H1 Review: Cloudy with a chance of slowdown

European private equity deal activity tailed off in the first half of 2019 amid growing signs of an economic slowdown across the continent. The three largest EU economies have all seen GDP growth either slow or head into negative territory in Q2. The UK's Office for National Statistics reported a 0.2% drop in quarterly output and the Bundesbank is anticipating a dip of 0.1% in Germany, while France has seen growth fall from 0.3% to 0.2%.

Buyout activity across Europe has reflected the continent's gloomy macroeconomic picture, with half-yearly deal volume falling 10.1% from 526 in H2 2018 to 473 in the first six months of 2019, according to Unquote Data. While this represents the lowest level since the 452 buyouts transacted in H2 2016, it remains above the five half-year periods that preceded H1 2017. Similarly, at €79.4bn, aggregate buyout value between January and June 2019 is considerably below the €113bn seen in H1 2018, but remains the third highest half-yearly total across the past five years.

"2017 and 2018 were outstanding years for buyout volumes in Europe," says Steve O'Hare, senior partner and UK country head at Equistone Partners Europe. "What we have seen in the first half of this year is a slight reversion to a more normal footing, triggered primarily by the broader political and macroeconomic backdrop. It is hardly surprising that this has been felt most keenly in the UK, but even amid acute political uncertainty the market is propped up by the large collection of entrepreneurial businesses and the established role of private equity as a source of funding to support their development."

There has been some respite from political uncertainty in western Europe since the beginning of 2017, with electoral victories for Emmanuel Macron in France, Angela Merkel in Germany and Mark Rutte in the Netherlands. Nevertheless, Alantra partner Steve Currie highlights the continent-wide impact that Brexit is having and says he anticipates the knock-on effects will continue into H2, with the UK's revised exit date now pencilled in for 31 October. "The decision to delay Brexit and the lack of visibility about what it will actually look like is just perpetuating market uncertainty and holding up sales processes," he says. "This is compounded by volatility in exchange rates, which makes it difficult to make business plan assumptions for significant importers or exporters."

Deals that are happening are having to pass "no-deal Brexit" sensitivity tests, says Currie: "This pattern is not confined to the UK; we are seeing similarities across all major European economies. All processes face the risk of business underperformance. This, combined with the high valuation expectations set in 2017-2018, is resulting in a higher number of aborted processes. We expect this trend to continue into H2 2019, although we also have to consider the [opposition leader Jeremy] Corbyn factor in the UK."

Maillot jaune
As has been the case in recent half-year periods, there was little to separate France and the UK in terms of deal volume as a proportion of overall European activity. France accounted for 21.6% of all buyouts in H1 2019, compared with 20.5% in H2 2018, while the UK accounted for 20.5% compared with 21.1% in H2 2018, according to Unquote Data. Meanwhile, the Nordic region accounted for around 13% of volume for the third successive semester, up from its 10.7% share in H2 2017.

"French GPs and VCs have risen up the rankings in terms of both domestic and international deal-making," says Hogan Lovells' global head of private equity, Tom Whelan. "Activity in France has been quite surprising, given there are a lot of restrictions and challenges for foreign investors and there are employment issues. It has not naturally been the dominant market."

The UK's fall from European private equity preeminence is illustrated more starkly in aggregate value terms, with the country contributing a smaller share of the H1 2019 total than both France and the DACH region. The latter accounted for the largest share of overall buyout value at 28.3%, compared with France's 16.3% and the UK's 14.9%. Indeed, the last time the UK accounted for the largest proportion of Europe's aggregate value was in H2 2017, when it contributed 25.1%.

While the rest of Europe has experienced high levels of uncertainty due to Brexit, the Nordic and DACH regions provide a stable and attractive economic environment for private equity investing" – Kristoffer Melinder, Nordic Capital

It is worth noting that the DACH region's figures for the first half of 2019 are impacted by EQT and Abu Dhabi Investment Authority's €8.9bn buyout of Nestlé Skin Health, the fifth largest European buyout ever recorded by Unquote. Nevertheless, when setting aside deals valued at €5bn+ the region still accounted for the largest share of overall European buyout value at 19.1%.

Nordic Capital has been increasing its activity in the DACH market in recent years, as was recently reported by Unquote, and in April 2019 recruited Goldman Sachs' Rainer Lenhard to co-head its Frankfurt office alongside Joakim Lundvall. "While the rest of Europe has experienced high levels of uncertainty due to Brexit, US and Chinese trade disputes and other political factors, the Nordic and DACH regions provide a stable and attractive economic environment for private equity investing," says the firm's managing partner, Kristoffer Melinder. "Relative macroeconomic stability remains a core characteristic of the Nordic market, and on account of this, coupled with the region's reputation as an incubator of successful and stable growth businesses, we continue to see high levels of investment activity and strong dealflow."

Exit activity also remained suppressed in the first six months of 2019. Volume and value both reached their second lowest totals across a five-year period, with 434 divestments totalling €65.8bn. In volume terms, this is marginally higher than the 423 exits in H2 2016, but considerably lower than the 571 sales witnessed in H1 2015. Aggregate exit value fell significantly short of the five-year peak of €112.2bn in the first half of 2015, though it was 28% above the five-year low of €51.4bn in H2 2018.

"It has been harder to launch some sale processes and to get them over the line," says Hogan Lovells' Whelan. "People have been finessing pricings, trying to re-cut deals, and in some cases sellers have balked at pricings and walked away. The increase in time taken has also meant some transactions have been pushed back into the next quarter or the one after that. But there are still quite a few exits in the pipeline and there are plenty of buyout houses looking to deploy capital, as well as trade buyers, sovereign wealth funds and pension funds actively pursuing direct investment opportunities."

Equistone's O'Hare says the recent drop-off in divestments can also be attributed to the high number of sales to have taken place in the preceding half-year periods. H1 2018 and H2 2017 saw steady exit activity across Europe, according to Unquote Data, with 525 and 498 deals respectively representing the third and fifth highest figures across the past 10 half-year periods.

"In recent years, private equity firms across Europe have been very active in harvesting their portfolios, driving up exit volumes," says O'Hare. "The decline in exits in the first half of the year is symptomatic of a slight shift in focus towards deploying capital and holding onto remaining high-quality assets. This has knock-on implications for investment activity as well, since it reduces the supply of secondary buyouts and requires firms to originate deals through avenues such as corporate carve-outs, take-privates and primary buyouts."

Indeed, the volume of carve-out transactions reached a five-year peak of 69 in H1 2019, surpassing the previous peak of 63 set in the preceding semester. Meanwhile, secondary buyout dealflow reached its third lowest total across the same timeframe at 135.

Given the current pricing in the market, the volume of completed deals has fallen, leading to a sharp rise in the wall of unspent capital" – Warren Hibbert, Asante Capital

Pouring in
Despite the exit and investment dip in H1 this year, strong realisations across the past three-year period and the continued attractiveness of private equity as an asset class mean that fundraising remained healthy in the first part of the year, with €63.03bn raised by 76 funds holding a final close. This marks the third-highest six-month period in terms of the aggregate value of capital raised since the financial crisis, arresting the downward trend seen since H1 2016, and more than doubling the cumulative total raised in the second half of 2018. H2 2018 marked a low point for fundraising across Europe, with just H2 2014 recording a lower total value since 2013.

Nevertheless, the feeling among market participants is that the extremely inviting fundraising window that opened in 2016 is now closing, given the record levels of dry powder accumulated since then. "The market has been preparing for a correction for about two years now, and given the current pricing in the market, the volume of completed deals has fallen, leading to a sharp rise in the wall of unspent capital and hence a slowdown in the rate of GPs coming back to market," says Warren Hibbert, managing partner at Asante Capital.

Headline figures for the first half are also influenced by a few heavy hitters, with 13 funds raising €1bn or more. The largest of those raised during this period was Advent International GPE IX, which hit its $17.5bn hard-cap in June, followed by the €10bn Seventh Cinven Fund and The Triton Fund V, which closed in January on its €5bn hard-cap.

These large-cap funds have found the fundraising climate relatively easy to navigate, with Advent closing six months after launch, Cinven spending just four months on the road, and Triton closing in January 2019 after launching in Q2 2018. This trend of larger, more established managers being able to raise in double-quick time was discussed on a recent Unquote Podcast, which highlighted a number of factors contributing to this, including LPs rationalising their portfolios, handing a significant advantage to GPs with existing relationships launching platform extensions.

Fundraising between January and June of this year resumes the trend of large-cap funds accounting for the majority of capital raised, with €5bn+ funds raising 48% of the market, and €2-5bn funds an additional 10%. In contrast, the second half of 2018 saw €2bn+ funds raise just 31% of the six-monthly total, a sharp decline from the 65% that €2bn+ funds accounted for in H1 2018, and well below the average of 52% for six-monthly periods since 2014.

Despite the advantages that brand names have in attracting the attention of institutional investors in a competitive fundraising market, the first half of 2019 has shown that newcomers can raise successfully. Notable examples include Novalpina Capital Partners – led by ex-TPG Capital and Platinum Equity executives – closing its debut fund on €1bn in March; Swedish firm Summa Equity hitting the hard-cap on its second fund, securing SEK 6.5bn in February; and Mayfair Equity Partners II raising £650m, closing on its hard-cap in January.

The success of these emerging managers demonstrates that, although established brand name houses are attracting a lot of attention from LPs, fundraising for newer groups is far from impossible, but also that a strong source of differentiation is necessary to secure LP commitments. One particular type of new manager that is finding favour with LPs are teams leaving established firms to set up shop. "Spinouts are interesting in the current context," says Hibbert. "LPs view these as realigned capital, as they have no older funds to worry about – they are really all in on the new fund they are selling. The fee aspect is important too, as they only really make money by generating carry."

Ones to watch – PE funds currently on the road (source: Unquote Data)

Fund Name	Fund manager	Country	Target (€m)
Permira VII	Permira	UK	10,000
Apax X	Apax Partners	UK	9,402
Ardian LBO Fund VII	Ardian	France	6,000
Carlyle Europe Partners V	Carlyle Group	UK	5,000
Investindustrial VII	Investindustrial	Italy	3,000
Montagu VI	Montagu Private Equity	UK	3,000
IK IX	IK Investment Partners	UK	2,500
Exponent Private Equity Partners IV	Exponent Private Equity	UK	1,711
DPE Deutschland IV	Deutsche Private Equity	Germany	1,000
Mid Europa V	Mid Europa Partners	Poland	800

Regional flavour
On a geographical basis, 2019 has so far seen only three regions, Benelux, CEE and the Nordic countries, fail to double the total amount of capital raised in H2 2018. The Benelux and CEE regions saw a drop in total value of funds raised of 7.2% and 32.5% respectively, where the Nordic region saw an (admittedly impressive) increase of 78.5%. Every other European region saw a half-on-half increase of 112% or greater: Southern Europe led the way with an increase of 155%, followed by the UK (126%), France (122%), and DACH (112%).

Illustrating this, uptick, during the first six months of 2019 the DACH region has recorded the most capital raised in any six-month period since 2014, with €10.73bn raised across 13 funds holding a final close. In line with the pan-European trend, a large part of this total was raised by brand-name investors: Triton led the way, raising €5bn, and Partners Group and LGT Capital Partners also crossed the €1bn mark.

This prevalence of brand-name investors, in the DACH region and Europe as a whole, is not surprising given their aforementioned advantages. It does raise questions, however, about whether the fundraising momentum seen so far in 2019 is able to continue into the second half of the year. "The level of bifurcation remains very high," says Hibbert. "Add to that the fact that there has been a fall in the number of deals completed and hence a sharp build-up of dry powder, it is not surprising to see the market slow down a little. There may still be a chance that funds raised in 2019 will end up exceeding the previous year, but that would be driven by a few very large closes in Q4."

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