themselves as Internet start-ups. They are highly dubious about many. "Someone sticks his name on a website, calls himself an Internet start-up, rings me up and says his company's worth £40m," notes one private equity investor. "It's the South Sea Bubble and Tulipmania all over again."
Be that as it may, a strong consensus appears to be emerging that investment fundamentals are being adhered to as rigidly with Internet businesses as with any others. "Investment proposals are not examined in an Internet-only vacuum," says a spokesman for Apax, an international private equity firm. "We don't change the investment criteria just because it's a new industry sector."
According to at least some in the industry, the real future for Internet investment success is business-to-business applications. Says Senia da Rapisard of Nomura's private equity arm in London. "A retailing company on the net is not an Internet company; it's just another way of retailing, using the Internet as a distribution channel. That's not the sort of company we want to invest in. We would concentrate on companies supplying enabling technology, technology that makes the Internet work. Business-to-business is the iceberg; retailing is just the tip."
A small company like Trondheim-born ClustRa presents a classic example as a provider of a complex product designed specifically for electronic commerce. It sees itself as a key player in the Internet infrastructure sector, and was recently a beneficiary of private equity interest in the high technology sector. ClustRa, a spin off from Norwegian telecoms company Telenor, provides what it describes as a 'non-stop, 24 hour a day seven days a week database to the telecoms industry'. It recently received $10m in a 'first-time' investment from San Bruno, California-based Vantage Point and Boston-based Argo Global Capital, and its future has changed out of all recognition.
"The funds were vital to ClustRa," says Gary Ebersole, vice president, marketing, and one of a number of new staff at ClustRa with previous experience in venture capital-funded start-ups. "It's not just the financial capital, it's the intellectual capital that came with it. We've injected the start-up culture and bring connections, perceptions and skills that the company needs to establish a credible global presence." ClustRa has moved its headquarters from Norway to Boston as part of its new business strategy. Trondheim remains the research and development centre.
While Internet hysteria mounts, private equity has demonstrated over and over how new funding allied to a new management approach can breathe new life into mature businesses in businesses that have a lower technology profile, and extract new profit therefrom. GE Equity, for instance, by virtue of working with the parent company's other eleven divisions, will inevitably invest significantly in lower tech manufacturing businesses.
UBS Capital, the private equity arm of UBS, points to its experience in a number of businesses which it has acquired, dusted down, livened up and resold. A classic case is its investment in the Nordic printing industry where it bought Tryckinvest i Norden AB (Tina) in January 1997 from the Bonnier Group, a Swedish publishing and media company, and Proventus, a Swedish financial holding company. It added on Helprint eight months later, and floated the combined group the following summer, in Stockholm's largest IPO of that year.
And could they be much more basic than the small but well reformed Perfect Pizza takeaway business? Paul Marson-Smith, Managing Director of Gresham Trust, sold the business at the end of November for £20m, just two years after buying it for £3.2m, representing an internal rate of return of 97% on its investment. Marson-Smith is not an obvious fan of technology for its own sake but is clear about its attractions. "The herd has gone .com-crazy, but we prefer situations that show real value growth. We are of course interested in the Internet, but only if the fundamentals are right. Applying technology to business fundamentals is a first class way of making good investment returns."