Hard to credit

A painful debt hangover continues to hamper Spain’s and Portugal’s economic recovery, not to mention the banks’ willingness to lend. But the turbulence is also throwing up opportunities from distressed sellers and previously reluctant family-owned companies, reports Nicholas Donato

A casual visitor to Madrid could be forgiven for failing to appreciate the seriousness of Spain’s current economic struggles. When Private Equity International took a trip to the city in September, bustling cafés were serving up morning coffee and pastries to business types, while tourists poured in and out of museums and legions of shoppers enjoyed the sunny weather in the city’s outdoor markets.

However, locals told PEI that much of this activity is “B-money” – underground trade evading official GDP calculations. Perhaps that’s why Spain’s projected economic growth looks so dismal: GDP is forecast to climb just 0.8 percent in 2011 and 1.6 percent in 2012, according to International Monetary Fund estimates. Neighbouring Portugal is likely to fare even worse: the Bank of Portugal expects national GDP to contract 2 percent in 2011 and another 1.8 percent the following year. 

Madrid is bustling despite economic struggles

For private equity houses operating in Iberia, this sluggish growth has made an obvious impact. A meagre €897 million was raised by Spain-focused funds in 2010. That’s roughly on par with the  lacklustre 2009 fundraising period, according to stats from the Spanish private equity association, Asociación Española de Entidades de Capital Riesgo (ASCRI). But it’s barely a fifth of the €4.3 billion raised by domestic funds in 2007, before the financial crisis.

Limited visibility on growth is the fundamental reason LPs are shying from new commitments in Iberia-focused funds, sources agree. “It’s hard to predict where the economy might go a few months from now let alone years,” says ASCRI chairwoman Maite Ballester, who is also managing director of listed private equity firm 3i’s Spanish operations. 


The root of the problem is a prolonged deleveraging process which is likely to stunt Spain’s growth over the coming years, a recent McKinsey Global Institute study suggests. Joining the Euro in 1999 stabilised the region’s high and volatile interest rates, opening billions in new lines of credit – which eventually led to a real estate crash. Government spending could help cushion the landing – but it would also increase borrowing, extending the amount of time needed to absorb the debt consumed during the boom years, McKinsey argues. 

Spain’s government seems to be embracing the opposite approach. In early September a constitutional amendment was agreed by Spain’s major political parties to cap the structural deficit at 0.4 percent of annual gross domestic product from 2020. Spain’s right-wing Popular Party (PP), which polls predict to gain control of the government when elections are held on November 20, has also vowed to introduce further debt-reduction initiatives – resulting in a quicker, but more painful, deleveraging process (see boxout, p. 53).

For Spain’s fund managers, one result of this stalled growth will be a smaller universe of domestic LPs from whom to seek commitments.  Spain’s numerous mid-size savings banks, or cajas – historically significant sources of capital for Spanish GPs – were heavily exposed to the housing and construction bust in the late 2000s and are now pulling in their horns to shore up capital, say sources. 

There is an upside to this: banks with wobbly balance sheets are more willing to negotiate with private equity-backed companies struggling to meet their debt repayment plans, says Javier Amantegui, a partner in law firm Clifford Chance’s Madrid office. Eager to avoid Spain’s notorious drawn-out insolvency process, both cajas and their larger banking counterparts are agreeing to restructure company debt in exchange for equity cures by their private equity sponsor. 

However, unfortunately that’s not true across the board. Some financial sponsors and their lenders are failing to reach agreements on debt restructurings, in “many cases [due to a] lack of common understanding regarding the distribution of the value to be created at the portfolio companies following the restructuring”, says Amantegui – as a result of which, the GP has had to hand over the keys of the company in question to the bank. Notable examples include Apax’s loss of Iberian bakery company Panrico in late 2010, and Cinven’s write-off of Spanish hospital company USP Hospitales in 2009.

More defaults are likely to follow. At the top of the market, in 2008, corporate debt in Spain stood at a whopping 136 percent of gross domestic product. That’s higher than any other country studied by McKinsey in its 2010 Global Institute study.  


But it’s not all doom and gloom. Since the banks have little interest in managing a portfolio company, these situations can become attractive opportunities for private equity bidders to negotiate favourable equity-for-debt swaps, says Amantegui.  Sources have told PEI that Barclays and Royal Bank of Scotland intend on marketing their majority stake of USP Hospitales; while Madrid-based supermarket chain Dinosol will be sold by a consortium of lenders after it was seized from UK private equity firm Permira earlier this year.  

The more likely scenario is that Spanish GPs will raise smaller funds and reduce the size of their deal teams.

Maite Ballaster

Equally, private equity investment levels in the region are still strong. In 2010, firms poured €3.4 billion of investment into the country, a 117 percent increase from 2009 levels. Despite the relatively low levels of recent fundraising (see chart), both Spanish GPs and pan-European funds with allocation targets for Spain are sitting on a wave of foreign capital committed to Spain during the boom years; much of this must be deployed soon in order to meet investment deadlines.

Will the difficult fundraising climate ultimately lead to a GP shakeout in Iberia? Ballester admits this is feasible – but she believes “the more likely scenario is that Spanish GPs will raise smaller funds and reduce the size of their deal teams.”

Generally speaking debt financing is scarcer and spreads are more expensive, says Eric Halverson of Qualitas Private Equity, an Iberian-based private equity house: “Even for quality deals the debt multiples will not go much further than 4x” – probably resulting in lower returns for many Spanish funds on new deals. 

But although bank loans aren’t easy to come by, Iberian GPs are still finding ways to get promising deals done, says one Madrid-based GP. Just like buyout firms in other countries, “Iberian firms are bumping up the level of equity in deals to 50 percent, pursuing mezzanine financing or high-yield bonds and conceding greater guarantees in their loan documentation,” he says.

Vendor loans, in which a seller helps finance their own buy-out, are also becoming a common strategy for bidders, says Javier Loizaga, head of Spanish firm Mercapital. 


A consistent way to grab the attention of banks and other creditors is to take Spanish gems and expand their businesses into more promising geographies, according to multiple sources in Iberia. “If you go to LPs and show them a Spanish business whose revenues are dependent on Spanish consumers, you can forget about seeing any smiling faces,” says Carlo Bonomi of Investindustrial, a Southern Europe-focused private equity firm. Earlier this year the firm purchased TSC, a Spanish ambulance operator, with the intention of broadening its service capacity across Europe and beyond, Bonomi told PEI.  

Cultural connections with a burgeoning Latin America can also fuel expansion, says Mercapital’s Loizaga. “Not only do Spain and Latin America share a similar culture and language, but a lot of countries in the region are seeing an expansion similar to the one that Spain had until recently.” Last year the firm opened an office in Brazil to scout mergers for its Spanish portfolio companies; it intends to cut the ribbon on another South America office later this year. 

Yet for all the promise of foreign markets Spanish GPs must first identify a management team capable of the task. In Spain, much of the deal opportunity lies within family-owned companies, which constitute a significant share of the country’s small- and medium-sized enterprises. Compared to other western European countries, Spanish family businesses are less able to meet the challenges of a business past a certain growth point, says Investindustrial’s Bonomi. 

This may become more of an issue as more family-owned businesses consider private equity offers, in the hope of expanding their company’s revenues to new territories. Until recently, many of these companies refused to even consider an offer from a financial sponsor. And for a 10 to 15 year period prior to the downturn, these businesses accumulated strong nest-eggs of capital which has seen them through the recession, says one Madrid-based GP. “But as the recession continues, these cash reserves can only last for so long – they too will have to adapt,” he added. 

Adaptation, it seems, is the key to taking the Iberian private equity market to its next stage of evolution. Smaller deals, completed with more equity, for companies that can expand into new geographies, can still provide GPs in the region with good returns. So let’s not write the region off yet. After all, as Bonomi says, Spain alone is “Europe’s fifth largest economy… It would be foolish to ignore this market”. 


If the conservative People's Party succeeds in removing the ruling Socialists, Spain’s private equity community is hoping for a more business-friendly government. 

Bloated public spending, overgenerous entitlement programs and inflexible labour laws promoted by the incumbent Socialist party, critics say, are partly to blame for Spain’s current sovereign debt woes. With its pledges to cut taxes and privatise state assets, the right-wing Popular Party (PP) seems to be capitalising on the Spanish public’s desire for change. 

A lot of [private equity] houses are in ‘wait and see’ mode.

Juan Picon

If predictions of a large conservative win on 20 November prove accurate – a poll in early September by Spanish daily El Mundo suggested the PP would capture  47 percent of the vote, compared to 32 percent for the Socialists – the country’s private equity industry is expected to benefit. “The PP has vowed tougher measures to cut the debt and continued privatisation of public assets – both of which would encourage M&A activity,” said Juan Picon, a lawyer in DLA Piper’s Madrid office. 

The wheels are already moving: In addition to plans to cap future deficits the government is in the process of selling state-owned airports and a lottery business, all of which will further nourish Spain’s private sector. 
Mariano Rajoy, the PP’s leader, has also pledged to introduce labour reforms and an entrepreneurial bill to spark job creation, should his party win power.  “Tax incentives for small and medium businesses and more liquid labour markets will be a boost for Spain’s private equity houses,” says Picon. 

But the greatest benefit from the election will be increased political certainty, says one Madrid-based fund manager. “A lot of [private equity] houses are in ‘wait and see’ mode. Deals in the pipeline are waiting until after the elections so there is less uncertainty as to what ideas or policy changes will be brought forward.”