Same song, different band.

Hardly a week goes by without the divestment of a major European business to a venture capital firm. This usually follows a hotly contested auction and a field of well-qualified trade buyers vanquished by a cash-rich, deal-hungry private equity player. With their ability to incorporate high leverage into deal structures and propelled by the emergence of a European high-yield bond market (see Insight: Adventure Capital, Financial Director, May 1998), these so-called ‘financial’ bidders can afford to pay more for companies than the average trade buyer – debt is cheaper than equity and more tax efficient. Further, in a private equity fund, with each deal ring-fenced, high levels of debt can be taken on board without jeopardising the group as a whole if an individual deal should go wrong. There was a time when these advantages were balanced by the strategic value that a trade buyer could extract from a purchase through its successful integration with their existing business. Now, however, taking their lead from the US leveraged buyout firms, the major private equity players in Europe are also incorporating the best trade features into their acquisition tactics. In taking a more focused approach to investments and buying businesses on the basis that they can be combined with companies already in their portfolios, financial buyers, too, are seeking to reap industrial synergies. This is enabling them to push target prices even higher. This trend has been emerging in the private domain, on a relatively small scale, for some time with the growth of the so-called ‘leveraged build-up’ (LBU). But the recent £250m recommended counter bid for Watmoughs by the Bahrain-based investment group Investcorp against a £188m hostile offer from the Canadian printing group Quebecor earlier this year, could mark the beginnings of a concerted move on the public takeover arena. At the same time that it was bidding for Watmoughs, Investcorp was also trying to acquire British Printing Corporation for £300m. The aim was to create the UK’s largest independent commercial printing group and to use the merged group to spearhead expansion into continental Europe. With the venture capitalists already being dubbed ‘the new conglomerates’ – and given that the odds on success in the M&A arena are stacked so firmly against trade buyers – one ‘old-style’ conglomerate, the diversified industrial Wassall, has notably sought to reinvent itself as a type of private equity house. In March this year it announced radical plans to create a new type of corporate hybrid – half offshore investment company and half industrial company to enable it to compete more effectively in the auction stakes. According to Wassall’s chief executive, Chris Miller, the writing was on the wall for traditional conglomerates back in 1988 when KKR, the US leveraged buyout group, outbid Hanson for RJR Nabisco. Hanson’s best price was 25% below KKR’s final offer. Ten years later he has come to the inescapable conclusion: if you can’t beat them, join them. Like any self-respecting conglomerate, Investcorp traditionally buys under-performing companies and attempts to boost their returns through tougher management controls. It then typically floats the companies with the hope of achieving big capital gains. Its European interests have included the luxury goods supplier Gucci and the German fashion group Mondi. At the beginning of last year it acquired the Welcome Breaks motorway service stations from Granada for £473m after beating off bids from supermarket company Asda and rival venture capital group Cinven. “What is inherent in our investment strategy is that we are not driven by short-term results but take a long-term view. And we are not into financial engineering. We work to take strategic steps in terms of restructuring. A publicly quoted company, driven by the need for dividend yield and earnings per share growth, might not be able to make use of these measures,” says Richard Warner, a member of Investcorp’s management committee. Financial buyers also claim to work with management teams in ways that trade buyers do not. “Management team can perform better for us than they can do in a public company environment. We are more entrepreneurial,” Warner says. Despite their inherent advantages, because of the high prices being paid for target companies, private equity houses still need to maintain a constant search for new ways to add value to their investments. This has encouraged the growth of the LBU where an initial buyout company is used as a platform onto which to bolt further acquisitions. Last October’s acquisition by the venture capital-backed company Avicore of Schlumberger’s French-based data acquisition and recording division, Enertec, is a case in point. Funding of the £7m deal was arranged by Barclays Private Equity (BPE) which had led Avicore’s £33m institutional buyout of W Vinten, the reconnaissance and electronic countermeasures business, in September 1996. The acquisition was structured as a quasi-MBO (off-balance sheet for Avicore) to allow the Enertec management to take a 20% stake in the business. This will be exchanged for a shareholding in the Avicore Group in which BPE is a substantial majority investor. Having gained sufficient critical mass, BPE plans to float the enlarged group in the near future. Illustrating this ‘buy-and-build’ strategy at the top end of the market is Cinven’s ground-breaking £1.1bn institutional buyout last year of the UK and French private hospital interests of France’s Compagnie Generale des Eaux (CGE) – the biggest LBO in Europe since 1989. Acquired after a fierce auction, Cinven split the transaction between CGE’s UK hospital interests, General Healthcare Group (GHG), and its French operations, Compagnie Generale de Sante (CGS). Cinven was able to justify a relatively full price for GHG and CGS since, having acquired UK private hospitals group Amicus from Compass in 1995, it came with all the benefits of a trade buyer. “With Amicus behind us we could compete as an industrial buyer with an established vehicle and a management team. We were comfortable with the sector and felt that we could see both revenue and cost benefits across the two companies. We certainly factored those synergies into our thought processes when it came to price,” says Yagnish Chotai, an investment director at Cinven. CGS is the leading private hospital group in France. As part of CGE, GHG had held second position in the UK (after BUPA). Newly combined with Cinven’s Amicus, it is now the UK market leader. But, despite all this, ever the chameleons, the venture capitalists also routinely suspend the niche approach. Basically they maintain an ‘opportunity-led’ stance, going after what suits their deals profile and looks best for their investors. Cinven clearly had this in mind when, with no existing publishing interests in its portfolio, it stumped up £860m to acquire IPC magazines from Reed Elsevier at the end of last year. In this case, however, from the vendor’s perspective price was not the only consideration. A financial buyer was the preferred bidder because it faced none of the regulatory hurdles which would have confronted many of the would-be trade buyers. Reed Elsevier was, at that time, in the throes of its ill-fated £20bn merger with Wolters Kluwer, and needed a buyer who would not be detained by an MMC referral. Even so, as Investcorp discovered with Watmoughs (the bid was examined by the Office of Fair Trading though ultimately not referred to the MMC) financial buyers are likely to come under closer scrutiny from the competition authorities as they build increasingly dominant positions in certain sectors. Transaction costs are also rising for the private equity houses on the major deals as, like their trade counterparts, they feel the need to turn to independent advisers for additional help and expertise. Cinven engaged Salomon Smith Barney on the IPC buyout and Rothschilds on the healthcare deals. Investcorp was advised by Lazard Brothers on the Watmoughs offer. The leading buyout players continue to dominate the headlines of the financial press as they continually beat trade buyers to the best deals. However, led by Wassall’s ground-breaking initiative and the fact that financial buyers are adopting trade buying characteristics, we are seeing the beginnings of a convergence between the trade and financial camps. This will introduce some interesting dynamics into the market and may lead to further restructuring and consolidation. However, it is still unlikely to lead to a significant reduction in competition for the trophy assets.