Crowding out in Switzerland

Switzerland’s economy may be much smaller than some of its European neighbours. But in recent years, as the crisis has escalated in the Eurozone, its favourable regulatory structure and robust economy have offered an attractive environment for investors seeking refuge from the region’s troubles. 

After a couple of fallow years following the onset of the financial crisis, private equity deals values hit a new high in 2010: $4.47 billion was invested across 12 transactions, according to data provider Dealogic. Last year, activity fell slightly – but there were still 10 deals done, with a total value of over $3 billion. Even as the rest of Europe (and the US) struggled during a turbulent second half of 2011, Switzerland’s relative resilience contributed to it being one of the few European countries to report positive GDP growth in the fourth quarter.

However, despite the growing interest in Switzerland from investors in search of a safe haven, sources tell Private Equity International that it’s becoming harder to get deals done, particularly at the larger end of the market. As of 31 August, the total value of deals in Switzerland so far in 2012 stood at $1.36 billion – well off the pace of 2010 and 2011.

To some extent, Switzerland has become a victim of its own success. The increase in interest has inevitably led to an increase in competition – which drives up prices. And the rapid appreciation of the Swiss franc relative to the US dollar and Euro has also made it much more expensive for non-franc-denominated funds to acquire Swiss companies.

But it’s also just a function of the size of the Swiss market. “Switzerland is a much smaller market than Germany, [so] as a consequence, there are few transactions taking place per year and the number tends to be more volatile,” says Rolf Friedli of Swiss private equity house Capvis. This explains why most GPs typically operate across the German-speaking region. “In this environment, it is difficult for a private equity house to concentrate exclusively on Switzerland.” 

THE BIG DEAL

Pricing has been particularly challenging in the mid- and large-cap segments, sources say. As strategic buyers and international private equity firms have expanded into the region, the number of proprietary deals has been dwindling and the number of auctions rising.  

One large-cap deal that did close this year was Apax’s €1.6 billion deal for Orange Switzerland, a Swiss mobile technology company. Providence Equity Partners and CVC Capital Partners had also reportedly been interested in buying the business. 

Gabriele Cipparrone, who led the deal for Apax, says that the country’s strong economy was one reason why the firm was attracted to the deal in the first place.  

“The macro situation is much better in Switzerland than in other European countries. It’s healthy. … it is affected by the Euro crisis but it … is fairly insulated,” Cipparrone says. “We believe the Swiss market is an attractive market, especially in relative terms with the other European markets.”

Indeed, the overall strength of the Swiss economy is sufficient to justify higher prices and currency risk, he says. 
Apax had developed an interest in the market, and more specifically Orange, through its indirect ownership of Swiss telecommunications provider Sunrise, which had been owned by portfolio company TDC until its sale to CVC in 2010 (Apax retained a stake in TDC). Before Sunrise’s sale to CVC, Apax attempted to orchestrate a separate deal that would have merged Sunrise with Orange – but the proposal was shot down by Swiss regulators, as it would have reduced the country’s mobile telecommunications sector to two players. 

But perhaps counter-intuitively, Cipparrone believes that illustrates how much more relaxed Swiss regulators are relative to those of neighbouring European Union countries. 

“Regulation in Switzerland is more benign than in the EU context. What we tried to do was reduce the number of players from three to two, which was fairly ambitious,” Cipparrone says. “In Europe, we wouldn’t have even tried.”

Beyond a friendlier regulatory regime, firms may also be drawn to Swiss deals based on the comparative ease with which they can obtain deal financing. This time last year, Swiss sources told PEI that the currency situation had contributed to a difficult financing environment, which forced a number of projects to be put on hold. But that situation seems to have improved.

“Especially for funds being outside Switzerland and doing deals here, financing availability and structures, time to implementation, scope and extent of legal documentation and credit agreements are quite different. Doing business is easier when it comes to bank financing than it is in most other European countries,” LGT Capital Partners managing partner Maximilian Broenner says. 

THINKING SMALL

So there are reasons to be positive about the deal market in Switzerland. And its economic fundamentals remain solid: the country was ranked first in the World Economic Forum’s 2011-2012 global competitiveness index, which measures the ease of doing business in different countries. 

However, the appreciation of the Swiss franc is continuing to affect domestic deal activity, sources say – despite the Swiss central bank imposing a hard limit to prevent the euro from falling below 1.20 francs last year.

“I would say that Switzerland has been, activity-wise, slow in the last two or three years – although people thought activity would increase, it was very subdued,” Friedli says. “One of the main reasons was because companies with a strong manufacturing base in Switzerland had to cope with the strong Swiss Franc – and that puts temporary pressure on margins. In the past few years, Swiss companies have adapted well, but it takes time until the margins of affected companies can increase again.”

The added pressure on margins prevents Swiss companies from growing as quickly as investors would hope – which has contributed to some firms holding onto companies for longer, in an effort to wait out the currency issues.
Furthermore, Swiss companies – although generally regarded as being well-run – are constrained by the size of the domestic market, which inhibits expansion. 

“Because our domestic market is relatively small, Swiss companies in general have a history to internationalise in an early phase of the development of a company. This know-how is very important and permits [them] to expand as there are always regions of growth around the world,” Friedli says. 

This may be why the bulk of Switzerland’s domestic deal flow takes place at the smaller end of the market. 
In its second quarter report on M&A activity in Switzerland, Germany and Austria, Ernst & Young indicated that approximately 85 percent of the private equity buyouts in the region are sized at less than €50 million – while buyouts in the mid- and large-cap segments represented only 12 percent and 3 percent respectively.

This meant that in the first half of 2012, small-cap transactions accounted for a higher proportion of deal volume than at any time in the last five years. 

“What happened in the last years is that some of the bigger players started to look at a little bit smaller deals, so there’s increased competition in the Swiss mid-market right now,” says Lars Niggemann of LGT Capital Partners, adding that throughout the market “also smaller deals have become more structured, more auctioned, and in general people are getting increasingly aware that Switzerland is an attractive playground to do business”. 

LOOKING OUTSIDE

As domestic deal flow has tapered off – and become more competitive – observers say that some of the country’s native firms have begun looking beyond the border for new deals. 

LGT, a fund of funds headquartered in Switzerland, has seen several fund managers take that route in an effort to avoid the fray. “We also see many Swiss funds right now looking primarily at deals that have a limited exposure to the Swiss Franc/Euro. Many of them go to Germany to make deals,” Niggemann says. “There are also Swiss players that are exclusively, for the time being, focusing on Germany until this Swiss Franc/Euro issue has a little bit resolved.”

Of course, expanding internationally is part of the natural evolution of some veteran firms; as local fund managers have gained experience in their domestic market, exploration of other similar markets is to be expected. Capvis – which has been named Switzerland’s top private equity firm in PEI’s annual awards for each of the last nine years – acquired a medical pendant company headquartered in Germany in July. Only a month earlier, the firm had announced the addition of Frankfurt-based clothing company Hessnatur to its portfolio. 

The firm’s non-Swiss activity has also led to substantial exits. In early July, the firm sold Wurttembergische Metallwarenfabrik Aktiengesellschaft, a German-based coffee maker producer, to Kohlberg Kravis Roberts for a reported $727 million. Capvis had originally acquired its 52 percent stake in the company for €19.05 per share through its €340 million, 2003-vintage second fund. KKR paid €47 per share – more than twice the original share price. 

Exits such as this are good news for LPs in Swiss or regional funds, who for many years were told to wait and see before making a judgment call on the country’s fund managers, LGT’s Broenner says. 

“Five or 10 years ago, people would say it is too early to tell, wait another five or ten years. And this story is over, because as the European and Swiss PE market is maturing, and you see results that are there, or they’re not there, that scrutiny is being applied to new commitments,” he says. “Either they made money for their investors or they didn’t.”

The divide between winners and losers among fund managers has had obvious ramifications when it comes to fundraising, he says. “This is why you have some firms that are effectively oversubscribed in a few months and others that are fundraising for years.”

In that respect, Swiss-focused GPs face many of the same challenges as EU firms (or those in the US, Asia, or anywhere else for that matter). The private equity boom in the years leading up to the recession allowed for more ample deal flow and higher returns – and faster marketing periods as a result. Now times have changed, the whole process is bound to become much more difficult. 

It’s clear that Switzerland’s GPs have some difficult challenges to confront going forward. With no real sign of a permanent resolution to the eurozone crisis, competition is likely to remain fierce – and the pressure on the franc is likely to endure for another two or three years, sources say, despite the central bank’s best efforts. Until this changes, don’t expect news of attractively priced Swiss buyouts to flow like perfectly melted fondue.

On the other hand, there are reasons for cheer: the economy is still fundamentally in good shape, particularly in relative terms.  So opportunities do still exist – as long as you’re looking in the right place. Friedli, like most of his counterparts in Switzerland, is certainly still optimistic: “We rate it as attractive. And I believe very strongly that activity will increase.”