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Silver linings

The Iberian private equity market was fast establishing itself as a part of the European mainstream when the clouds of the credit crunch started to gather. Toby Mitchenall reports on whether it has the strength which might see it through

In 2006 the European Private Equity and Venture Capital Association (EVCA) was chaired by a Spanish national. Chairman of Mercapital, Javier Loizaga, dismisses the suggestion that this reflected the Iberian private equity market coming of age. He does, however, concede it was at about this time that the region entered what could be described as the European mainstream.

Data from the Spanish private equity association, Asociación Española de Entidades de Capital Riesgo (ASCRI), shows that 2007, despite the latter half of the year's credit market constraints, was a bumper year. “All the variables involved in the business hit record levels,”proclaims ASCRI chairman, Jaime Hernández-Soto, in his introduction to the trade body's 2007 review.

Fundraising was up by 34 percent to around €5.2 billion, while the amount of capital put to work in Spain during 2007 hit €4.3 billion – up 39 percent from 2006. To put this in context, Germany saw capital invested of €4.1 billion over the same period, while the UK saw €12 billion.

DEAL DURABILITY
While a record 2007 may not come as a surprise to anyone – almost all private equity markets around the world could boast the same – it is worth noting that deal volumes in the first half of 2008 did not drop off a cliff. While deal values shrank, the number of deals done increased by 16 percent. “It is very well segmented by size, and with a well developed midmarket, says Loizaga of the Spanish private equity scene.

Pan-European firm Doughty Hanson has been present in Madrid since 2006. Francisco Churtichaga, who heads up the firm's Spanish operations, describes Spain as having been a “big bright star”among European private equity markets recently. During 2007 alone, 20 new firms opened in the country, bringing the total number to 162.

Unlike in some parts of Europe, Iberia currently seems to view private equity favourably. “It is very well received by the public and the regulator, probably because we have had fewer large deals with syndicates and potential conflicts,”continues Loizaga.

Spanish firm Mercapital has been investing in the Iberian mid-market since 1986. 2006 and 2007 were slow years for the firm, which is now investing its eighth and ninth funds, in terms of acquisitions: it made one investment in 2006 and none the year after.

During this period Mercapital was in exit mode, as high price expectations ruled the firm out of most of the deals in which it was interested. By contrast, in 2008 the firm has made five investments: three for its €550 million mid-market buyout fund and two for its €400 million minority investments fund.

STILL YOUNG
As a proportion of GDP, Iberian private equity has some way to go before it reaches the same levels of its more mature European neighbours. Private equity investment in Spain constituted just 0.291 percent of the country's GDP last year, while in Portugal the corresponding figure is just 0.097 percent. The European average is 0.584 percent.

But this means room for growth. Legal reforms over the last few years have fostered increased private equity activity and look set to drive growth in the future. In the EVCA's recent benchmarking study, which rates jurisdictions in terms of how much the tax and legislative regimes encourage private equity, Spain and Portugal rank sixth and eighth respectively out of the 27 countries included.

Spain in particular has undergone a number of regulatory changes in the last few years to direct more Spanish institutional money into the asset class. Only since July 2007 have insurance companies been able to invest in private equity, and pension funds were, until last year, heavily restricted in terms of how much they could invest and what exactly they could invest in. In the words of one LP, “the law made it difficult but not impossible”.

GOOD LAWS
One such restriction – now lifted – required that assets held as part of a pension portfolio be “freely transferable”, a description not readily applicable to LP commitments. “The law in Spain is amongst the best in Europe: good for carry and good for institutions,”says Loizaga.

As a new member of private equity's European mainstream, Spain has been subject to the same pattern of reduced exit opportunities and debt deprivation as elsewhere in the world.

“During the ‘credit fiesta’, private equity houses were dominant, but the corporates are once again in a better position to acquire,”says Carlos Pazos, managing partner of law firm SJ Berwin, in Madrid. An illustration of Pazos' point would be Doughty Hanson's attempted acquisition of transport group Seura in August. Doughty Hanson, which typically makes investments at the upper end of the mid-market, had to make do with a €1 million break-up fee after its €500 million bid for 52 percent of the company was matched by minority shareholder Geopost, a French-owned international delivery conglomerate.

3i executed a rare secondary buyout in August, proving that private equity buyers have not been totally sidelined. It bought 75 percent of funeral chain Mémora Inversiones Funerarias, which operates across Spain and Portugal, from Spanish conglomerate Accion, in a deal that valued the asset at €330 million.

Trust in the public markets is shot, and whereas before investors would seek safety in blue-chip stocks, now they are more likely to seek safety in blue-chip private equity funds

Carlos Pazos

Aside from the thwarted bid for Seura, Doughty Hanson has been active in developing its current portfolio companies, having made three bolt-on acquisitions for Spanish bus operator Avanza.

So notwithstanding the recent bout of financial turmoil, the young Spanish private equity market, is, if not kicking, at least still breathing. In the first half of 2008, even though the value of deals dropped off by 37 percent to €1.3 billion – which takes it back to 2006 levels the number of transactions edged up 16 percent to 426.

LP FAITH
Furthermore, fundraising for Spanish private equity was up for the first six months of 2008, with LP commitments growing 5 percent year-onyear to €1.9 billion. Being relatively new to private equity, will Spanish institutions, which include the likes of Telefonica's €3.9 billion pension fund Fonditel, banking group BBVA and fund of funds Altamar, continue to build their exposure to private equity, or will they back away at the first sign of trouble?

“Some will, some won't,”says Altamar co-founder and partner, Jose Luis Molina. “Everybody is more scared about market volatility than ever, but more so on the public equity side than on the private equity side. Therefore, we are somewhat relaxed about this, particularly in the medium term, as it clearly makes sense for LPs to have some allocation to private equity. In the grand scheme of things, total Spanish exposure to private equity is still low.”

Pazos thinks that recent market developments could well lead LPs to place more trust in private equity. “Trust in the public markets is shot, and whereas before investors would seek safety in blue-chip stocks, now they are more likely to seek safety in blue-chip private equity funds,”he says.

The problem, thinks Mercapital's Loizaga, is not so much whether LPs consider private equity a safe bet, but more whether they are able to make further commitments in the short term. Spanish institutional money in Mercapital's funds has rocketed in the last five years from 5 percent of the total to 30 percent, but Loizaga feels that the amount of money raised in the next two years will drop off. “Some LPs have invested too quickly, so they have dried up their ability to commit more. They will need to see some distributions first.”

This is a view, however, not shared by Altamar. “We have strong relationships with most, if not all, of the Spanish LPs and many assure us they have further capacity to invest in the private equity asset class,”says cofounding partner Claudio Aguirre. Next year Altamar will put this conviction to the test. The firm has pencilled in 2009 for the launch of its fourth buyout fund.

A large portion of Spanish institutional money is committed to domestic private equity firms. Jose Luis Segimon manages the private equity investments for Spanish bank BBVA's pension fund, which currently has 36 percent of its private equity allocation with Spanish GPs. There is no sentimental or political motivation for this, explains Segimon. “The quality of the private equity manager is the first concern,”he says. “It is very useful to have a very good manager just across the street. It is positive and helpful to have Spanish companies in the portfolio. When I meet with pension fund investment committee members, it means they can see their investments in action.”

But LPs in Spain should pay close attention to their managers. SJ Berwin's Carlos Pazos maintains that while Spain has produced some good managers,“the returns have often been volatile”, something he puts down to the fact that there were a lot of market entrants at the same time.

A GOOD PLACE TO DO BUSINESS
Spain and Portugal have risen through the ranks to provide some of the most favourable tax and regulatory regimes for private equity funds.

Results for 2008 Results for 2006(2) Results for 2004(3) Results for 2003(4)
Country Total score Country Total score Country Total score Country Total score
France 1.23 Ireland 1.27 UK 1.26 UK 1.20
Ireland 1.32 France 1.36 Luxembourg 1.49 Ireland 1.58
Belgium 1.33 UK 1.46 Ireland 1.53 Luxembourg 1.67
UK 1.45 Belgium 1.51 Greece 1.75 Netherlands 1.79
Greece 1.46 Spain 1.52 Netherlands 1.76 Italy 1.96
Spain 1.58 Greece 1.55 Portugal 1.81 Greece 1.96
Netherlands 1.63 Netherlands 1.60 Belgium 1.82 Total average 2.03
Portugal 1.63 Luxembourg 1.62 Hungary 1.86 Belgium 2.08
Luxembourg 1.65 Portugal 1.71 Italy 1.86 France 2.09
Lithuania 1.75 Italy 1.72 France 1.89 Sweden 2.09
Switzerland 1.76 Austria 1.74 Switzerland 1.95 Spain 2.17
Denmark 1.77 Denmark 1.75 Spain 1.96 Finland 2.25
Hungary 1.84 Hungary 1.83 Total average 1.97 Portugal 2.32
Total average 1.85 Switzerland 1.83 Norway 2.04 Denmark 2.36
Austria 1.87 Total average 1.84 Sweden 2.05 Germany 2.41
Latvia 1.88 Finland 1.91 Czech Republic 2.12 Austria 2.53
Finland 1.92 Estonia 2.08 Poland 2.13
Poland 1.95 Norway 2.08 Finland 2.30
Italy 1.96 Sweden 2.12 Germany 2.37
Sweden 2.02 Latvia 2.12 Austria 2.42
Norway 2.03 Germany 2.15 Denmark 2.46
Estonia 2.06 Poland 2.16 Slovakia 2.49
Germany 2.18 Slovakia 2.17
Cyprus 2.24 Czech Republic 2.21
Romania 2.27 Slovenia 2.26
Slovenia 2.30 Romania 2.35
Slovakia 2.33