European PE Breakdown 1Q16 – An Increasingly Complex Investment Scene by PitchBook
An increasingly complex investment scene
Introduction
In the last edition of this report, released in January—devoted solely to analyzing European PE activity in terms of leveraged buyouts, growth, recapitalizations and more—we stated that the European investment scene was only growing more complex. Since then, that complexity has scarcely abated. If anything, it has only intensified. Setting aside the effects of ongoing political concerns centered on the refugee crisis or terrorism, there remain more than enough variables for investors to consider. The specter of Brexit and its accompanying regulatory and currency risks are certainly depressing PE investment prospects in the United Kingdom & Ireland, Europe’s most active PE market. Norway’s offshore operations are still suffering. Germany’s exports may have recently strengthened, but such strength will need to be sustained to translate into investor-encouraging growth forecasts. The European Central Bank’s continued quantitative easing seem to exhibit diminishing returns, with inflation remaining stubbornly low. In fact, current monetary policies are exerting pressure on banks’ profitability, even as some still grapple with the aftereffects of the financial crisis, as evidenced by Italy’s new state-sponsored fund looking to take on the burden of bundles of bad loans.
All in all, there are plenty of pessimistic or uncertain indicators to give pause. But as in any complex environment, pockets of promise remain. Banks are still deleveraging in the post-Basel III era, leading the way for alternate, direct lenders to step in. Firms with strong track records in particular niches or the resources to develop robust investment theses for operational enhancements—the most important lever for value creation in the current environment—will still be able to close deals. In short, there remain incentives and opportunities to deploy the ample amounts of capital hoarded in PE coffers currently; they will simply remain more difficult to navigate than they were in the preceding years.
Garrett James Black
Senior Analyst
European PE – A slow start
Overview
European PE deal flow fell by a considerable amount in the first quarter of 2016. Even if these figures are revised up by a small margin as more data trickles in, the volume of deal flow slid by 21.7% relative to 4Q 2015, while overall value plunged by a staggering 40.8%. It’s clear the unfortunate circumstances the continent faced to start 2016 were more than enough to dissuade PE investors from maintaining the pace seen throughout 2014 and 2015.
Not even the overabundance of dry powder, nor the growing acceptance and usage of direct lending—which makes sense in light of banks’ ongoing troubles—could help soften the impact of growing investor risk aversion. In short, a return to the levels of investment seen in 2012 and 2013 seems likeliest, as PE firms still grapple with relatively higher valuations and tougher growth prospects. Opportunities still exist for shrewd investors to deploy capital, of course, it’s simply that disparities still exist between buyers and sellers, with owners of top-tier assets all too aware of their privileged position.
Competition from strategic buyers mustn’t be discounted as well. Meanwhile, the loan market will continue to be transformed by the emergence of direct lending as a palatable alternative to banks’ dominance, encouraging PE funds to begin making inroads into becoming private debt providers to European mid-market enterprises. In short, the European investment scene is only growing more complex to navigate, which will lead to deal flow either sliding lower in future or at least plateauing to a subdued rate.
Growing disparity in the market as risk aversion rises
Deals by sector & size
Amid a slump, it’s interesting to note that a flight to quality has resulted in the lower and upper middle ends of the market—in terms of deal size—proving the most resilient. Unsurprisingly, the smallest size range has accounted for the most deals thus far, with the attraction of bolt-ons helping prop up the flow of investments. At the same time, PE investors are still cutting deals with fairly hefty price tags, exhibiting a willingness to pay up when justifiable. Deals like the acquisition of Saverglass by The Carlyle Group or EQT’s investment in Piab, however hefty, will still close given not only the caliber and resources of the buyer but also the nature of the target company. It’s probable that as European activity remains subdued there will be further concentration of buyouts at the lower end of the market, as well as a consistent trickle of higher-valued deals when buyers find reason to spend considerably. The spate of Eur 2.5 billion+ deals seen in the past couple years is unlikely, barring some considerable divestitures.
Spotlight: Nordics
Overview of PE activity in the Nordic region
At 58 closed investments for an aggregate of Eur 7.4 billion in value, Nordic PE deal flow is down from the past several quarters. The ongoing rout in Norway’s high-yield debt market given persistently low oil prices is a troubled patch amid wider unease, helping exacerbate general turbulence, although it’s worth noting there is some degree of currency shielding. Meanwhile, relatively higher valuations and ample dry powder are still driving elevated rates of bolt-ons, as PE firms seek to source among the lower end of private market companies. Continued interest from U.S. PE firms—with 74.1% of deals thus far in 2016 garnering U.S. participation—has doubtless helped soften the downturn in activity thus far in the year, although subdued investment going forward is likely.
Down, yet likely not out
European PE Exits
In the wake of a blockbuster 2015, European PE-backed exits were almost bound to underwhelm, if only due to timing. Even accounting for the impact of seasonality, exits haven’t been this low in volume and value since the same period two years ago. The effects of volatility as well as macro concerns were certainly felt, with corporate acquirers in particular dialing back their pace. However, with the overall environment favoring stock buybacks and acquisitions, M&A of PE-backed holdings could pick up once more, particularly if Chinese multinationals look to Eurozone businesses for purposes of becoming globally competitive. As for sponsor-to sponsor transactions, at this point, questions of quality become ever more paramount.
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