guest column Europe: Finding the Sweet Spots for U.S. Investors

Europe has traditionally been seen by U.S. investors as a market rich in opportunities. While it remains true that the European private equity market is less mature than in the U.S., the market is becoming increasingly competitive. Operating as a U.S. private equity investor in Europe is complex, requiring an understanding of multiple national markets. Notwithstanding the fact that interesting opportunities for U.S. investors do exist, it is still too early to tell whether the initial U.S. entrants have been successful. This article will address the top questions that U.S. investors contemplating a European investment are posing.

Is there lots of low-hanging fruit for funds has shifted strongly toward how in this issue.) These reforms will prove private equity investors in Europe? to add value to their transactions rather beneficial in the medium term by No, the European private equity market than merely relying on financial engi- increasing deal flow and flow of capital is at least as competitive as the U.S., neering to generate returns. into the asset class, but in the - with more deals conducted by invest- Europe is one market these days, right? term significant differences exist in legislation between countries which will ment bank auction and fewer Wrong. Europe is still a multitude of continue to mean that market dynamics proprietary deals. different country markets each providing differ between states. The last few years have seen a surge differing opportunities and requiring Furthermore, the competitive situa- in European LBO activity. In 2001, local knowledge and networks. tion and key success factors required the value of deals done in Europe out- Europe is not really one market for within each market create different levels stripped the U.S. market for the first private equity, despite the launch of the of opportunity for private equity investors. time. However, despite growing oppor- single currency and growing harmo- For example, the Italian market is much tunities in Europe, the private equity nization of legislation. Opportunities less penetrated by private equity than market has become highly competitive. differ considerably by country, with the comparable countries, but is very diffi- On the one hand, the flow of funds private equity market at varying stages cult for foreign funds to operate in into private equity has risen dramati- of maturity across Europe. part due to the importance of strong cally as institutional investors continue The UK market has traditionally domestic political and business contacts. to increase allocations to private equity. been the most advanced, and Scandinavia, on the other hand, has One result of this is that the market accounted for 50% of all European opened up rapidly to external private has seen major European players, such deals by value 1997-2001. However, equity investors, with external investors’ as Apax, Candover, Doughty Hanson, recent growth has been stronger in share of deals by value rising from 28% and CVC Capital Partners, Germany, and Sweden, and much in 1997 to 61% in 2001. raising billions of dollars for Europe- of the current effort of European The key to operating in Europe is focused funds. private equity investors has shifted to understand that private equity is Added to this has been the growth toward such markets. predominantly a local business. Some in auctions as a means of conducting European governments and the of the larger deals can be conducted acquisitions. Auctions are particularly European commission have realized on a pan-European basis from one prevalent in the UK market. But they are the great potential economic benefits location. But for mid-market deals it is increasingly being used to increase the of private equity. As a result, structural critical to have a local presence, a local efficiency of the acquisition process else- reforms are in progress in the major network, local advisors who understand where. Across Europe, virtually all large markets and at the EU level, for example national and European industry struc- deals are now conducted by auction. Germany’s removal of capital gains tax tures and trends and a familiarity with This has made it harder for private on the sale of shareholdings and recent language, customs and culture – this equity funds to find proprietary deal flow. corporate law reforms in Italy. (See takes time to build. The auction process, often conducted by “German Tax Reform: A Primer for Fund So where’s the angle? the large U.S.-based investment banks, Managers,” The Debevoise & Plimpton has made it very difficult to find deals Private Equity Report, Summer 2001 and Opportunities exist in Europe to create below fair market price, and has pushed “Italian Corporate Law Reform Promises value by restructuring acquisitions. prices up and expected returns down. Friendlier Deal Environment” elsewhere However, this can be difficult to achieve As a result, the focus of private equity given government regulation, employ-

The Debevoise & Plimpton Private Equity Report l Spring 2002 l page 4 ment legislation and union strength Despite the difficulties, there are From 1997-2001 approximately 8% in some countries, and the pool of some examples of U.S. private equity of European private equity deals were European turnaround management investors taking a value-added approach secondary market sales, and this is is small. and successfully improving perform- likely to increase as long as IPO market Compared to the U.S., European labor ance of their acquisitions in Europe. For conditions remain difficult. laws generally afford a far greater example, Texas Pacific Group is in the Are there many privatization degree of employee protection. This process of driving growth and increasing opportunities left? EBITDA ahead of the industry at its UK can be problematic for private equity Interesting state privatization oppor- pub chain, Punch Taverns. funds hoping to create value from tunities still exist; however, networks restructuring their investments. What’s the opportunity for taking public and political connections are key. Legislation differs across Europe. companies private? Following hectic activity in the late One example of legislation making Taking public companies private is a 1990s, the rate of privatization in restructuring very difficult exists in rapidly growing source of deals, with Europe is slowing, with $47 billion France. There, layoffs must follow a the advantage initially of allowing “quasi- raised from privatizations in the EU strict procedure, which takes not less proprietary” deal flow for private equity in 2000 vs. $60 billion in 1999. This than 180 days before they can finally funds. drop can be attributed partly to a be implemented. If changes are made Historically, public to private deals in reduction in the number of assets left to the proposed retrenchments during Europe have been rare given complex to be privatized, but also to unfavor- the period, the 180-day period restarts. legislative requirements and corporate able equity markets that have caused Another problem facing private control rules. But transactions of this states to postpone privatization plans. equity investors in Europe is scarcity of type are growing. European However, attractive opportunities managerial talent available to execute sentiment has moved away from smaller do still exist, particularly in Eastern turnarounds. First, the talent pool is stocks, and this has led to a growing per- Europe and in sectors where liberaliza- small overall, and, second, for any given ception among private equity investors tion is incomplete, such as telecoms deal there exist national, language and that many smaller stocks are under- and energy. And there is evidence that geographic barriers to accessing that valued. This has fueled public-to-private private equity investors will play a bigger talent. Some U.S. investors have resorted transactions, which rose from less than part in privatizations going forward, with to bringing in U.S. management, but 4% of European deals by value in 1997 governments increasingly seeing private there have been high-profile cases where to 20% by 2001. equity as an alternative to the IPO. this has failed to work due to a clash of Public-to-private deals can allow a One of Europe’s high-profile private management styles and culture. private equity investor to understand equity investors, Guy Hands, former When the talent is available, incen- the company better and potentially head of Nomura’s Principal Finance tivizing that talent appropriately can be develop an advantageous relationship Group, has recently set up his own tricky. UK managers typically respond to with an incumbent management team firm, Terra Firma Capital Partners. U.S.-style incentives, like stock options. before they bid, after which manage- Terra’s goal is to invest about 40% of But continental managers do not always. ment is required by law to disclose the its new fund in German government For example, in Germany, management bid and thereby open up the acquisi- privatization projects. tends to put a higher priority on commu- tion to other players. nity standing and cooperation at the The major U.S. private equity players work place than on financial incentives. Are there any interesting exit have already been successful in Europe, Furthermore, some U.S. private equity opportunities? haven’t they? investors have provoked a strong nega- The secondary market (sales of com- It is too early to tell whether any of the tive reaction in the business community panies from one private equity investor major U.S. players have been successful in some countries by announcing U.S.- to another) is providing a greater in the European market, as there have style management compensation opportunity for exit. been few exits. Those that have not yet packages that are viewed as excessive The secondary market provides a entered are behind the game, particu- compared to local norms. growing source of potential exit for larly given barriers to entry. European private equity investors. continued on page 20

The Debevoise & Plimpton Private Equity Report l Spring 2002 l page 5 Sponsored Spin-offs (continued)

is required to file with the SEC on a Form For the Division, the fifth factor erties and management, and includes 10 and provide to the shareholders an ensures that Parent will not be deemed information on executive compensation, information statement, which contains an underwriter engaged in a public employee benefit plans, financial data, essentially the same disclosure as distribution of “restricted securities.” management’s discussion and analysis required for a registration statement on The two-year holding period does not of results of operations and financial Form S-1 under the 33 Act. The fourth apply where Parent formed the sub- condition and historical and pro forma factor – the need for a valid business sidiary being spun off. financial statements. SEC review of a purpose – also addresses the issue of Staff Bulletin No. 4 also confirms Form 10 registration statement is whether the parent company receives that the Division will not require 33 Act substantially similar to that for an S-1. value for the spun-off shares. Examples registration simply because the parent —— of a valid business purpose are allowing company asks its shareholders to vote Structuring the sale of a non-core management of each business to focus on the proposed spin-off. So long as business as a spin-off clearly involves solely on that business, providing there is a valid business purpose for the significant and challenging hurdles employees of each business stock-based spin-off, the Division declared that a and will require close coordination with incentives linked solely to his or her vote on the asset transfer that may be counsel and other advisors; yet it can employer or business’ performance, involved in the spin-off does not change often be the only good way for a corpo- enhancing access to financing by the overall nature of the transaction. rate parent and a prospective private allowing the financial community to Form 10 is used to register the spun- equity investor to tap the pent up value focus separately on each business and off securities under the 34 Act. Much like in an underutilized line of business. enabling the companies to do business an S-1 prospectus, the information state- — Paul S. Bird and Peter F.G. Schuur with each other’s competitors. ment included in the Form 10 describes the spun-off company’s business, prop-

Guest Column (continued)

Many of the major U.S. players such of Ducati and ’s investment do, particularly give barriers to entry as Clayton, Dubilier & Rice, Inc.; Texas in SEAT. However, many U.S. players such as the need to build local net- Pacific Group; have found entering Europe on their own works in European markets. U.S. & Co.; Partners and and expanding across the continent chal- players currently in Europe are trying have entered the lenging. Several, such as Blackstone and to build these networks, for example European market. In most cases, initial Bain Capital, have been in Europe for by recruiting senior advisors such as offices have been set up in the UK. several years but have yet to do many former UK Prime Minister John Major Some are beginning to venture further deals from their European operations. at Carlyle, or senior industry figures as onto the continent. There have been some high-profile investment professionals. A thorough Their presence is reflected in the successes though, such as KKR’s understanding of opportunities within share of European deal value taken by acquisition and subsequent IPO of each market and European industry U.S. investors, which has risen from 4% financial services firm Willis Corroon. trends and structures and the strategic in 1997 to 13% in 2001, with a further 7% But other than that, there have been issues facing particular acquisition share in 2001 accounted for by syndi- very few exits to date by U.S. investors, targets will be critical to success. cates which included U.S. players. U.S. and so it is too early to judge success. — Geoffrey Cullinan, based in London, private equity investors have been Is it too late to get in the game? and Tom Holland, based in San Francisco successful with some European invest- direct Bain & Company’s global private U.S. private equity investors that have ments made from their U.S. operations, equity practice. Simon Baines, a London- not yet entered the European market such as Texas Pacific Group’s acquisition based consultant, assisted with this article. will find themselves behind when they

The Debevoise & Plimpton Private Equity Report l Spring 2002 l page 20