Private Equity in Europe: The market situation remains tense

Roland Berger market analysis provides an outlook for 2010

European private equity firms have been hit especially hard by the financial and economic crisis. In 2008, investment volumes dropped by 27% and the forecasts for 2009 show a further decline by up to 40%. Despite cautiously optimistic economic forecasts for 2010, the market environment will remain tough – according to Roland Berger Strategy Consultants as indicated in their current "European private equity outlook 2010" analysis. Key success factors for surviving the crisis include carefully examining each acquisition, actively managing portfolios and quickly implementing necessary restructuring actions. In 2010, more and more attractive companies will be coming on the market, thereby providing PE firms with new opportunities.

In 2008, investment volume dropped considerably in almost all Western European countries, whereas this remained stable at a low level in CEE. Especially affected were Great Britain, where the market plunged from EUR 20.9 billion down to EUR 13.75 billion (-66%), and Austria (-62%). The private equity market in Austria now has a volume of only EUR 330 million and thus trails Poland (EUR 630 million), Hungary (EUR 480 million) and the Czech Republic (EUR 440 million). In the wake of the crisis, PE funds are also struggling with sinking returns. The internal rate of return (IRR) fell from 17.1% in 2007 to 11.6% in 2008. Additional declines are expected in 2009. Only top funds are currently able to meet investors' high demands. The performance gaps between funds is increasingly. We can expect a shakeout in the market in 2010.

Especially several larger companies that currently have available capital at their disposal can use the crisis to their advantage by making anticyclical investments. On the other hand, a lot of smaller PE funds are in trouble – they can neither raise the necessary capital nor can they sell existing investments at a reasonable profit because there are currently no exit options. Funds raised will drop significantly. During the first six months of the year, there was a historical low with a total of only EUR 5.7 billion. Simultaneously, divestments will shrink by roughly 50% for the second time in a row.

To compound matters, today banks are more hesitant to provide the necessary M&A financing. This is especially evident in plummeting leverage ratios. Whereas in 2007 the total ratio debt a company could use to acquire a company in 2007 was six times its EBITDA, this figure was fivefold in the first six months of 2009. In the future, returns will not be generated by debt, but instead by improving operational performance. However, PE companies still have to adjust their business models according to the changing market conditions.

Investors remain conservative
The challenging market environment means that investors have become increasingly conservative since late 2007. Focus remains on later stage buyouts, and across Europe the volume of startup and expansion financing is declining. In 2008, buyouts constituted 70% of the market while startups and expansions dropped to 5% and 7%, respectively. In 2001, the market share of startup financing was still at 15% while expansion financing made up 25% of the market. On the other hand, there has been an emergence of financing for growth programs: prior to 2006, this did not play a role, but in 2007 this constituted 5% of the market and even jumped to 14% in 2008.

The macroeconomic environment and developments on the stock exchanges are essential for the recovery of Europe's private equity markets. Lower growth rates are expected in 2010, which make the environment for exits less attractive. "Many investments are ready for an IPO, but the appropriate environment is not there. The sales pressure is still not strong enough for a secondary buyout. Bargains are not yet available so that a secondary buyout is only possible given major markdowns," explains Bremer. Therefore, restructuring the investments' core business is gaining importance once again, also to realize a favorable selling price after the crisis is over.