Fitch Ratings reports on recycled deals dominating the private equity landscape in 2004

15 May 2004

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In a report entitled: 'Recycling Activity Continues to Dominate European LBO Exits', Fitch Ratings notes that secondary buyout and recapitalisation transactions (together known as 'recycled' transactions) represented 43.4% of total LBO issuance rated by Fitch in 1Q 2004. The international rating agency outlined that private equity investors seeking divestment from European leveraged buyout transactions in 2004 will continue to pursue the principal exit strategy adopted in 2003: a recapitalisation or a sale to another private equity firm.In the report, Fitch argues that the IPO exit route has not been particularly successful for European LBO issuers. While the market conditions for IPO issuance are currently more favourable than they have been for the last three to four years, and a number of Fitch-rated issuers have been contemplating IPOs, to date, there is still plenty of speculation but little execution. The trade sale exit route has proved to be more successful for Fitch-rated LBO issuers, with recent examples including the sale of Messer Griesheim's US, UK and German industrial gases business to Air Liquide and the sale of BSN Glasspack to Owen-Illinois and the sale of Oxoid to Fisher Scientific.The rating agency concluded that recycled transactions remain the dominant exit route for private equity firms and that the popularity of recycling activity is a reflection of high levels of un-invested cash in the private equity sector. Fitch added that the market conditions are such that a lower equity contribution is accepted in recycled transactions, thereby facilitating a potentially enhanced internal rate of return for the private equity firms. Moreover, such transactions are quicker, easier and cheaper to arrange compared to flotations, and offer far less execution risk for the private equity firms. SJ Berwin comments on proposed IAS changesThe debate about the application of proposed new rules on consolidation of accounts rumbles on. The main issue arises because under International Accounting Standards (IAS) as currently proposed, private equity funds would need to produce accounts which consolidate portfolio companies in which they hold a majority stake. The result would be a nonsense, and misleading, according to law firm SJ Berwin. To produce accounts which show, on a consolidated basis, the results of a range of disparate businesses which are held for investment purposes is a time consuming and apparently purposeless exercise. The change - and for most it would be a change, since under current rules it is usually possible to avoid consolidation - will affect the whole industry. It is true that IAS rules will only be mandatory for listed companies from January next year, and optional for others. But for two main reasons that limited effect will be short lived. First, it is unlikely that the two sets of standards will co-exist for very long. Many companies will voluntarily convert to IAS as those standards begin to dominate. Secondly, all major national accounting standards boards are committed to a process of convergence with IAS, and it is likely that the two sets of rules will be virtually identical before too long. Inevitably, national rules will change to reflect the IAS standards, rather than the other way around. So IAS matters to the private equity community, even those operating outside the public markets. The European Private Equity and Venture Capital Association (EVCA) has made its position very clear, and published case studies illustrating that the rules will create very odd results for funds which are forced to consolidate. Coming up with some sensible and widely respected valuation policies is a project on which the BVCA, the EVCA and a number of other national associations, have spent a considerable amount of time. Finding the right way to value investments in illiquid private companies is not easy. But it will be a retrograde step if published accounts are encouraged, let alone required, to use a rule which works well for trading companies, but looks very odd in an investment context. There is still time, and the private equity industry is working hard to secure an exemption for investment companies. Given that the purpose of the international accounting project is to improve the quality of financial information available to users of financial statements, it would be paradoxical if the lobbying wereunsuccessful.