Trade winds blowing

Go back 10 years, and talk of China and India centred around low-cost manufacturing. Now, unquote" has recorded six sales of European private equity-backed businesses to trade buyers in these emerging markets in the last 18 months, with Lion Capital's sale of UK cereal business Weetabix to China's Bright Food for £1.2bn the latest in Europe. That week, Indian drugmaker Piramal Healthcare bought US-based healthcare data provider Decision Resources Group from Providence Equity Partners for $635m. A month earlier, Duke Street sold Adelie Food to India Hospitality for $350m, and, in December 2010, Italy's Investindustrial reaped a 3.6x multiple when it sold Italmatch Chemicals to a Chinese investor, a few months after opening a Shanghai office.

At the end of last year, Shandong Heavy Industry Group bought luxury Italian yacht-maker Ferretti for €220m. The business had been backed by Candover Partners.

There may be more to come, with Permira's Bird's Eye attracting interest from Thai firm Charoen Pokphand Foods in what could be a £2.5bn sale. Lion is also eyeing up another sale to an Asian trade buyer.

Emerging markets are increasingly offering exit routes for European private equity houses

"Big companies in China are hungry to do deals," says Jonathan Reardon, Pinsent Masons' head of corporate in Asia.

Bright Food approached Lion for the iconic British brand – Lion's first deal as an independent operator: "There were many approaches over the years, some of which were entertained and others which were turned away outright. So to let Weetabix go, we would have to realise a significant price or know that we could share in the continuing upside," explains Lyndon Lea, partner at Lion Capital. Bright Food offered both: by taking a 60% stake in the deal, Lion will ultimately make at least 4.7x money, and maybe more when the remaining stake is eventually sold.

Bright Food's acquisition of Weetabix marked a high point in the acquirer's two-year quest to snap up international brands: it had previously attempted, unsuccessfully, to buy yogurt business Yoplait, sugar company Sucrogen, consumer giant United Biscuits and nutritional company GNC in the US. Its luck in Australasia was better, with two brands in its portfolio from the region.

"We will see more of this trend," says Reardon. "There are numbers of companies – state-owned enterprises and privately owned - sitting on large amounts of cash. They are being encouraged, as a matter of Chinese national policy, to have more international brands. There are also strategic reasons, as domestic business alone becomes more challenging or the international target can add more to the Chinese domestic business through technology, for example."

In a recent survey conducted by Grant Thornton, 46% of privately held businesses in mainland China indicated an intention to grow through acquisition over the next three years. This is up markedly from 26% a year earlier.

"Acquiring an established western brand lends authenticity to the purchaser, while the purchaser has access to new markets and possibly more efficient manufacturing techniques to help grow profit," says Simon Turner, managing partner at Inflexion Private Equity.

The fact that Chinese corporates are looking at private equity-backed businesses may also be an indirect consequence of changes to the UK Takeover Code, which last September made delisting a business listed in the UK more difficult – and privately held companies relatively more attractive targets. "Chinese companies are relatively new to the game of outbound expansion and acquisitions. They are learning through experience, so the more straightforward the deal and the more professional support they get, the more likely it is to complete," says Reardon.

Who you know or what you know?
Relationships often play a big role in deals, especially in new markets – but whether the relationship requires a local presence polarises opinion. "It's extremely helpful to have a presence on the ground to identify opportunities for potential buyers of assets or acquisition and expansion opportunities," explains Reardon.

Inflexion is the latest to have announced a presence in each of China, India and Brazil, joining the ranks of LDC, Cinven, Terra Firma, Baird and Bridgepoint in terms of an emerging markets presence. Providence established its Hong Kong and New Delhi offices in 2007 and its Beijing office earlier this year, while Summit opened an office in Mumbai in February. The GP stated its intention to increase its investment activity in India, but also that it will be used to provide support to US and European portfolio companies looking to expand in the region – namely Belkin, Ogone and Snap Fitness.

But who needs the relationship? It depends on the goals, says Daniel Domberger, director at Livingstone Partners: "If a GP intends to be very operationally involved with a target and it is seeking or has business in China or India, then it can make sense for that GP to be on the ground. It will also depend on the volume of investments the house makes." This is one reason it might make sense for LDC and Baird to have local presences. "Baird, for example, works closely with portfolio companies on manufacturing in China. If this is an important part of the business, then an investment from Baird, all other terms being equal, may be more attractive to a target than an equivalent offer from another private equity house."

While some deem a local presence key to wooing trade buyers down the line, others feel the presence is likely to be more helpful to win a deal in the first place – by impressing incumbent management that you're serious about the Asian growth story. "Simply opening an office in China will not help you get on the radar of potential trade buyers. The significant relationship is the one the potential buyer has with the management team, not the backer," says Sean Whelan, ECI managing director, indicating announcements by some firms of regional openings may be mere marketing efforts.

WCI Consulting was sold to Indian technology firm TAKE Solutions at the beginning of last year. ECI, its backer, has no presence outside the UK and has no plans to establish any. "WCI had a relationship with TAKE two years prior to the sale," Whelan explains – adding that relationships are important, but between management and the buyer, not the GP and buyer. "As TAKE were ultimately buying senior management, it was crucial they had a rapport. This doesn't come overnight by issuing an investment memorandum on the desk and asking for a bid within a month." Similar to the Weetabix sale, ECI retain a stake in WCI and so may reap further upside.

"The relationship side of things is very important. Trade buyers in India and China may be willing to take part in a process, but they prefer to build a relationship that pre-empts that process and to deal one-on-one if possible," explains Domberger. Indeed, Livingstone was involved in the sale of WCI, while Lion worked with Bright for a full year before the deal completed.

"Clearly, when a portfolio company operates locally, it helps attract attention; that could be on either the sales side or supply chain," says Turner. "We also think that a local presence helps and the support teams we have in place will certainly help us. Particularly in the markets we focus on, local knowledge and local relationships unlock opportunities. Local corporate finance relationships are important too, but, as with all relationships, you need to keep them warm, so being in the same location is paramount."

Long-distance relationship
"Bright Food is government-owned, so several levels of approval were needed. It also had no track record of acquisitions in Europe. Despite this, it ran smoothly," Lea explains. And perhaps, some might say, despite Lion's lack of any office there. The firm operates its consumer-focused business solely out of offices in North America and Europe - the two geographies it targets for investment.

"Around half our exits are done without an auction," says Lea. "We own strategic assets, so the exit is often fairly evident. You get better speed and certainty of execution this way. Of course, with financial buyers we would usually seek intermediation, but with strategic buyers it is more straightforward."

"We open doors through our sector focus. For example, historically we have found we can simply say to a business ‘we have similarities' – be they pricing issues, concerns with moving a manufacturing base or maybe we're direct competitors. It means we speak the same language and it doesn't matter if we have a local office or not. I have been humbled and shocked by the ability to pick up the phone to some large businesses – with 14 businesses in the consumer sector we can seem not dissimilar to a consumer company the scale of Heinz to certain players. As such, a local presence – unless you are a generalist – is not necessary."

And some say it is even a very expensive marketing effort. "Astute investors like to see ‘local presence' if the GP's target companies are small- and medium-sized businesses in that location," says John Hess, chief executive of gatekeeper Altius Associates.

He would know – Altius's clients consist of 17 investors, roughly half of which are US-based.

"Investors will look at the competencies of what the GP is trying to do in its core markets," Hess continues. "Sure, if the focus is on growth companies in Brazil, then a GP needs a local presence. But if the local presence is only to help the GP's investee companies source a low-cost manufacturing market, then there has to be a proven value added. Sometimes I wonder if these arguments are more for marketing purposes than for substantive added value, but then I am an old sceptic."

There are whispers of the reliability of offers from trade buyers in emerging markets, though they are dissipating, perhaps as they hone their buying skills. "We'd had a number of flirts with Indian trade buyers but it's never come to anything. Previously they had a reputation for looking but not ever executing. So the market was largely sceptical of their ability to deliver a result. But TAKE was very honourable in their conduct," Whelan says.

And Western advisers may help iron out any remaining wrinkles. "There is a sophisticated growing corporate finance network in Shanghai, Beijing and Hong Kong. There is a lot more play now between local offices there and UK/US/European offices to identify opportunities," says Reardon.

Indeed the auction by 3i of loading equipment maker Hyva Group ultimately went to a Hong Kong consortium, but attracted at least one Chinese trade bidder. CSFB in London was the mandated corporate financier and involved its Asian offices.

"There could have been communication breakdowns, but Bright had a very skilled adviser. Both sides had frustrations, largely down to the different cultures. It's been educational, and tremendous patience saw us through," Lea says.

With 40% of Lion's skin still in the game, the deal is something of a joint venture. Says Lea: "If we took ourselves to India or China on our own accord, it would have been a very difficult start. It would have taken decades to gain traction. Any new brand entering a foreign market will be cashflow negative for some time. The relationships just aren't there. But Bright has a ready-made distribution chain of lots of supermarkets in China. A more straight-forward joint venture would have been more complicated at the time of sale, with change of control issues, transfer pricing etc. As it stands, we have a formula in place for when it is time to sell, and a floor on the price."

Lion has done well for its investors by selling the UK's most iconic breakfast brand to China - but is one of a small few to have done so as a GP in Europe without a presence there. Eurozone issues are forcing down the value of the euro, making further European acquisitions more attractive for foreign buyers. "It's extremely helpful to have a presence on the ground to identify opportunities for potential buyers of assets or acquisition opportunities. We will see more European private equity firms setting up offices in China," Reardon says.

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• Topics
• Industry
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• Lion Capital
• Providence Equity Partners
• Investindustrial
• Arle Capital Partners
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• Inflexion Private Equity
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