Around the table

• August Equity
• ECI Partners
• Isis Equity Partners
• LDC
• Lyceum Capital
• Marsh
• Phoenix Equity Partners
• Silverfleet Capital
• Summit Partners
  

Europe is toxic – at least as far as US corporates are concerned, bemoaned guests gathered for the latest dinner hosted by Real Deals and global insurer Marsh earlier this month. International acquirers may have been stalking these shores voraciously just a year ago, but the latest wave of macroeconomic and political entropy has trade buyers
running scared.

“Certainly most Americans we speak to are saying ‘Why on earth would we want to be coming to Europe? Isn’t it a moribund group of dysfunctional economies? Surely we are better off going somewhere else, or staying at home’,” according to one mid-market investor.

Another had direct experience of what “the latest blip” can mean for an exit process. “We had trade buyer interest for an asset a few months ago and it fell away very quickly when things started to spiral out of control once again,” he said.

It is clear, then, where the power lies. If GPs do wish to entice trade to the table they must accommodate the latter’s demands. Chief among these is a refusal to participate in auctions. “We have had a number of situations where corporates have approached us for a quiet conversation, but have said that if the asset goes to auction and private equity get involved they won’t look at it,” said one UK private equity partner.

And that is a concession that most appear willing to make. Indeed, it is clear that whether selling to trade or private equity, auction processes have had to evolve. In particular, a narrower, more tailored approach is believed to garner the best rewards.

Nonetheless, auctions do still seem to have a way of metastasising, something the private equity community blames both advisers and bankers for. “Once you get the banks involved, everyone finds out,” said one GP. “So as a buyer you may start as one of four people and then suddenly you get into the third round and you are one of six.”

“It is a very gossipy market and I agree the leaks come from the banks,” added another.

Trade deficit

Ultimately, of course, what every process is trying to achieve is maximum price. But while the perception historically has been that trade delivers strategic premiums, this is not necessarily the case.

“We have had situations where we were convinced an asset would go to trade but when private equity heard trade were interested, they were willing to dig into their pockets for an extra few quid,” said one guest. “Trade interest validates a private equity investment decision.”

But price, while paramount, is not the only consideration. In the current environment, certainty of delivery is also key. A secured source of funding and a track record of seeing acquisitions through to completion is hugely appealing. In reality, this means private equity buyers in particular must have their finances in place. But it is the proven ability to deliver seamlessly that can sometimes put trade in a poor light.

“The trouble with trade buyers is that there is often a disconnect between senior decision-making and the people actually carrying out the M&A,” said one GP.

“With trade you will also often not see problems coming,” added another. “It’s invisible. If you are selling to a bigger competitor in a secondary, you can sit down with them face to face, you have known them for years – that mitigates the risks significantly. Buying and selling businesses is our job. That is not the case for most corporates.”

Furthermore, in a general age of anxiety, the concerns uncovered by trade buyers during due diligence are becoming increasingly abstruse. “It could be a health and safety issue, for example, which in our terms is meaningless and very easy to deal with,” one senior dealmaker explained. “But from an internal political risk standpoint within the corporate it becomes a major issue that can scupper a deal and those things are incredibly difficult to predict.”

Public nuisance

But if a trade sale comes with some uncomfortable uncertainties, they are nothing compared to the vicissitudes of the public markets. Indeed, most mid-market GPs have ruled out the IPO option almost entirely.

First, management teams are rarely advocates of a float. As one guest explained, “a lot of the managers we work with are from plc land and they don’t want to go back”.

And management, particularly in Europe and especially in the mid-market, holds a lot of influence. “Management packages are very generous and the ratchets above certain returns can create huge amounts of wealth,” said an investor. “If you are a high-quality manager there is a money-making machine there and understandably, therefore, you get managers building relationships on the side and directing companies into secondaries.”

In addition, the public markets are often suspicious of private-equity backed assets.
“They don’t see us as good sellers of businesses,” said a GP. 

But another countered that this was a “triumph of nonsense over common sense.
The one-year returns for private equity floats outstrip any other type of IPO”, he said.

The lack of a clean exit is another major deterrent for buyout investors. “You end up holding paper, you decide to sell it and it goes up, or you decide to hold it and it goes down. It’s horrible,” said a mid-market partner. The difficulties have been exacerbated by a lack of support infrastructure around small-cap stocks which means that even where there is liquidity, there is no real capacity.

Ultimately, however, once again it comes down to valuation.