The UK and France have proven strong markets for mid-market private equity managers through September/October, but as we reach the end of the year, and as Brexit uncertainty lingers three months out from the deadline, some believe the UK deal market, in particular, will soften in early 2019.
The Q4 buyout figures for the UK are not yet known but if one looks back at earlier in the year, they suggest that GP activity has been vibrant. In Q2, 58 UK buyout transactions were completed, the most since Q2 2008, while France was home to the highest volume of deals with 61; the most since Q2 2007. Looking at figures for the first six months of 2018, France maintained strong momentum with 63 buyouts worth EUR11 billion, up markedly from 51 deals worth EUR6.3 billion in H2 2017.
Across Europe, some 543 deals were recorded in Q2; the highest quarterly volume on record according to Aberdeen Standard Investment’s quarterly Private Equity Barometer, which it produces in association with Unquote, a specialist provider of private equity information.
The combined value of European private equity-backed investments rose 17 per cent, to EUR64.2 billion, while the average deal value in Q2 was EUR118 million, the largest in over a decade. These are solid figures and have helped mid-market players raise substantial capital with little sign that LPs – or global GPs – are losing interest in the opportunities on offer in Europe.
Jon Edirmanasinghe is partner at Cavendish Corporate Finance, a leading M&A advisory firm. He notes that US private equity sponsors continue to favour Europe’s mid-markets where price multiples are more competitive.
“In the US, you are likely going to pay more for a business compared to the UK and the rest of Europe. A deal priced at 12x earnings in the US, for example, could be priced at 10x in the UK and 8x in other parts of Europe. US managers are increasingly seeing these price arbitrage opportunities and exploring European prospects, especially businesses with international ambitions that include accessing the US market.
“Moreover, foreign investors with a long-term view are also likely getting a 20 to 30 per cent discount on UK assets if you consider the exchange rate at present. That said, there are still some US mid-market fund managers who are staying clear of the UK and Europe at this time due to Brexit uncertainty,” says Edirmanasinghe.
Through June 2018, the total amount of dry powder within global private equity stood at USD1.09 trillion; a vast sum, up from USD1.03 trillion at the end of 2017 according to Preqin.
European GPs have enjoyed great success this year, particularly those with established brand names and decent track records. PAI Partners has done a EUR5 billion raise, Astorg have done a EUR4 billion raise, while Triton Partners is currently targeting EUR3 billion for its fifth flagship fund having also completed a final close of EUR448 million in the summer for its first lower mid-market fund.
Another manager that has done well is Inflexion Private Equity Partners LLP, securing GBP1.25 billion for the Inflexion Buyout Fund V.
“LP interest in Europe has been strong and sustained through 2018,” says Andrew Bentley, Partner at Campbell Lutyens, a leading global placement agent in private markets. “LPs are still trying to get capital to work, as they have done for a number of years now. The key question is whether 2019 will be quite as strong. With distributions no longer outpacing drawdowns in the way they have been there’s a chance that demand might soften.”
Even so, to underscore how strong Europe is, Bentley confirms that EUR40 to EUR50 billion is being sought by four large-cap pan-European managers in 2019. He notes that many GPs have been increasing their fund sizes by 1.6x to 2x and good fund raisings have been completed quickly.
“We are completing a (fundraising) process currently with one manager, which will have taken only 12 weeks,” says Bentley.
“LPs have been expanding their allocations over a number of years. Pan regional funds have fared well as have country funds especially in Germany and the Nordics. In the UK there has been some added complexity due to Brexit but fundamentally the opportunity remains. Epiris has done very well, for example, recently completing its debut raise at GBP821 million. There have been some high profile failures as well this year so fundamentally manager quality still matters.
“Well known managers with good track records, a team that is aligned for the next fund, and who have a strategy that is relevant have all been fundraising successfully.”
Edirmanasinghe says the general sentiment is that pricing is “very high” and that deal flow might slow down in 2019.
“Nevertheless, UK mid-market funds have raised an awful lot of capital in the last couple of years, which they will need to deploy. As long as there is competition for assets, regardless of what happens politically, pricing should be propped up, by and large,” he says.
Since the summer, there has been a lot of noise in the UK market. There has been a feeling among PE managers looking at UK buyouts that if they can get deals completed before the Brexit deadline on 29th March 2019, they might be in good shape.
“We did one deal in July,” confirms Christiian Marriott, Partner, Head of Investor Relations Equistone Partners Europe. “We have looked at other deals but we got the sense they wanted to be done in such a hurry that we felt we wouldn’t be able to do it to our standards or had unrealistic price expectations.
“The French deal market has been feeling better and better in terms of confidence since Macron’s arrival. He’s currently going through a rough patch but I think the shift from a socialist to a more centrist business friendly President has improved the business climate in France. We’ve announced one big deal in France this year, which was Courir, and we came very close on another deal. If you were to ask me what our barometer reading is for doing deals this year, we’ve certainly been busier and more productive in France in the second half of this year than the UK and Germany.”
Emmanuel Raffner is Head of Private Equity Infrastructure & Corporates, Alter Domus. He agrees that the French buyout space is strong and has seen a trend towards small and mid-sized buyout funds successfully fundraising over the past 24 months.
“They have struck a lot deals. I was looking at Q1 2018 LBO figures for France, which was EUR3.8 billion: 17 per cent higher than Q1 2017,” says Raffner, referring to figures on the France Invest website. From a performance perspective, the French PE market has been able to generate a net internal rate of return of 10 per cent-plus over 10 years.
Some LPs feel they can find more returns, or feel less exposed, by allocating to European mid-market funds. It is a much wider universe of funds and gives PE managers a wider array of entry points than in the large-cap space.
“We see a lot of activity and a clear trend towards these small and mid-sized buyout funds but this trend is getting eclipsed by the mega buyout funds coming to market,” says Raffner.
In his view, everyone is looking at private equity, to such an extent that it is blurring the lines and contributing to a more expensive, more competitive deal landscape as larger LPs embark on doing their own direct deals.
“If you look at deal size in France, there is a blurring of lines,” comments Raffner. “Canadian pension funds such as Caisse de dépôt et placement du Québec, PSP or OMERS have set up their own direct investment programmes. Over the years they’ve gained experience doing minority deals with GPs, they have steadily grown their own internal teams and now we see them striking their own deals worth several billion euros in the French market.
“You also have asset managers and insurance companies doing more co-investment deals alongside GPs and are increasingly trying to do their own minority deals. Are they truly equipped to do this? Do they have the right skills and the knowhow of when to enter and exit an acquisition? Family offices and entrepreneurs are also setting up their own PE investment funds to do club deals and, in some cases, raise third party money.”
There is no question whatsoever that European mid-market specialists are sought after among global LPs, as they look to build core and satellite allocation programmes to larger established managers on the one hand, and more niche managers on the other hand; who have the potential to offer spicier returns.
Accessing these managers is a serious business, with LPs doing more and more due diligence on how a GP thinks about deal origination and transforming the fortunes of companies.
Marriott confirms that over the last three funds that Equistone has raised since 2008, each successive fund has attracted more interest from US investors.
“People have liked Europe in the last few years because the purchase multiples being paid in the US mid-market are significantly above those being paid in Europe,” suggests Marriott. “I think what investors like is that Europe is clearly not a level playing field. It creates a market environment where good players who buy well have an advantage. That is why mid-market managers who are successful and have a niche do well. It’s not an easy market to operate in.
“The US mid-market, by comparison, is very intermediated, very transparent and very accessible and I think it is sometimes hard for LPs to determine where GPs have an edge.”
Karsten Langer is Partner at Riverside Group, which specialises in investing in growth companies with enterprise values of up to USD400 million.
Speaking about value creation, and how Riverside works with mid-sized companies, Langer refers to ‘the course, the horse and the jockey’, i.e. the market, the company and management.
“And I guess the operating partner would be the stable master,” says Langer, tongue in cheek. “Ideally you want to get all of them right, but there is no doubt that having a strong operating team allows you to accelerate growth and fix problems that may occur. We look at revenue and EBITDA (before making an acquisition) but more importantly, we look at the underlying KPIs. These might include trends in volume and price and the sustainability of growth.
“This can be driven by market factors – for example the adoption of a new type of product or service – or by factors specific to the company such as a proprietary technology or business model.”
One of the more recent exits that Riverside has completed is an agreement to sell DPA Microphones (DPA), an Allerød, Denmark-based developer and manufacturer of high-end microphones, to RCF Group. Over the course of Riverside’s investment, the share of sales coming from new products rose from less than 5 per cent to more than 40 per cent.
The ability to seek out growth companies in such a wide and varied landscape as the European mid-market is where the real skill of the manager comes in to play. Even if more LPs do embark on doing their own deals, it will take many years to build the necessary expertise. Right now, European PE managers’ stock is as high as ever, and shows no signs of diminishing.
“We are witnessing a period of increased interest in the mid-market,” asserts Langer. “I believe investors are seeking out investments where returns are realised from growth rather than excessive financial leverage, and that the mid-market has matured and institutionalised to an extent where execution risk is better managed and results therefore less volatile than in the past.”
One of Equistone’s most recent acquisitions was WHP Telecoms. It followed a three-year stewardship with Palatine during which time the business’s revenues grew from GBP30 million to nearly GBP75 million. “We’ve also done other telecoms deals such as Camusat Group, a French mast company, so we have some experience in the telecoms sector. WHP was the second investment in our latest fund,” confirms Marriott.
Growth Capital Partners(‘GCP’) have also been active in the telecom space, making a strategic investment in Indigo Telecom. Part of the attraction was the quality of Indigo’s management team, first and foremost, and the fact that the business has grown well over the last few years, with revenue per customer growing and the buy-and-build strategy already commenced.
Edirmanasinghe advised Indigo’s shareholders on the sale to GCP.
“The telecom market is consolidating quite a bit, and the management team’s vision at Indigo was buy-and-build. Growth Capital Partners understood the market and viewed it as an opportunity for Indigo to acquire businesses in the UK and overseas, within two or three years, then potentially exiting to a larger trade buyer.
“From Indigo’s perspective, GCP were a very good fit given their track record and understanding of the telecoms market. GCP have a couple of similar businesses, one being John Henry Group, which operates in the civil engineering telecom infrastructure space. From the start, it was obvious GCP’s market knowledge was on a level above other potential investors,” says Edirmanasinghe.
Pierre Vinci is Head of Origination, Asset Based Finance, ABN AMRO Corporate and Institutional Banking. He sees ‘buy and build’ strategies becoming more popular among PE sponsors, and refers to a recent lower mid-market transaction that the bank recently worked on.
“The investment firm bought three small timber production businesses in Scotland and within two years they had added another three businesses, adding one more recently. They’ve doubled the size of the business from EUR150 to EUR250 – EUR300 million. All of these acquisitions were family businesses, which they bought in a ‘buy and build’ strategy. Each had a complimentary footprint in Scotland.
“They have managed to build a leading timber business, taking what was a 3 to 4x EBITDA regional player to a national player with an EBITDA of 7 to 8x: it’s a clear value creation story,” opines Vinci, adding:
“We see more of these transactions, not to a great extent in Europe yet, but I do think buy and build is a trend that will continue to develop in Europe’s mid-market space.”
The benefit of buy and build strategies is that PE managers can control each element of the supply chain. This means they know where the margins are, and can apply necessary changes across the supply chain, from producer to distributor, to build operationally efficient, higher value businesses.
Given how highly valued the markets are at present, it is no surprise that this has been a good time for European mid-market managers to exit positions and distribute healthy returns to their investors.
Riverside recently announced that it was selling Euromed to Dermapharm Holding. It is one example of how the firm aims to build bigger, better businesses.
In the case of Euromed, as with many others, Riverside made a detailed strategic plan at the beginning of the investment and focused on growing the business where it had the most sustainable opportunity. “This involved adding sales people, adding product development resources, launching new products, investing significantly in plant and equipment and even building a new Innovation centre. As a result, revenues and profitability both grew substantially and Euromed is today very well positioned to continue on a strong growth path,” explains Langer.
Last month, Equistone Partners Europe completed the GBP380 million sale of Apogee to HP Inc. This was its ninth exit in 2018 and fourth in the UK market, three of which were to trade buyers.
Equistone took a majority share in the company in September 2016, in a deal worth GBP185 million. It supported the business through a number of acquisitions including Kopiervertrieb Rhein-Ruhr GmbH (Germany), Danwood Group (Lincoln), CityDocs (London) and Clarke Office Solutions (Cambridge). Apogee has grown its revenues from around GBP120 million and headcount from around 450 in two years.
Equistone supported the bolt-on acquisition of Danwood very shortly after making its investment in Apogee. “Danwood was a transformational and prized asset. It was one of the ways we added a lot of value post-deal, which made it interesting for HP.
“We definitely look at buy and build as a way of growing companies. The vast majority of our deals have this component; sometimes it might be taking a company into new international markets, sometimes it is acquiring new technology (investing across the service chain) and sometimes it is just building domestic market share; Apogee buying Danwood being one such example of the latter,” outlines Marriott.
100 per cent equity
With so much dry powder in the market, one feature of the marketplace that has emerged in the last 12 months is a growing preference among PE sponsors using equity to underwrite the entire deal.
The acquisition of Indigo by Growth Capital Partners, for example, was underwritten this way.
Edirmanasinghe believes PE sponsors are coming at it from the perspective that they need to put capital to work “and even if the equity underwrite the traditional debt component and take an 8 or 9 per cent yield, it can be better than not putting their investors’ money to work. PE sponsors can then refinance after two or three years, prior to the eventual exit.
“I’ve done seven deals in the last 12 months and with the exception of just two deals, the rest were underwritten in full with equity. This simply didn’t happen five years ago and is a function of competition in the market,” says Edirmanasinghe.
In this current environment, managers need to move quickly. Whether using debt in a refinancing arrangement at a later date, rather than a matter of months, becomes a sustained trend is hard to say, but it could if the threat of recession emerges. Some managers would like to see more volatility in the marketplace.
“My two penny worth is that any correction will be good for the market,” says one prominent European PE house, which asks not to be identified. “Prices are unsustainably high and there is a lot of downside risk baked in. We see a lot of potential interesting situations coming around should there be some chaos caused by Brexit or other international political crises.”
It should be noted that high valuations are not a recent manifestation. In 2015, there was plenty of concern about prices being paid in the buyout market and much of the narrative was the same as it is today.
As one PE manager states: “We’ve been cautiously disciplined throughout the cycle but the reality is you could have paid a full price for a business in 2015 and be selling it for a full price now because there hasn’t been a big market correction. People are right to be concerned about high prices, but this is always something buyout firms should not take for granted.”
Price is not the be-all and end-all. It is not the only success factor. There are plenty of examples where mid-market managers have stretched on price for fundamentally sound businesses that have grown their EBITDA and those where managers paid a modest price for businesses that didn’t work out.
“There are PE firms who are known to be higher payers for assets but they produce absolutely stellar returns,” says one undisclosed source. “I’m not saying the good times are going to continue and that GPs should be paying 12x for a business but we are not market timers, and nor are our investors. We’re trying to pay the right price for the right business. For us, that means we consistently aim to pay 7x, on average, but some deals will be 4 or 5x and some deals will be 8 or 9x.”
Deal innovation
At Campbell Lutyens, Bentley notes that managers have been working harder at origination in response to high valuations. For some this might involve looking into overlooked sectors, for others this might mean more structure around calling programmes to increase the dealflow funnel.
“A lot of European private equity has been focussed on growth, but with high entry prices LPs are receptive also to strategies that address industries that need restructuring and have been less loved,” suggests Bentley.
The other side of the equation is of course for GPs to work harder on transformational initiatives to earn through the high prices they are often having to bid.
“GPs are having to work on either or both of those areas,” continues Bentley. “There are some contrarian areas where the competition is not so great but in general the overall approach from GPs has been to focus more on value-add and the transformation of companies and to generate value beyond the entry price. The biggest challenge for managers has been not raising capital as much as deploying it well.”
Vinci says that both the UK and France have a very dynamic buyout market. In France, he says, there are now many more PE mid-market specialist funds, but large US private equity houses are also keen to invest there.
“Historically, one of the reasons some private equity and private debt managers were shy to invest in Europe was because of the jurisdictional complexity of the region,” says Vinci.
“However, with Brexit, some EU countries are opening themselves up to more private capital. President Macron has said France will make it easier for PE managers to invest in the country, and we are seeing a trend towards more transactions.”
When seeking out mid-market opportunities, Europe certainly offers a huge array of opportunities across a diverse set of countries and economies. One aspect that has to be considered, especially for managers looking for more distressed companies with lower quality credit, is putting in place the right capital structure to best achieve transformation. This is especially important given that the marketplace has seen more and more covenant lite deals being used by corporates in the low rate environment.
Within the Asset Based Finance division at ABN AMRO, Vinci oversees a 10-strong team who originate and execute transactions in the middle market, lending anywhere from EUR10 to EUR150 million to corporates and PE fund sponsors alike.
“There are a lot of covenant lite deals and debt multiples rising, which some are concerned about. My team operates in a segment where the credit strength of companies is often challenged. We provide secured lending against assets, which enables us to support these companies where other lending solutions might struggle.
“A PE sponsor might come along and buy a company experiencing a period of stress with 100 per cent equity and then in 12 months time, once things start to improve, they might look to refinance it, which is where we come in,” explains Vinci.
He concludes by stating: “Some people think covenants aren’t needed. When a PE sponsor is looking at mid-market companies with strong to average credits, the potential opportunities may be few, but if there is a market crisis, how will these companies behave? There remains a big question mark over how these businesses will fare.” n
