Strange bedfellows

Of the nearly 4,000 buyouts recorded by unquote"/Private Equity Insight since 2004, only 73 have consisted of partnerships between corporates and private equity firms. The total number represents a meagre 2% of the total buyout deal volume for this period, with values ranging from EUR500,000 to a few billion. The EUR3.1bn acquisition of UK-General Healthcare Group by Apax Partners and South African healthcare provider Netcare in May 2006 is one of the most notable by size. Then in March last year, the same GP joined forces with Guardian Media Group in the EUR1.4bn acquisition of B2B publisher Emap. Of course, the true number of such collaborations is likely higher, as some are done behind-the-scenes in an effort to win over targets - or to not scare them off.

More recently, there has been media coverage of the collaboration between Kohlberg Kravis & Roberts (KKR) and German media group Berterlsmann, which in July saw the two develop a global music rights management business. In Italy, 21 Partners and Mediaset joined forces to form Capitolosette (page 28), a venture aimed at consolidating the film distribution industry. Currently in the UK there is ongoing noise surrounding transport firm National Express which has had to fend off take over attempts by a CVC/Cosmen Family consortium; the task is proving all but easy. The Cosmen family controls close to a fifth of National Express. Are these deals anomalies or a sign of things to come?

Unholy alliance

Prior to the credit crunch, strategic players were often competing with private equity firms. Before 2006, corporates were often in a better position to make acquisitions than their private equity rivals as their reserves were significant, as was their willingness to pay a "strategic premium" - meaning they were often well placed to outbid financial buyers. But in the frothy years that followed, private equity gained the upper hand, enjoying cosy relationships with banks which enabled financial buyers to outbid even the hungriest corporates.

Can "joint ventures" present private equity firms and corporates with the opportunity to combine their efforts and resources? Although currently constrained by poor credit availability, private equity has a lot of financial muscle to deploy if we go by the size of the funds raised shortly before and after the collapse of the credit market. Blackstone, for example, raised a massive $21.7bn fund in August 2007 - just before the credit markets slammed shut; 77% of the fund has been committed, leaving short of $5bn left to invest.

As for corporates, even though they might find their acquisition possibilities hindered by poor trading and cashflow constraints affecting potential acquisitions, they still have intrinsic sectoral insight. So an alliance of private equity (which has the money) and corporates (which have operational expertise) could be a way of capitalising on opportunities in this market.

If only it were that straightforward. "Forming joint ventures (JV) between corporates and private equity for a buy-and-build strategy at a subsidiary level often morphs into a discussion about the outright sale of that subsidiary or raising finance at the parent company level," says Alex White, partner at BDO Stoy Hayward. Private equity invests with an exit in mind; corporates have sectoral interests at heart. White continues: "Once parent companies think the association through, they realise that JV cashflows will be ring-fenced and that an exit will be need to be created in the future. In many cases companies begin to realise that a JV involving a subsidiary is not practical and they may be better off selling the subsidiary completely."

Another issue may be the exit. It could prove difficult to agree on its type and timing. "To avoid the requirement to sell the JV, parent companies may attempt to agree fixed contractual equity returns to be delivered by some future refinancing. Depending on trading, this may put a strain on the cashflows and the equity investment just starts to look like exceptionally expensive debt," observes White. So what starts as a nice idea can soon prove to be a complicated affair. Losing control over the development of the subsidiary may prove dissuasion enough for corporates.

Marriage of convenience

Though outright partnerships between corporates and private equity are unlikely to take off, we may well see an increase in development capital deals involving both parties. "We will not see joint ventures for single acquisitions between PE funds and corporates but rather the purchase of minority stakes in corporates to finance the acquisition of a competitor," notes Eugenio Morpurgo, CEO of Fineurop Soditic.

For private equity, the advantage of investing in the acquirer and not in the target is that it can automatically enjoy the benefit of synergies between the corporate and the target. For mid-sized corporates who intend to consolidate their market, this is also an attractive solution. "Liquidity scarcity is one of the main factors which can result in alliances between PE funds and corporates. But there is a necessity for private equity funds to gain additional industrial insight in their activity and to rely on a strategic approach," adds Morpurgo.

Perhaps realising the difficulties in collaborating with trade buyers to amass operational savoir-faire, a handful of private equity firms are setting up or strengthening operational boards. Advent International for instance has run an Operating Partner Programme since the late 1990s. It has been ramping up efforts lately: in the last couple of years, 30 new partners have been appointed and it currently comprises more than 60 high-level industrialists, many of whom have been involved in multiple Advent investments.

In the future, the nature of the relationship between private equity and corporates may be more opportunistic. The volume to come will be determined by those who need to transact - on both sides.

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