2010: a vintage year in the making?

Francinia Protti-Alvarez
15 January 2010

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Steve Cahill, Senior vice president, Monument Group

LP sentiment towards each part of Europe should be considered in a global context. While we anticipate some improvement in 2010, many LPs will still have relatively small amounts of capital to invest and so will continue to be "rifle-shot" in their approach when considering how optimally, on a risk-adjusted basis, to deploy their limited capital across asset classes and geographies.

Although there are a handful of large-cap, pan-European and global buyout firms operating in Southern Europe, the majority of funds (by number) is made up of smaller and mid-sized growth capital and buyout firms focused solely on the region. For many of these players, local investors can represent a majority, even the entirety, of the investor base. If a GP needs to broaden its investor base internationally, 2010 will be a highly challenging time to execute this. Indeed, while European small and mid-sized buyout and growth capital funds are often cited as an area of interest for many LPs, interest in Southern Europe is consistently lower than for the larger European markets of France, Germany, the Nordic region or the UK.

The reasons for this are complex and varied, but likely to boil down to a belief among LPs that the local markets in Southern Europe are just that, local; they are potentially less transparent than their Northern European neighbours and with challenging growth prospects. Furthermore, many LPs have not enjoyed a long run of consistently strong returns from their investments in the region. This is tempered somewhat by the recognition that parts of Southern Europe have a long-standing commercial heritage and entrepreneurial mindset, making them theoretically attractive for the asset class.

Overall, fundraising will be challenging for the next year or more, for the majority of private equity firms. The GPs that are most likely to be successful are those that can demonstrate several qualities: a strong track record through the cycle with value created by sustainable strategies, particularly active operational impact by the GP; well-considered sector selection and timing of acquisitions and exits during the most recent market cycle; the quality, stability and depth of team; its alignment of interest; and the level of backing from existing investors.

The additional element for Southern European markets, which is arguably more important than for some Northern European neighbours, is the network and relationships that a GP has in its local markets, especially with family entrepreneurs, industrial groups and banks. Given the "insider" nature of these markets, it is those with the proprietary, non-replicable relationships that will likely be able to source the best deals, sometimes relatively uncontested, and have a higher probability of continuing to be able to secure an acceptable level of debt financing from local sources.

GPs should be mindful not to ignore LP demands for greater transparency. Many LPs have cited this as a perennial issue with some GPs in Southern Europe; now it is at the top of the LP agenda globally, and anything less than full transparency will be a significant hindrance to fundraising. Given the lack of recent exits for most GPs, the potential of the unrealised portfolio will be a vital factor in LP due diligence. It is only through full transparency that investors will be able to get comfortable with this potential. Furthermore, given the "insider" nature of the Southern European markets, LPs will demand transparency to understand clearly the depth, stability, relevance and uniqueness of a GP's industrial and banking relationships, as well as why its strategy remains robust and replicable in the new economic reality.

GPs would be well advised to hold off from coming to market with a new fund until there is compelling recent proof in its portfolio to demonstrate this, and then to approach any fundraising exercise in a thoughtful and holistic manner, because the future of their firms may ultimately depend upon it.

Mounir Guen, CEO, MVision

What happened in 2009 in Southern Europe was very different to what occurred elsewhere on the Continent. It is a regional market with very different dynamics and practices, and has always followed its own path.

The downturn that began in late 2008 displayed a number of strains in these countries but interestingly, as the relative growth rates were not as high as in other European countries, the effects were not as dramatic. The banks were inactive in 2009, but then they had not been that active before. Private equity houses were still a little out of sorts, but those that had solid teams, a focused industrial approach and a privileged and insightful sourcing capability were able to make it through the slump. These are now the local leaders: they have dry powder, they have attracted outstanding investment professionals, and are actively making investments that capture some of the opportunities created by local market dislocations. Perhaps most importantly perhaps, they are actively using their internal resources and talent to continuously address challenges in the portfolio and re-underwrite their investments.

Italy was historically a top-performing market but never had as many GPs as Northern Europe - and now in 2010 has even fewer. Iberia had a host of new GPs that formed in 2007 and 2008, but today, a small number still dominate. The Italian market is focused on being world class in specific product areas and when it faced stiff competition from Asia, some firms went there to fully understand the situation, with some of the GPs opening offices to not only source, but also to learn, and once again these companies have re-established their edge.

For Spain, as in the past, the kicker may well come from Latin America. There has always been an early beneficiary of growth there, and the recent upturn is likely to be reinforced and enhanced by the recent pre-salt finds in Brazil.

We need to understand and accept the different characteristics of these markets. Spain will continue to undergo changes through 2010, and Italy will emerge with a small number of GPs who can execute with the same confidence, insight and performance that we saw 10 years ago, when these markets generated returns equal or better than their Nordic counterparts.

Private equity partner, SJ Berwin

2009 will be remembered as a period of palpable inactivity for the private equity sector in Spain. Fundraising levels fell below expectations, investments reached volumes witnessed a decade ago, and distributions to investors remained far from what they would have expected. The economic turmoil, lack of financing imposed by credit institutions and the defensive position adopted by many investors (mainly by institutions and corporations seeing enormous depreciation of their portfolios) have resulted in very disappointing figures for the sector.

However, the activity shown in the last quarter of 2009 is seen by many as the beginning of the path to recovery, even though similar figures produced during pre-crisis times are not expected, at least for a while.

It is true that the recession should bring attractive opportunities for investments, given that multiples over EBITDA are expected to continue to fall in the next few months. Statistics also show that difficult times have resulted in extraordinary figures for the private equity business. Despite that, many funds currently have a considerable volume of capital ready to be invested, the banks are still not actively lending and, on many occasions, sellers are reluctant to adjust prices in line with the real economic situation.

On the side of divestments, expectations are deposited in IPOs. In particular, the Spanish alternative market (Mercado Alternativo Bursatil), could give an interesting opportunity to facilitate exits and obtain the required liquidity that private equity investors have long been awaiting.

As for fundraising and LP-GP relationships in general, 2010 is being viewed as a period still marked by uncertainty. It could take time before investors turn back to private equity. Managers will need to adapt to the new situation and strongly activate transparency in their relationship with investors: in this new era, only those that are perceived as reliable and prepared to face new challenges will be considered by the investors as an option.

Finally, it is important to highlight that private equity is still considered by public institutions and government bodies as a key element for stable economic development, and a useful tool for alternative financing, with several initiatives being recently made public in Spain that will be developed in the coming months.