European Private Equity: A Banner Year For Exits – Part 1 by [email protected]

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European private equity firms reported a record exit valuation of 84 billion euros in 2014 from 86 deals, according to a recently released EY study. The twin trends of increased corporate M&A and receptive public markets converged to realize record values for PE investors – a good thing since PE firms have been working off an overhang since the financial crisis. The study said 29 PE-backed firms went public across 10 different stock markets.

EY’s decade-long data showed that acquisitions by PE firms at eight times EBITDA or below would result in higher-than-average returns. However, even those that are much more expensive have shown similar returns. That’s because at higher valuations, PE firms pick higher-quality, higher-growth businesses that retain their value. [email protected] recently spoke with Michael Rogers, EY’s global deputy private equity leader, and Stephen M. Sammut, a senior fellow and lecturer at Wharton, to discuss the findings of the report and prospects for the European PE market.

What follows is an edited version of Part 1 of that conversation.

[email protected]: To begin, may I ask each of you to very briefly explain how private equity in Europe differs from private equity in the U.S.? What are the headline points of comparison?

Michael Rogers: There are a handful of differences in the operating environment that we see. Europe is a little bit more regulated. They have new regulations, including AIFMD [the Alternative Investment Fund Managers Directive], and some other regulations that have been put in place.

We also see that there are changes in terms of the size of deals. There have been a number of larger deals coming out of Europe in recent years but historically, we’ve seen strength in the middle market in Europe, and that really came out in 2014 as well. In the U.S., the big have gotten bigger, and in Europe, we’ve seen the resurgence of the middle market.

I think the secondary buyout market is a little bit different as well. Deals in Europe, they’re different than what they’ve been in the U.S. They’ve lost some popularity in the secondary market from LPs [limited partners] pushing back a little bit. But for the most part, the industry is the same, talking about taking good companies and making them better through balance sheet optimization and improved governance. Not a terribly large number of differences, but there are some unique aspects.

Stephen M. Sammut: I see it, by and large, the same way. Just drilling down a little bit into the structure of the funds and the operation of the funds and the way the funds are staffed: While this still very much is a financial enterprise in Europe, the funds oftentimes are populated with people with somewhat more operating experiences than you find in the United States, which gives them a wider breadth of opportunities to look at in terms of basic businesses, and also the kinds of businesses that are available for acquisition.

Mike, you might have to aid me on this — but I suspect there’s probably more activity in terms of corporate spin-outs, sources for deal opportunities, than there might be in the United States.

Rogers: Yes. I think the carve-out business is thriving in Europe. Also — just from a structural perspective — we do tend to see a lot of the funds operating out of the U.K., and heading to the Continent from the U.K.

“The main thing we saw was that the stronger European economy really led to a lot of the opportunity for exits to happen.” — Michael Rogers

[email protected]: Mike, could you take us briefly through the report’s key findings?

Rogers: It was a very active year, 2014. I think the main thing we saw was that the stronger European economy really led to a lot of the opportunity to get the exits out the door. So we saw record-breaking exits, but at the same time, PE was really demonstrating a lot of discipline in terms of how they approached the market and what they did.

We’ve noted on these calls before that the hold periods extended out, and this was a window of opportunity to allow many of those funds to go to the exit markets and be well-received. It was a very competitive year in the marketplace from [the] PE [perspective], and it just happened to be that the right combination of aspects really opened up the opportunity.

There were 29 IPOs on 10 different exchanges in Europe during this period, which was very strong. Then they [portfolio companies] were faced with corporate buyers: competition was up, so many of the sales ended up in the trade market as well. So those exits were up as well, because corporates in Europe had an appetite for many of the entities that PE was selling.

They [Private Equity] certainly created value for their investors during this period, and were able to roll out — almost 16% of the portfolio’s entry value was exited in 2014, so you can see how strong it was. This was secondary only to 2006. So we worked through a lot of that overhang that we’ve talked about in the past. And new investments were up — a major increase in businesses acquired from corporations, from 24 to 44 during that period. So we’re seeing that active carve-out space. And there were 49 new purchases from PE, so it was very much an opportunity to take advantage of the markets. It allowed for the PE funds to release some of that overhang and find a very, very nice pocket of return for their investors.

[email protected]: Just so everyone knows, the name of the report is “Forging Ahead: How Do Private Equity Investors Create Value? A Study of 2014 European Exits,” and it’s available without a fee from the EY website.

I notice from the report that corporate sales were a big part of the picture, but there weren’t so many corporate buyers. Steve, you were talking about this in terms of how that’s one difference between the U.S. and Europe. Is that what was showing up in the numbers?

Sammut: Well, I think what was showing up in the numbers was that in terms of exit opportunities, that there was perhaps wider international participation, especially from North American corporations seeking to buy European assets from private equity funds.

“It’s certainly a signal that the European market has become attractive to North American corporations, for perhaps a variety of reasons.” — Stephen M. Sammut

[email protected]: More so than would be typical?

Sammut: Based on the report, the way I read it, yes, more so than would be typical.

That may actually be a long-term trend. It’s certainly a signal that the European market has become attractive to North American corporations, for perhaps a variety of reasons. There may be a sense of stability or maturity that’s there.

In terms of participation by existing European companies, what I was referring to was that many of them are restructuring, reconfiguring their operations or deciding to divest certain operating units, and these have found their way into the deal flow of the private equity funds operating in Europe. Whenever this happens, it’s actually a fairly good sign, because

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