Slow but steady ..

In comparison to the other major European regions, the French buyout market has shown far less volatility throughout the downturn. Following a Q2 rally, activity in the UK plunged over the second half of 2008 and quarterly deal numbers are currently down more than 75% on their peak a year ago. In Germany, steady rises in the first three quarters of 2008 have been mirrored by a nine month slump, ending in a recent low of just four buyouts in Q2 2009.

Meanwhile, France maintained fairly steady activity levels through much of 2008 and, despite dropping off post-Lehman, deal numbers have remained strong in comparison to its peers (see chart 1). The general consensus among industry professionals seems to be that the country is currently easing past the bottom of the trough, though the upturn is likely to be as protracted as the slide that preceded it.

Downshift

It is important, though, not to give a false impression: French private equity is struggling at the moment. As with the rest of the continent, fundraising remains challenging to say the least, a dearth of debt is making buyout investments difficult to finance, and portfolio company issues are dominating GPs attention. If investments are a guide to market sentiment, then confidence is low. Indeed, statistics show that there has been a more than 90% decline in volume and value in Q1 2009 compared to the same quarter in 2008.

However, as alluded to above, the market has demonstrated some degree of resilience in the face of the extraordinary economic backdrop. There was a drop of just four deals to 13 in terms of activity between Q4 2008 and Q1 2009 and by 42% in value to EUR824m, making it the largest European market in Q1. Volume dropped only slightly again in Q2 2009, falling by three deals to 10, although value has slipped significantly to EUR278m (see chart 2).

That value is declining at a faster rate to deal numbers is unsurprising given the tail-off in the larger deal brackets in the past two years. "Large- and even most mid-cap buyouts are now gone from the market, with the former not expected to return in the near future," notes Gerard Pluvinet, managing partner of 21 Centrale Partners. It is the small-cap space, then, that is propping up dealflow; a fact that Pluvinet attributes to the continued availability of financing in this area.

Leaving aside the much-publicised problems within some of the larger banking institutions - which, notably, have been less prevalent in France - the country benefits from a significant number of regional banks that were largely insulated from the sub-prime crisis. "Many local companies have a long-standing relationship with local banks and GPs are able to call on these institutions to provide leverage to acquire said companies," confirms Michael Diehl, partner at Activa Capital.

As a comparison, in the mid-market, where deal opportunities are scarcer and banks are less willing to lend, financing of about 2.5x EBITDA is still possible, although the terms and conditions on the loans have now shifted in favour of banks to compensate risk. "In terms of mid-cap debt financing, it's still possible to pool a number of banks together and get something done - everything just takes far longer and is far more complicated," Diehl continues.

Safety nets

France has traditionally been far more conservative in nature than its neighbours. The reason debt is still available in moderate quantities from domestic banks is that they had previously been less adventurous than their foreign counterparts and are thus in better health. This is in part due to the traditional French bank ethos of not overcomplicating structures and in part due to rigid government banking legislation restricting such actions.

Indeed, while the country has often been criticised for allowing heavy state involvement to stifle economic growth, French businesses may now find themselves better protected from the effects of the recession. The government has attempted to establish a number of safety nets to support companies during the downturn, including incentives, direct funding and support, and new legislation that focuses on company survival and job retention (see page 18).

This combination of conservative capital structures and state support appears to have benefitted private equity portfolio companies. According to a recent survey released by the French Private Equity Association (AFIC), 80% of French LBO-acquired companies are honouring their debt agreements, while 4/5 of those that have breached covenants have negotiated a suitable solution with creditors. Overall, just 4% of private equity-backed companies in France are currently struggling to manage their debt.

That the vast majority of restructurings have been resolved amicably is perhaps further testament to the conservative nature of French creditors, which have been less aggressive than their European counterparts with regards to covenant breaches. French banks have been largely unwilling to take over controlling equity stakes in business, even at the top end of the market where write-downs have inevitably been substantial.

But any enthusiasm over the modest default rates should be tempered with caution. Unemployment is still on the rise and this is liable to continue to affect consumer spending. Many businesses have seen trading performance decline consistently over the past 18 months; if this continues then portfolio company failures will surely rise. That said, there has been much talk of green shoots in the wider economy and this has given rise to a cautious optimism over what the second half of the year may have in store.

Slow recovery

Talk of a recovery in the economy has some analysts discussing the possibility of a recovery in private equity deal activity, as greater certainty over trading numbers should alleviate the ongoing pricing issues. Pluvinet boldly states that "the worst is over for the French buyout market", pointing to "a steady increase in dealflow recently in the small- to mid-market". Diehl concurs, suggesting that regional family companies are largely responsible for the rises, as they are increasingly turning to cash-rich private equity firms for funding.

Gwenael de Sagazan, managing director at Close Brothers Corporate Finance, adds that large industrials divesting non-core assets to bolster balance sheets have also added to dealflow. He stresses, however, that any upturn is likely to be long and slow. "It will take a long time for the French market to operate on a 'normal' level, possibly longer than its neighbors. The market had the luxury of a parachute on the way down - unfortunately this will mean that it must wear the same parachute on the way up."

Deals could start trickling through in the second half of the year, beginning at the small end of the market and working upwards. Initially, Diehl suggests, the majority of these buyout deals will resemble growth capital transactions, involving little debt and focusing on high-growth businesses. "Private equity will go back to its core: taking a small company and guiding its growth." Debt for larger transactions will eventually return, but not at more than 3-4x EBITDA and not for some time. But then again, doesn't slow and steady always win the race?

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