Adapt to survive

Like many of its peers, the Italian buyout market has collapsed in 2009, with unquote" data revealing a dramatic fall from its 2008 peak. Activity over the first three quarters of the year has fallen from 75 deals worth EUR8.2bn to just seven deals with a combined value of EUR1.1bn. The country, once a fast maturing symbol of the relentless growth of private equity in Europe, has become one of the major casualties of the crisis.

However, speaking at the unquote" Italia Private Equity Congress in Milan in November, Mara Caverni, partner at PricewaterhouseCoopers argued that the Italian private equity market remained in good health despite the big declines, claiming that, in overall terms, "activity has, in comparison to its European counterparts, fared relatively well".

Bravado? Maybe, but despite the travails encountered by the sector over the last 28 months, there was a general consensus that the medium- to long-term impact of the current crisis will be positive. Andrea Bonomi, chairman of Investindustrial, for example, likened the downturn to a rite of passage where only some will make the cut. "The reduction in the number of players means that those that survive will come out re-invigorated and with a new set of skills and enhanced experience".

Lessons learnt

Most speakers conceded that the next 12-18 months will be difficult, particularly in relation to over-leveraged buyouts closed at the peak of the boom years, whose structure never considered the possibility of facing such extremely negative conditions. The key going forward, argued Bonomi, was that the firms that survive change their business model.

"Debt packages must be fully paid back within six or seven years, making certain multiples mathematical impossibilities. Financing facilities with 6x senior and 1.5x junior debt multiples are not sustainable. This also means not all companies are well suited for private equity ownership," agreed Alioscia Berto, managing director of Doughty Hanson.

Andrea Mugnai, partner at law firm PM & Partners, picked up this theme, warning that the industry was "currently somewhere between the bottom of the market and the next boom." Other panellists concurred, broadly expressing concern at the prospect of a quick recovery. "I fear a recession that is too short," commented Berto. Bonomi added that an uptick now "may see just 30% instead of 50% of businesses failing. This would allow some weak companies to survive, instead of just the fittest".

Aside from now familiar criticisms of financial engineering, great emphasis was placed on the value of industry-specific knowledge and a return to "active ownership". "In-house industrial expertise is complementary to financial expertise. It allows for a different analytical angle and insight on the potential investments and allows for improved portfolio management," noted Claudio Sposito, chairman of Italian buyout house Clessidra.

Sposito went on to advocate the advantages of the operating partner model, arguing that operating partners provide not only a different perspective, but also a network of contacts that complement that provided by financial partners. He underlined his points by arguing that "increasing scrutiny is being placed on how investments are managed, as valuations are inherently a reflection of the portfolio management".

The strain of LP/GP relations

Indeed, portfolio management was a major discussion topic, having become important for GPs not just in terms of valuations (and returns), but also as a critical part of managing LP relationships. "The difference in quality between those GPs that are quick to reply to assessments and those who take longer is a reflection of how they manage their portfolio," stressed Peter Mayrl, investment director at fund-of-funds Allianz Private Equity Partners.

Challenges in the LP-GP relationship do not stop there. The issue of fee alignment was, perhaps predictably, also brought up. John Holloway, director at the European Investment Fund, called for greater alignment of interest in fees. "We haven't had a major change in approach regardless of whether the situation is LP- or GP-friendly," he stressed.

Holloway also called for greater transparency on remuneration terms, adding that his fund is "looking at transparency on full fee offset when considering commitments". This was seconded by Mayrl, who insisted that "transparency is a must not just on economics in general - how are salaries, bonus and carry split - but also when it comes to the reporting and inclusion of more commented information on comparables."

LP speakers were also keen to discuss the ways GPs must change their approach. With more banks currently dealing with restructuring and risk provision, many emphasised the importance of effective local banking relationships in order to get deals away. "The mid-cap funds with the best track records with local banks are likely to be the ones able to build viable debt syndicates. These will be the funds with the highest possibility to do deals and thus generate returns," said Katharina Lichtner, partner at fund-of-funds Capital Dynamics.

Sowing the future

This talk of changing models and finding effective ways of executing transactions was allied to a general sense that there are strong opportunities in the pipeline in the near-term future. "First movers will achieve returns that far exceed their expectations. Not just GPs but also lenders, which are commanding higher premiums and far better security on deals," claimed Bonomi optimistically. "These are by far the best conditions we've seen in our professional lifetimes," he continued.

This was tempered, though, with caution over exits, the business-end of the investment cycle. Certainly, from the sellers' point of view, there was a general view that valuations need to rise before any meaningful rise can occur. The new wave of investments was therefore thought unlikely to take place before the second half of next year, which could cause problems for liquidity starved LPs receiving an increase in draw-downs.

This means there may also be opportunities for other players, such as secondaries buyers. "The past year has seen a bit of a standstill, but investors still want to manage and exit their portfolio," noted Eric Pathe, investment director at secondaries specialist Greenpark Capital. He warned against rushing into potentially weak deals, however, asserting that "a considerable amount of effort will go to separating the wheat from the chaff." (see feature, page 18)

Despite this, there was general agreement that exit prospects have improved, particularly in relation to public markets. "Volatility has decreased and we are seeing a growing trend in the number of IPOs, most notably in the Far East but moving to North American and now slowly reaching Europe," commented Massimo Capuano, CEO of Borsa Italiana. Capuano also reminded the audience that over the last three years, 40% of all IPOs originated from private equity-backed firms.

If these debates over exits did nothing else, they reinforced a general sentiment that, while the mood in Italy (and across Europe) remains optimistic, the current issues are far from over. Bonomi concluded by calling on the industry to use the current crisis as a time to improve the way it does business, though he argued that this will take investment. "This is a time to build up the franchise, but don't forget we need to invest in people in order to grow."

unquote" would like to thank PricewaterhouseCoopers, Greenpark Capital, IKB Deutsche Industrie, Adveq, Egon Zehnder International and Pirola Pennuto Zei & Associati for their support and sponsorship of the event.

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• Southern Europe
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• Price Water House Coopers
• Investindustrial