Print | Share | Reprint

The downstroke of PE in France

by David Carey | Published February 17, 2012 at 12:00 PM

Imported from America and Britain, the leveraged buyout entered the French financial universe in the mid-1980s and over time became a mainstay of Gallic high finance. To the chagrin of linguistic purists, an Anglo-inflected tide of terms and acronyms like "junk bond" and "LBO" swept into the lexicon. In the ensuing years, the trajectories and traits of the French and the American buyout markets have largely mimicked each other, from their cyclical peaks and valleys to the divided views on the part of the public toward the phenomenon of leveraged buyouts.

But today, say most private equity specialists, the two markets are headed in different directions. While American private equity is perking up, France is in a deepening funk.

It is hardly alone. Like much of Europe, its economy has been rocked by the euro crisis, with close to zero growth expected this year. But France has weaknesses of its own. Inflexible work rules and barriers to streamlining companies' operations and workforces contribute to soaring unemployment, now 9.9%, a 12-year high, and make it harder for French industry to compete. France recently lost its triple-A credit rating and must prune government spending.

Unlike the U.S., France's capital markets have not rallied back from the autumn swoon set off by Greece's woes. While the CAC 40, France's leading stock index, is up nearly 7% so far this year, that gain pales beside last year's 17% drop. The European junk bond market, dead for months, tentatively flickered back to life in January. But several big French banks, their books freighted with rickety sovereign debt, have cut lending to LBOs.

French buyout houses are pressured on several fronts. "If you do LBOs, and the 'L' is not available, you're in trouble," remarks Antoine Dréan, CEO of the Paris-based fundraising group Triago. "That's what is happening today on the buy side and the sell side. You also need credit available for there to be sales."

Buyout specialists worry that asset values, which have stayed high, will plummet if the credit crunch and economic gloom persist. While that would make new deals cheaper, it also would shrink values of firms' existing investments, threatening back-end returns.

Against that backdrop, a handful of firms, including London-based CVC Capital Partners Ltd. and U.S. buyout giant TPG Capital, have trimmed staff in Paris or other European cities. Vestar Capital Partners, a New York middle-market player that had maintained a base in Paris since 2000 and had offices in Milan and Munich, decamped from Europe at the end of last year to focus on its home market.

But most in Paris' private equity set are sticking it out. Many, such as Sébastien Bazin, a Frenchman who, from an office just off the Champs-Elysées, steers European operations for Los Angeles-based Colony Capital LLC, are bracing for a rough ride: "When you buy something today, you have to price in two years of misery in front of you."

At the same time, he and others observe that turmoil breeds opportunities in spades. "You just have to be more prudent, more disciplined than ever," he says.

Until the 2008-'09 financial crisis, French private equity largely enjoyed a charmed life. France, Europe's second-largest economy, measured by nominal gross domestic product, after Germany, and its second most active private equity market after Britain, long yielded plusher average returns on LBOs than the U.S. The reason: a paucity of competitors. For years, a tiny circle of sponsors chased a wealth of inviting targets in the immature French market, an imbalance that lifted profits. In the mid-1980s, while Kohlberg Kravis Roberts & Co. LP was making waves in America with multibillion-dollar takeovers, private equity was still getting off the ground in France. Pathbreakers like LBO France, founded in 1985, and the investment unit at Banque Paribas SA, a prominent French bank, quietly set about to stage small-scale buyouts of closely held, midmarket businesses and of castoff corporate divisions. France had a rich supply of family-owned enterprises, which started turning to private equity to fund expansion or to monetize the founders' fortunes.

Competition stepped up in the late 1980s and early 1990s when, smelling opportunity across the Channel, London buyout shops moved in. BC Partners Ltd., Barclays Private Equity Ltd., Cinven Ltd., Bridgepoint Capital Ltd. and Montagu Private Equity LLP all opened offices within walking distance of the Champs-Elysées. The Americans arrived in 1996 and 1997, with Washington-based Carlyle Group and then Colony settling in. Carlyle's Paris outpost was its first in Europe, and both firms' Paris offices would soon become hubs of their European activities. In their wake other leading U.S. players set up small satellite offices in the city while orchestrating most French deals from London. By the late '90s, the elite powers of the buyout world had trained their sights on France.

Not that France back then reciprocated the attention. In 1999, Lionel Zinsou, now the CEO of PAI Partners SAS, France's second-largest PE investor, worked at Rothschild as a private equity banker. That summer, after having helped a Dallas buyout firm, Hicks Muse Tate & Furst, buy two of France's most popular champagne brands, G.H. Mumm and Perrier-Jouët, from Seagram Co. Ltd., he escorted the firm's John Muse around Paris and to the Champagne region to introduce him to union leaders, power brokers and politicians.

"I remember it well. No one had ever heard of him or of Tom Hicks. They'd ask: 'What is a private equity fund?' The unions and even Seagram were not very clear what private equity was. To the French, private equity was something very American, very strange," Zinsou says.

Their ignorance would soon vanish. In the early 2000s institutional money began to flood into the country, junk bond financing for bigger deals revved up, and French banks such as BNP Paribas SA and Société Générale SA and non-French rivals like Royal Bank of Scotland Group plc and ING Groep NV competed to offer masses of low-cost loans. Starting in 2002 with KKR and French holding company Wendel Investissement SA's €3.6 billion ($3.5 billion at the time) buyout of plug and switch maker Legrand SA--the biggest European buyout up to that time -- the market was off and running. Over the next five years, France turned torrid, with LBO volume peaking at $33.4 billion in 2006 and hitting $23.6 billion in 2007, a little more than half the U.K.'s total in those years, according to the research firm Preqin Ltd. The biggest French buyouts of the boom era, including those of broadcast tower operator TDF SAS, electronics distributor Rexel SA and Yellow Pages publisher PagesJaunes Groupe, were $3 billion to $5 billion in size. This was much smaller than the gargantuan prices of some U.S. buyouts. But in both markets, as well as in the U.K., a combination of fierce competition, unfettered lending and soaring prices spawned an unsustainable market bubble that finally, painfully burst.

France during this time stood out in one important respect: the crazed intensity of the battle to buy assets. In France, the wild free-for-all reached the point that buyout houses often would race to make pre-emptive offers for targets at the start of an auction while forgoing the usual due diligence. Recalls one dealmaker: "It was called vendor's due diligence. The target's auditors, lawyers and banker would pull together the financial data and say: 'Don't bother with due diligence. We've made it easy for you. Come and get it!' "

Very often, that banker was Laurent Baril, Zinsou's former Rothschild colleague. By 2004 Baril had emerged as the show's ringmaster, the go-to guy for private equity firms looking to buy or dump. Though it was risky for bidders not to take time to vet the numbers, many targets were well-known quantities, having been auctioned off one or two times before. Too, bidders were frantic to gain an edge. This behavior was less common in the rest of Europe.

Adding fuel to the frenzy was the fact that, more than in the U.S. and other European markets, France had a severe imbalance in deal supply and demand -- opposite to the imbalance of the '90s that benefited buyers. Now there were too few targets to absorb all the money raised to do large-capitalization deals. In part, this was due to the fact that opportunities to do large take-private buyouts in France, a major source of large-cap dealflow in the U.S., were limited. France does not offer buyers an easy squeeze-out procedure that forces minority shareholders to sell to an acquirer after the majority of shareholders have approved a deal. Consequently, most big-ticket buyouts in France are of operations shed by large corporations, or of businesses unloaded by other private equity firms -- deals known as secondary buyouts.

What's more, top-end players had way too much money to deploy to focus on the middle market and its store of family-owned enterprises, which historically had yielded the best returns. They had to think big.

This wasn't a problem early in the last decade. Coming out of the 2001-'02 recession, many European conglomerates needed to raise cash to cut debt and were keen to sell divisions. That's how KKR and Wendel were able to snap up Lagrand at a low valuation. But when conglomerates' profits swelled as the decade wore on, that sort of dealflow dwindled dramatically. By the middle of the decade, large buyout players were increasingly forced to buy from each other, and secondaries came to command the high-end action. In 2006, in Charterhouse Capital Partners LLP's €3.5 billion deal for footwear and apparel retailer Vivarte SA and in TDF's €3.3 billion pickup by TPG and the PE unit of giant French insurer and money manager AXA SA, buyout firms were the sellers. Tertiary and quaternary buyouts weren't unheard-of: Cinven's €900 million buyout of plastic pipe retailer Frans Bonhomme SA in late 2005 was the fourth LBO of the target in 10 years. The seller was Apax Partners LLP, which had bought Frans Bonhomme for €520 million only two years earlier from none other than Cinven.

"It was a game of musical chairs," says Robert Rosner, who led Vestar's European business until the firm's recent pullout. "I moved to Paris at the end of 2000. By 2008, I was seeing companies come up for sale for the third time. The names were no longer new to me." In 2007, secondaries accounted for 53% of LBO volume in France, versus a 25% rate in the U.K. and 6% in the U.S., according to Preqin.

Rosner explains how the French landscape changed, from largely virgin territory favoring buyers in the late '90s and early 2000s. Even the first spate of secondary sales yielded good results for sellers and buyers alike. "From 2001 to 2003, first-time buyouts were being done by new market entrants at low prices, and those deals did well. France had a great run."

Five years later, he says, "the market flip-flopped, and it became a seller-advantaged market."

The boom's collapse inflicted considerable damage on the French buyout industry. A string of medium-sized private equity-backed companies such as roofing materials maker Monier Group Services GmbH and bottle maker SGD Groupe ran aground and fell into creditors' hands; others, like building materials companies Materis, owned by Wendel, and Terreal SA, controlled by LBO France, are troubled.

So far, while the very largest LBO targets acquired at the market peak have escaped insolvency or bankruptcy, some skirt the edge. TDF as well as KKR- and Goldman, Sachs & Co.-backed PagesJaunes struggle under towering debt loads, the sponsors' equity worth a fraction of original cost. In addition, two high-profile minority investments that PE firms made in pillars of the CAC 40 -- Carrefour SA, France's biggest retailer, of which Colony Capital and luxury-goods titan Bernard Arnault jointly hold 16%, and the construction materials producer Saint-Gobain SA, 18% owned by Wendel -- are underwater. Carrefour's persistent woes and management turnover lately have been front and center in the French press. As for Saint-Gobain, the stock has dropped from around €75 to €36 since late 2007, when Wendel began to amass a €5.5 billion stake. Margin loans have magnified Wendel's loss.

Though the financial crisis didn't topple any prominent French private equity firms, as it did Candover Partners Ltd. in the U.K., there were aftershocks. At PAI Partners, a well-publicized face-off between the firm and its largest limited partner and former parent, BNP Paribas, over its soured investment in Monier caused strife among partners and ill will among LPs. Top partners were pushed out, and the firm's €5.4 billion buyout fund was cut in half to free LPs wanting out from commitments.

The full repercussions of the crisis and, in particular, its impact on France's private equity capital base have yet to be seen. A broad rollback in the industry's funding may be in the offing. Several big players, PAI and LBO France among them, will soon seek to freshen their coffers as the investment periods on their current funds run out. Firms with lackluster records may find themselves shut out by unhappy investors and forced to wind down. Even if French private equity doesn't undergo a massive pruning, as many expect in the U.S., there clearly will be casualties.

Even top-flight performers will have to work hard to meet the funding levels they achieved in the past. Up to now, European banks and insurance companies had accounted for nearly 40% of the money pledged to French private equity, according to the Association Française des Investisseurs en Capitale, or AFIC, the French private equity trade association.

But that font of funds will run dry once Basel III regulations, intended to strengthen European bank balance sheets, kick in, together with a new regulatory regime for insurers called Solvency II. Banks already are preparing for Basel III's arrival by dumping PE assets and swearing off new commitments.

"I'm very pessimistic about the fundraising side of our business because of Basel III," says Louis Godron, a partner at the middle-market buyout firm Argos Soditic and senior official of AFIC.

"Not just equity will be hit," Godron adds. "Basel III will also put a lot of stress on lending, especially to midsized businesses."

For now, the biggest question firms confront is how to deploy money in a straitened, tight-credit economy. Many European and American investment shops, not surprisingly, are looking hard at distressed debt. Seasoned vulture investors such as Apollo Global Management LLC and Oaktree Capital Management LP reportedly are primed for a coming surge in troubled corporate loans cast off by European banks.

In France, though, distressed plays have a thin history, and for good reason: the hurdles investors face trying to take title to ailing companies whose debt they own. French law makes it considerably tougher than in the U.S. and the U.K. to pull off restructuring in which debtholders wrest ownership by swapping their debt for equity. That's because under the French bankruptcy process, called sauvegarde, owners' interests are safeguarded and lenders have limited clout. Says Zinsou: "The courts tend to postpone a resolution to give more flexibility and time to companies, delaying what lenders can do for months or years."

Even so, U.S.-style debt-into-equity conversions have occurred. In 2007, Miami-based H.I.G. Capital LLC laid claim to marketer Diam Europe in this way; three years later, Oaktree achieved a debt-swap takeover of bottle maker SGD. Late last year U.S. hedge funds Silver Point Capital LP and Tennenbaum Capital Partners LLC and giant debt fund manager Pacific Investment Management Co. LLC used the technique to capture Groupe Novasep SAS, a provider of chemical synthesis services. In all three instances, the parties skirted the sauvegarde process to negotiate a change in control.

Restructuring specialist Douglas Rosefsky, a managing director at Alvarez & Marsal France, says he expects to see more such deals as investment houses learn the game's fine points: "You have to know how to use the different negotiation processes of the French system, out of court or in court. It also depends on the situation. Is there a need for new money? Are the existing sponsors willing to put in new money? Are the banks interested in taking ownership?" says Rosefsky.

"France reminds me of the U.S. in 1995, when banks and funds were gaining sophistication in distressed investing. France is opening up."

The same cannot be said of France's buyout market. Nor is that market hermetically shut, as it was from late 2008 into early 2010. For the moment, the door to doing deals is ajar.

French buyouts enjoyed a months-long renaissance from the second quarter of 2010 through last summer, as European economies revived and the credit market emerged from hibernation. Buyout shops jumped at the chance to sell and buy. BC Partners, Bridgepoint, PAI and Carlyle all scored sizable profits offloading or taking public some of their choicer French holdings. On the buy side, France's private equity deal volume was $9.8 billion in 2010 and reached $19.5 billion in 2011, the highest since 2007, according to Preqin.

Even so, debt financing was hard to come by during the reawakening, requiring sponsors to cough up most of the deal value. Carlyle's €490 million purchase of boiler maker Giannoni SA, for example, was funded 50% with equity. And Bridgepoint's 2011 acquisitions of Infront Sports & Media AG, property manager Foncia Groupe SA and healthcare services provider Groupe Médipôle Sud Santé were financed predominantly with equity.

The global panic over European sovereign debt halted leveraged finance for a spell, though credit loosened somewhat in January. Nevertheless, banks are finicky, offering up to 3.5 turns of Ebitda for buyouts of strong cash generators, while balking at financing buyouts in the flagging retail and consumer products sectors. What's more, as in 2005-2008, buy-side demand for larger LBOs has outstripped supply, keeping prices high.

Notwithstanding present-day woes, fund managers voice optimism for their industry's future. To a man, they believe the euro zone will survive, the economic gloom eventually will lift and French PE will produce generous returns.

Indeed, the prospect for buyout returns represents the flip side to Godron's downbeat views on fundraising: "There will be much less domestic money for our private equity funds" owing to Basel III, he says. However, curtailed bank lending is sure to stoke demand for PE from midcap companies that need capital.

Thanks to that dynamic, Godron reasons, "[deal] prices will go down, and private equity returns will go up dramatically. I can't imagine a scenario where returns will go down given the greater demand for equity. It will be a great time to invest in our country."

Carlyle managing director Benoît Colas draws a parallel to an earlier era: "We did some great deals between 2002 and 2004," he recalls. There was a recession on, financing was scarce. The harsh conditions enabled Carlyle to snare businesses divested by conglomerates on the cheap -- deals on which Carlyle made over 4 times its money.

Today as then, "I think we'll see prices go down. We'll be able to buy good businesses at low multiples, with not too much debt," he says. "Time will tell, but we hope we'll be able to look back and say, 'Man, those were great deals we did in 2011 and 2012.' "

Share:

Tags: France | Kohlberg Kravis Roberts & Co. LP | PE

Private Equity

The downstroke of PE in France

Free preview

Meet the journalists

David Carey

Senior writer, private equity

Movers & Shakers

Video

Coming back for more

Sectors