Italy on a cliff

A rapidly crumbling economy is making it increasingly likely that Italy will become the second ‘I' in the Eurozone's PIGS, as the economically troublesome Portugal, Ireland, Greece and Spain are unfondly called.

Italy has staved off disaster for some time: domestic banks have relatively low exposure to the PIGS (one ‘I'), but the economic situation is starting to look frighteningly similar to that seen in Portugal and Ireland just before those countries imploded. They entered bailout territory just as their cost of government borrowing hit 7% - the so-called ‘cliff' for countries' economies. Italy is now teetering on the brink, with borrowing now at around 6.7%.

"Is this Italy's Fate Presto?" Dante Roscini of Harvard Business School asked, referring to headlines of today's domestic broadsheet Il Sole 24 Hore. He was delivering the keynote this morning at the fifth annual unquote" Italia Private Equity Congress in Milan.

On the face of it, the situation is dire. Italy must refinance €200bn by next spring. To boot, its total gross general government debt-to-GDP ratio is roughly 120% - the highest since WWII. On a more positive note, Roscini points out "the country has had a positive primary surplus the last 17 of 20 years. This has been largely on the back of increasing revenues, rather than through cost-cutting."

This should imply that austerity measures could be the way forward, however that is likely to be very difficult in Italy. Therefore continued revenue increases could come from the government selling off assets. Roscini reckons there is roughly €104bn in the Italian government's coffers, including stakes in ENI (€22bn), ENEL (€11bn), CDP (€10bn) and SACE (€6bn). Many are politically sensitive, he points out, but privatisation of some could prove a real revenue generator.

This is where private equity could play a role. In fact, in the first 10 months of this year, Italy has recorded €5.3bn in deal activity (EV), a marked uptick on last year's lackluster €3bn, according to unquote" data. And roughly two thirds of Italy's total €5.3bn deal value has come from a handful of mega deals (EV>€1bn). This translates to a healthy appetite for large deals when the opportunities are there. The question is whether the funding will continue to be available. A staggering 90% of respondents to a recent sentiment poll conducted by unquote" and communications specialist Equus feared it would be more difficult to secure leverage in 2012.

"We are unlikely to see much more LBO activity this year because banks have already achieved their 2011 budgets," points out Daniele Candiani of IKB Deutsche Industriebank. He added that offered little incentive for lenders to back businesses now, especially given the high cost of funding: Italian bond yields soared yesterday as global confidence in the world's third largest debt market foundered.

But next year may be a different story. Candiani indicated that activity could pick up again as early as the first quarter of 2012. "The situation in Italy is not as difficult as the press makes out," he says.

"The market needs to be optimistic to have the strength to forge ahead," Mara Caverni, PwC partner, said. Unfortunately, optimism is in short supply, with over three quarters of respondents to the aforementioned survey fearing foreign institutions are less likely to invest in Italy as a result of the Eurozone crisis.

Changing face of deals
Transactions will take on a new look. The way we do deals must change completely, says Michele Russo of Opera SGR.

Good deals today are capital increases in good companies with too much debt, he continues, adding that the oft-cited leverage dearth should not pose a problem as the businesses often contain plenty of finance already. You should not buy a company because it is for sale or because finance is available for it but because you want to own it. The days of large, simple deals where you get a lot of money for limited work are over. It is back to basics.

Indeed changes in the banking industry are challenging the business model. The days of generating returns by optimizing financial engineering are over, warns Vito Ronchi of BNP Paribas.

There was general consensus on the issue of problematic over-leveraging. Many companies even good ones have been put in a corner because of over-leverage. It prevents management from pursuing growth, says Nicolo Saidelli at AXA Private Equity.

In fact capital structure evolution is picking up pace, with senior-secured bonds and high yield set to take up a larger part of deals than in 2010. Equity and shareholder loans are also on the up, while mezzanine and senior secured credits are on the wane.

The wall of re-financings is forcing the market to either decrease its reliance on leverage, or to allow high yield investors to step into the structure, Banca IMI's Vincenzo De Falco points out, adding that such tools are no longer the exclusive preserve of large deals. It is not a question of size but of risk appetite. CLOs are disappearing and banks much decrease their risk. There is no other way of getting around the liquidity wall. High yield is already showing signs of a comeback.

 

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