The State at play: Italian government jumpstarts flat market

While Southern European neighbours tremble in the aftershock of a burst real estate bubble and the collapse of the foundations of the banking system, the Italian economy stagnates in a deep recession. With a chronic shortage of credit available for Italian companies attempting to pull the country out of anaemic growth, the economy remains emaciated.

Grass roots initiatives such as Why Not Italy, which unites the country's leading private equity players, have proved particularly proactive in amplifying calls for foreign investors to reconsider the country. But the Italian government has also been strikingly responsive, harnessing private equity as a source for growth and throwing a lifeline to sinking SMEs.

"We have at least three tools that are directly or indirectly backed by the government, but they are private equity funds, with a PE structure and regulations. I think that there is a lot of focus on that," says Andrea Montanino, director general of the Italian Treasury, board member of Fondo Italiano di Investimento and F2i, and member of the Why Not Italy initiative.

State-backed funds are driving Italian private equity, but for how long?

"The government has also passed a law on venture some months ago to attract investment. There is now no capital gains taxation when investors invest in venture capital funds. So this is another important action," says Montanino. "There is an effort to support private equity and general capitalisation of Italian firms through market instruments," he adds. With foreign investors reluctant to back the country, the Italian job is more a case of DIY than outside help.

Three of a kind
The eldest of the state-backed private equity funds is F2i, a national infrastructure fund with €1.85bn on the books. Italian banking foundations and pension funds have provided the majority of capital commitments. Contributors include Banca Infrastrutture Innovazione e Sviluppo, the bank of the Intesa Sanpaolo group that specialises in finance for infrastructure and the public sector, and Cassa Depositi e Prestiti, a bank 70% owned by the Italian Ministry of Economy and Finance. The fund is the largest country-specific infrastructure fund in the world and the largest private equity fund in Italy.

In July 2011, the Italian government launched Fondo Strategico Italiano, a €4bn fund that backs Italian businesses generating revenues of more than €240m. Cassa Depositi e Prestiti has once again contributed to the state-backed fund providing 90% of the capital. The remaining 10% comes from Fintecna, a holding company whose subsidiaries provide consulting services, wholly owned by the Ministry of Economy and Finance. The fund has a €7bn hard-cap and is also open to private companies and foreign investors.

The elder sibling of the Fondo Strategico, Fondo Italiano di Investimento, is smaller in size but notably more active. The vehicle backs Italian companies with a €10-250m turnover and made its first investment in December 2010. It has since backed a further 23 firms, with five deals completed during a somewhat hyperactive week in December. The four main contributors to the fund are once again Intesa-Sanpaolo and Cassa Depositi e Prestiti, flanked by UniCredit Group and Banca Monte dei Paschi di Siena. Each of the four banks has contributed €250m.

Unfair advantage
But since the focus of the Fondo Italiano is the segment in which the most deal activity already occurs in Italy, the fund has been accused of competing with existing mid-market private equity companies. With €1.2bn on the books, the support of the state, and less pressure to deliver returns to investors, industry players have suggested that it is an unfair competitor. What's more, critics have suggested regular conflicts of interest arise given that many target portfolio companies have debt with one of the subscriber banks investing in the fund. These criticisms have been locked to all three state-backed funds.

"There is some truth in that criticism, but it misses one fundamental point," explains Innocenzo Cipolletta, president of the Italian private equity and venture capital association AIFI. "Italy records very low levels of private equity activity compared to other countries due to the reluctance of business owners to turn to the instrument."

With such herculean balance sheets and resolute governmental support, these giants of Italian private equity are unsurprisingly shaping the landscape.

Responsible for 27% of deals recorded by unquote" data in Italy since December 2010, and 50% of investments in Q4 of 2011, Fondo Italiano is striding ahead in terms of deal activity. But when the Fondo Strategico burst onto the scene in May 2012 with maiden investments totalling €650m, deal value increased eight-fold on the previous quarter. Leaving such a marked imprint on volume and value, these funds are pushing the Italian market forwards in leaps and bounds. But why has it taken the hand of the state to stir deal activity?

Leading by example
"Italian companies are very hesitant when it comes to private equity. These companies are small, and owners are often very reluctant to give up any kind of control," says Cipolletta. "But since Fondo Italiano and Fondo Strategico acquire minority stakes, they offer some sort of guarantee to business owners worried about losing control. They give businesses a gentle introduction to the instrument of private equity. And that's why I think these state-backed funds are important at the moment, because they are training business owners to look to private equity and external funding, and to share some of the management of their companies," he explains.

"Generational change is also affecting a lot of Italian companies and private equity allows companies to continue operating," explains Fabio Sattin, coordinator of WNI, founding partner of Private Equity Partners and former chairman of EVCA. External investment from private equity players often represents the only way a company is able to maintain its headquarters in Italy while consolidating the role of existing managers.

"Private equity is a key tool for supporting growth in Italy," states Montanino. "Part of my job at the Italian Treasury is to support the development of these tools and I am directly involved in the board of F2i and the Fondo Italiano d'Investimento. We want to explain, especially abroad, that Italy is a country to believe in and look at. And especially now," he adds.

What's more, private equity could answer another particularly Italian question. Given that 90% of Italian companies are family-owned SMEs operating amid a chronic shortage of credit, how are local firms to find the capital to expand in domestic and international markets? Private equity could be Italy's best kept secret.

Cut from the same cloth
It seems, then, that Italian state-backed funds have risen from the same mire that fuelled the rise of British private equity veteran 3i. After the 1929 stock market crash, the British government established the Committee on Finance and Industry, more commonly known as the MacMillan Committee. Primarily composed of economists, the committee was charged with determining the roots of the depression in a report.

The 1932 MacMillan Committee Report identified the "MacMillan Gap", a chronic lack of small loans that put SMEs seeking funding at a serious disadvantage. The report answered this disparity with a recommendation to establish an institution to finance small businesses, which laid the foundations for what we know today as 3i. "The Italian private equity market is a bit behind the times and these funds give the market a push. So yes, they play the same sort of role," says Cipolletta.

But given that the main strengths of these funds is to drive the evolution of Italian private equity, just how sustainable is their role? "Of course, once the Italian private equity market matures and becomes as developed as it is in other countries, these funds no longer have much of a role. At most, they will be useful in their role as a fund-of-funds," Cipolletta explains. While 3i continues to cast long shadows across the landscape of British private equity, the rising of the Italian market may signal the twilight of state-backed funds.

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