Private equity is rapidly increasing in popularity among European pension funds. According to the European Institutional Asset Management (EIAM) Survey 2004, continental European institutions doubled the proportion of private equity in their portfolios to 1.3% in 2004 from 0.6% last year. The survey covered portfolios (41% of which were pension funds) in France, Germany, Italy and the Benelux countries.
Much of this investment goes into US private equity funds. But when it comes to the continental European markets that Europeans themselves favour, success is firmly focused on the Latin Quarter, according to some commentators.
“Spain is a market which is now attracting attention,” says Georgina Wyatt, associate, Helix Associates. “It is small, but with a lot of opportunities and recently raised a lot of money.”
Three Spanish players attract international institutional capital: Corpfin Capital, a Helix client that will be raising its third fund later this year with a target of €200m; Mercapital, which raised the largest Spanish fund with commitments of €600m in 2001; and Nmás1, which raised its last fund in 2003.
Wyatt says that Italy is another market that has recently come into serious contention. “The Italian market is not the obvious place for investment but a very good company, Investitori Associati, closed in the summer, raising €700m,”
she says.” Italian funds often struggle to get money but this was a sell-out and made €100m more than its target.”
However, Robert Klap, fund manager, alternative investments, at Dutch pension scheme administrator and investment manager Mn Services, is more cautious about the Italian private equity market. “People are enthusiastic about Italy at the moment, pointing to the good deal flow,” he says. “But whether that translates into attractive returns is another matter.”
Other European regions have their fans. “Central and eastern Europe has become more popular,” says Jamille Jinnah, managing director of placement and research firm Almeida Capital. “Meanwhile, interest in Scandinavia is still high, and also in the UK and Germany.”
In terms of the type of company targeted and the size of investment, there has for some time been a well-publicised trend towards lower-end mid-market buy-outs worth between €50m and €400m. However, large private equity funds that are likely to be involved in the biggest deals are still popular with investors. “Despite the statements by many limited partners that lower-end mid-market is the place to be, large funds continue to attract a lot of capital,” Klap says. A recent example is EQT, which had no trouble reaching €2.5bn for its northern European fund.”
Steen Villemoes, Nordic representative with Altius Associates, says: “Pan-European players that have a track record and are raising their third, fourth, or fifth fund are still able to attract large sums of money. Last year we saw €5bn raised by Permira’s pan-European funds. But the newer regional funds from, say, €250m to €1.5bn are increasingly in demand, especially if they have a good track record. However, it is still difficult for first-time country-specific funds in somewhere like Denmark.”
Jinnah agrees that the buy-out sector is becoming more competitive. “People are now much more selective about which groups they back than in the past,” he says. “In the next 12 months well over a dozen large groups are coming out to raise money and investors will not be backing all of them. What tends to be important is the past track record of the general partner, and whether they add value to a business rather than the sector itself.”
Having said that, he considers the most popular areas for private equity deals to be the service and manufacturing industries, although the larger buy-outs can also include retail deals.
“Historically, the large buy-out groups have been strong in manufacturing and other traditional sectors, but recently they have been building up their expertise in the service sector too,” he says. “There have been some interesting deals in the retail sector over the past 12 months in particular.”
Others point to the telecoms sector, as well as companies with a global bias such as furniture retailer Ikea and mobile technology company Ericsson.
Carol Kennedy, senior partner, Pantheon, says: “We are seeing increasing differentiation of strategies within the buy-out space. Buy-outs are a larger part of the private equity market in Europe than in the US, and because more inefficiencies remain in the European market, this space is attracting more attention from US buy-out houses. For example, Hicks Muse is now prioritising its European activities, and Hellman & Friedman is establishing a European operation. This trend is particularly well illustrated in the German market, where the majority of mega-deals have involved US funds – such as KKR’s €2.25bn buy-out of Dynamit Nobel from MG Technologies.”
The venture capital sector is picking up after a period of stagnation. Klap says: “Venture capital, including funds of funds, is attracting more interest. Returns have been improving and, after a long dry spell, we are seeing some more exits this year.”
Klap also sees a trend towards the more established names being favoured by investors. “Proven funds with long track records and blue-chip names are becoming more popular than before, and this seems to be getting stronger,” he says. “But first-time funds continue to have a tougher time raising money.”
Villemoes says: “European venture still leaves a lot to be desired. When you compare it with US venture, it lags behind in terms of track record and performance. It has been, and still is, quite a tough area.”
According to Villemoes, one exception to this rule is technology. “IT and other technocentric funds are not as difficult as a year ago,” he says. “But for biotech and life sciences it is harder, and these funds are finding it difficult to raise money.”
Kennedy sees spin-outs – where experienced professionals leave an established private equity firm to form their own fund business – as another trend in Europe. Lacking the cumulative fee revenues of more established firms, spin-outs are more motivated to produce performance.
Spin-outs have long been a feature of the more mature US market, with many of the newly created firms ranking in the top tier.
Kennedy points to Exponent, the four-man spin-out from 3i that recently capped its debut fund at £400m, as a recent European example. Last year Pantheon also backed Altor, a spin-out from prominent Nordic house Industri Kapital. “Good entrepreneurial people will always attract capital, even in a difficult fund-raising environment,” she says. “Both Exponent and Altor were particularly exciting opportunities for us.”
But how does the first-time investor dip a toe into private equity? Wyatt says that these investors tend to stick with local groups in their own countries to begin with. “They prefer to stay in their comfort zone, where they understand the way things work,” she says. “After that they will go for an established pan-European businesses like Bridgepoint Capital, Candover, CinVen or BC Partners.”
This stay-at-home policy is relatively common in Germany, where many institutions are run by family capital offices and invest in local funds because they are familiar with them. However, according to the EIAM Survey, a quarter of all investors – mainly in Germany and the Benelux countries – use funds of funds for the private equity segment of their portfolio.
According to other observers, this seems to be increasingly the pattern for those new to the market. Kennedy says: “Whereas once first-time investors in private equity tended to start looking only in their domestic markets, the new entrants we are seeing now take a far more sophisticated approach, adopting pan-European, or indeed global, strategies. The best means for most of these investors to implement such strategies is via funds of funds. While many of these investors choose a one-stop shop, some make the decision to use specialist funds of funds for the US and Europe.”
Villemoes agrees: “Private equity is an international asset class, and it is important to get a broader diversification.”
Besides the diversification effect of using a fund of funds, Klap considers that it can also be a way to gain insight into private equity investments. He says: “Often investors use funds of funds as a stepping stone to building a direct private equity programme, although they may continue using consultants.”