Dynamics of building Swiss portfolios
In 2003 the Swiss private equity market was heavily affected by the re-engineering of corporate portfolios. Michael Peterson, director of 3i Schweiz, says: “From a general partner perspective, we have seen a remarkable wave of corporate restructuring. This resulted in the reorganisation of many corporate activities that led to some interesting deal-flow in Switzerland, notably some high-profile buyout transactions.”
In some cases, such as Swiss Air’s divestment of SR Technics, this was done out of necessity, while in others, such as the Swiss Industrial Group (SIG), it was part of a strategic move to concentrate on a firm’s core activities. This has been a positive development for the industry and private equity is now seen as a credible, long-term solution for vendors.
Although more than 90% of the Swiss economy is made up of small to medium sized companies, buyouts are now attracting more attention in Switzerland, echoing the trend in the rest of continental Europe. According to Max Burger-Calderon, a partner at Apax Partners Beteiligungsberatung, Switzerland only produces two-to-three sizeable deals per year.
The ability of such a small economy to produce high-value deals is partly attributable to the presence of a number of large corporations as well as the overall maturity of the Swiss financial sector. In the past, the majority of Swiss buyouts came from corporate spin-offs, mainly in traditional industries, and were often completed by international rather than domestic private equity houses.
But according to the European Buyout Review (EBR), although these deals may have boosted the total volume of the market in particular years, there has been no clear trend towards market growth since the mid 1990s, with between seven and 15 deals completed in recent years. (Private equity market figures in Switzerland are very unstable. Due to the low number of deals completed in the market, one or two large deals can completely transform the figures.)
As the Swiss market does not have the critical mass necessary to satisfy institutional demand for buyouts, Swiss buyout funds operate mainly outside Swiss borders. The leverage used in Swiss buyout transactions is often low, with even major players often using no more than 50% leverage. Lattmann of Venture Partners explains: “At the moment, there are certain limitations on the amount of debt that can be used in a transaction and the seller incurs a tax liability because it is likened to a liquidation.”
From 2002 Switzerland witnessed a surge of secondary deals,
including substantial divestments by UBS Capital and Swiss Life. These deals were driven partly by disillusionment with the asset class and the need for liquidity. Lattmann says: “The current appetite for secondary transactions is such that it will grow to become a separate asset class in its own right.” But recent secondary deal activity has led to a significant reduction in sellers and distressed sellers are becoming increasingly difficult to find. It appears that vendors are becoming more discerning in their search for liquidity and are divesting more strategically, refusing to exit their investments at low prices.
As in many other European countries, venture capital in Switzerland has been on the back burner since the collapse of the hi-tech bubble. “Most of the banks that used to have direct private equity activities on the venture side have pulled out of the Swiss market,” says Van Swaay a partner at Pictet. “UBS Capital, Credit Suisse and the Cantonal Bank of Zurich have all stopped their local activity.”
The Swiss venture capital market is still underdeveloped despite Switzerland’s natural affinity with biotechnology. Even at the height of the bubble, the amount of venture funds raised only reached a modest CHF1.5bn (e968m). In 2001, total investment in venture capital fell 62% to CHF367m, according to EVCA.
Swiss venture capitalists tend to invest in later stages and their investment profile is very risk-averse. Although this means that investors were more cautious during the bubble, it is a barrier to the economic development of new ventures. In recent years, several government-backed initiatives have been established with the aim of developing an entrepreneurial spirit and attracting greater venture capital funding.
According to EVCA, firms coached under the CTI Start-Up programme administered by the Federal Office for Professional Education, raised €90m in 2003. Most venture capitalists operate elsewhere in Europe as well as Switzerland as the market is not large enough to carry such a high number of venture capital investments. Consequently, attractive ventures are only those that have international appeal.
Unlike countries such as Spain or Italy where domestic private equity houses often focus on domestic deal opportunities, Swiss private equity managers appear to be more open to doing deals abroad.
The Swiss market is not that large and there is a finite number of deal opportunities. Conradin Schneider, a partner at the independent listed AIG Private Equity, says: “The majority of Swiss investors have a very small percentage of their portfolios invested in Swiss companies.” Kubr adds: “The majority of the private equity capital managed here is not Swiss money but foreign-sourced money invested in a global arena.”
Auguste Betschart, managing partner at independent private partnership Leman Capital, does not think there is a significant domestic bias when it comes to portfolio composition. He says: “Each general partner has its own investment philosophy.”
As a rule, the less sophisticated the investor the more it is likely to invest locally. “When people first invest in private equity, they have a tendency not to look any further than their own canton,” Van Swaay explains. “But, inevitably, they get burned and learn the importance of diversification and start to build a proper portfolio by investing in a larger market.”
There appears to be a split in the market related to deal size. Peterson says: “In general, foreign private equity managers don’t look at deals that are smaller than CHF150m because their completion requires an extensive network of local contacts.” Indeed, Van Swaay maintains that the small size of the country makes it difficult for large international groups to justify having a full-time team dedicated solely to the Swiss market.
Andre Jaeggi, managing director of fund of funds Adveq Management says: “We haven’t noticed a significant domestic bias. Many investors know that investing with local players is not a guarantee of quality. In fact, often when you increase the domestic portion of the portfolio it increases the risk profile of the portfolio. In more mature markets such as the US and the UK, you notice that investors tend to look beyond the domestic market and focus on a diversified global portfolio. The Swiss market is too small to stand alone, it should be looked at in the context of a global investment strategy. Just because a number of fund of funds are based in Switzerland is not, in itself, a reason to consider investing in Switzerland.”
Manager selection does not appear to be affected by issues of nationality. “Managers are usually chosen on track record,” Jaeggi says. “The only real difference is that some investors prefer their managers to be able to report to them in their own language.”
Opinion is divided as to whether the advantage lies with the international private equity house or the domestic one. “Swiss general partners may find it harder to raise funds as they don’t have the advantage of a long track record or the network of contacts that foreign players generally have,” says Schneider. “At the moment, there are only one or two Swiss funds of institutional quality in the market.”
But Peterson says: “In some cases, domestic players have a certain advantage as they tend to find out about deal opportunities sooner and have an insight into the local issues affecting the business they’re buying.”