The enemy within?

The prospect of the first Socialist president for 24 years, coupled with continuing uncertainty over the fate of the euro, has led to a marked slowdown in French private equity, writes Oliver Smiddy.

In April (and possibly May), the French public will vote in the 2012 presidential election – and at press time, incumbent Nicolas Sarkozy was widely tipped to be defeated by Socialist challenger François Hollande. The impact on France’s buyout industry, one of continental Europe’s most mature and traditionally its most active, could be enormous. As an avowed enemy of “finance”, Socialist Party candidate François Hollande could prove to be private equity’s ‘bête noire’, assuming some of his election promises become law.

First, there’s the pledge to introduce an eye-watering 75 percent income tax rate on the highest earners – enough to test the resolve of even the most patriotic French private equity executive. And it appears that the mere threat of that tax rate is already having an effect: one private equity executive at a high profile Paris-based private equity group said he knew peers who had already begun making arrangements to move abroad.

Second, there’s the fear that a new president could seek to make changes to the way carried interest is taxed. Legislators in Sweden have already proposed that at least some of carried interest be taxed as income rather than a capital gain; France could well follow suit.

But it’s Hollande’s pledge regarding the tax deductibility of interest payments on debt that has really raised eyebrows.

“If Hollande is our next president, it will be bad news for private equity,” states Antoine Dréan, founder and chairman of French placement agent Triago. “He has told people that finance is his greatest enemy. He has proposed that carried interest be taxed as ordinary income, and his law banning the tax deductibility of interest on debt would ruin the buyout model.”

If Hollande is our next president, it will be bad news for private equity.

Antoine Dréan

Luis Marini-Portugal, director of investments at listed French private equity group Eurazeo, adds: “Nothing has been articulated clearly yet with regard to the deductibility of interest on debt, so it’s hard to tell what the impact will be. If any regulation is retroactive, that will have a serious effect on current debt structures, which would be a serious issue for the companies having to deal with them. If it’s prospective, it would impact pricing but would at least be manageable.”

However, other industry participants are sanguine about a future under Hollande – chiefly because president’s ability to radically re-shape the country’s financial services industry and its regulatory environment is constrained by France’s position within the European Union.

Robert Daussun, chief executive of LBO France, says: “Any decisions taken by the next French President will be made within an EU context, taking into account international constraints. That will limit how far-reaching potential reforms could be. Between April and August there will be a period of uncertainty, however, as following the Presidential election there are parliamentary ones.”


In tandem with this political uncertainty, economic issues are also contributing to the impasse. European banks are trying to deleverage in response to regulation like Insolvency II and Basel III, which has also reduced their willingness to issue new credits.

“The main characteristic of the French market at present is that only French banks are lending to deals in France,” says Daussun. “The debt market will change in the months to come, but for the time being it’s a national market where international lenders are largely absent – and that has an impact on volume.”

Daussun estimates that each of the six main French banks is able to provide about €20-30 million per deal. So the largest debt package it’s feasible to assemble is about €180 million to €200 million of senior debt, with perhaps €80-100 million of mezzanine. That equates to an overall financing package of €300 million.

“The impact is that for the time being, the French buyout market is a lower-mid-market one,” Daussun concludes.
Even listed private equity groups in France, which don’t have the pressure of traditional fundraising cycles to raise equity, are affected by the scarcity of debt.

“The financing market has been volatile. It reopened last year, along with the high yield bond market, before closing again towards the end of the year,” says Marini-Portugal. “We made a conscious decision to diversify beyond the mid-market – where you’re dependent on financing for deals – to smaller deals which are less dependent on debt and therefore offer steadier dealflow.”

Sure enough, deal sizes have shrunk markedly, according to data provider Dealogic. Whereas the top five deals of 2011 included buyouts such as the $3 billion acquisition of Spie by Clayton Dubilier & Rice, Caisse de Dépôt et Placement de Quebec and AXA Private Equity, or the $1.4 billion acquisition of Foncia by Bridgepoint and Eurazeo, the biggest so far this year has been a $77 million investment in Buffet Crampon by Fondations Capital.

The only truly feasible deals at present are those already known to the banking community, adds Marini-Portugal. “If you have a good company that is already funded, banks might be willing to roll-over their exposure. There are alternative sources of financing however – with Foncia, for example, we worked with Goldman Sachs’ senior debt fund. Such funds are an interesting new way to give liquidity to the market, although there are still only a limited number.”

Equistone Partners Europe was similarly resourceful in sourcing debt for its acquisition of pharmaceuticals business Unither in October. The firm used a unitranche facility provided by AXA Private Equity to back the deal, it said.

But third party debt providers can’t hope to make up the shortfall created by the banks’ retreat from the market. Deal volumes this year have plummeted: to date, there have been just 35 private equity buyouts in France this year worth a combined $162 million, according to Dealogic. That compares with 174 deals worth a combined $14.8 billion in the whole of 2011.

In other mature markets, firms have sought to maintain dealflow by targeting market niches or specialist strategies. But French firms are generally not equipped to do this.

“Things in France aren’t looking too different from other mature markets,” Dréan comments. “The difference though is

The general economic situation is still better than three years ago.

Guillaume Jacqueau

 that there aren’t too many specialist funds in France – most funds tend to be generalist. Investors, at present, seem to be more drawn to specialists.”

As a result, it’s not just dealmakers that have taken a time-out. Fundraising teams have also paused to see how the election and indeed the macroeconomic travails of the Eurozone play out. LBO France, for example, has postponed the launch of its next White Knight mid-market buyout fund until the third or fourth quarter – despite impressive recent returns and a lengthy track record, according to sources with knowledge of the process. (The firm declined to comment on fundraising plans.)


So financing is harder to source, fundraising is challenging, and people are nervous about the regulatory implications of a gung-ho Socialist President. But what about the final piece of the puzzle: the macro state of the economy bequeathed to the next President?

“The general economic situation is still better than three years ago,” insists Guillaume Jacqueau, managing partner at Equistone Partners Europe.

Marini-Portugal agrees. “In terms of the economic picture in France, things today are better than we expected them to be back in November, for example. From a general corporate perspective, we’re not back to 2005/ 2006 levels, but things are OK – performance in the corporate sector is not as bad as feared. Looking at the wider eurozone, there’s a clear delineation between Northern and Southern Europe in terms of economic performance. And France is on the right side of the divide so far.”

Admittedly this didn’t prevent ratings agency Standard & Poor’s stripping France of its AAA credit rating in January; the country has run a budget deficit every year since 1974, and this state of affairs is unlikely to change any time soon, despite recent efforts to curb spending.

But for private equity firms, there should still be opportunities for deals – given that some of the long-term trends in the market remain favourable. “There are several trends which are likely to drive dealflow this year,” says Jacqueau.

“There are a number of family-owned businesses which need to address succession issues. Some of the large French corporate also need to refocus on their core businesses, which means divesting non-core assets. Finally, there will be secondary opportunities with some sponsors needing liquidity.”

Some sectors will fare better than others, of course. “Purely consumer sectors are probably suffering the most. On balance, the industrial sector, and specifically companies with exposure beyond France – to the BRIC countries for example – are holding up relatively well.”

Jacqueau even sees positives in the banking community’s reluctance to lend. “Banks are certainly more selective, but that’s no bad thing. Leverage multiples that sponsors are able to obtain are also lower, which again is no bad thing. It’s clearly more challenging to obtain financing, but for nice assets you can still find debt, particularly from ‘local’ French banks that want to maintain a close relationship with customers. As far as the mid-market is concerned, it’s still possible to finance deals.”

For the time being though, the private equity industry in France is collectively holding its breath. The year ahead will clearly be a testing one. A number of high-profile fundraisings due to launch – including LBO France’s White Knight IX and PAI Europe VI – will gauge LP appetite for French-based GPs. And there will be a fight to promote the wider industry’s achievements too, in a bid to soften potentially punitive regulations if Hollande finds himself in the Elysée palace.

But there’s no need to panic, according to Jacqueau. “There is always a worry when you see your industry described as ‘the enemy’. But I’m pretty confident people will see that private equity has had a positive impact on the French economy, and has helped to create jobs over the medium to long-term. We cannot afford to destroy that. There are obviously some communication issues that need to be addressed, but when you consider the real impact of private equity in France, I’m not worried about the future.”