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July 2001

After the fall


European private-equity firms escaped the full effects of the tech collapse that hit their US peers so hard last year. But they could hardly escape the atmosphere of panic and have trimmed their sails, avoiding riskier start-up-style ventures and giving more attention to buy-outs and blue-chip companies’ disposals of non-core businesses.




       
Kamal Tabet
Not so long ago, private-equity firms seemed to have the road to riches well mapped out. Funds were returning multiples of money to investors virtually overnight. Every bet on a new technology was a winning one, with returns of up to 78% within six months being touted. Buy-out firms, meanwhile, were acquiring companies, making superficial changes and realizing massive gains by floating or selling them off to a trade buyer a year later.
Encouraged by the phenomenal returns, investors piled in to private equity. During 2000, e48 billion ($41 billion) was raised in Europe according to the European Private Equity&Venture Capital Association (EVCA), a 89% increase on the previous year.
Throughout 1999 and early 2000, funds were being raised in shorter and shorter time frames. Schroder Ventures secured e3.3 billion of commitments in just three months in 1999, for example. What's more, that money was being invested just as quickly. It was almost, recalls one fund-of-funds manager, as if general partners wanted to get their funds spent so they could go out and raise some more before the door closed.
But nothing lasts for ever. As the Nasdaq Composite crashed 40% and the Dow Jones and FTSE 100 began to display startling levels of volatility, the IPO market shuddered to a halt. Trade buyers started to hesitate, too, because they had enough to do worrying about their own share prices, let alone making acquisitions. And the industry caught the scent of a slowing fund-raising market. Most investors peg their exposure to alternative investments to their public-equity portfolio. When that went down in size, the allocation for private equity was squeezed too.
The party is over
Private-equity firms were left holding the baby. The businesses they had been priming for an IPO and a correspondent blaze of glory were suddenly unloved and unwanted. The halcyon days were over.
The industry had run away with itself. It had overheated as the focus switched to fanciful business models and away from actual businesses with profits and revenue figures. "I don't know a single investor who didn't make a couple of investments during that time that they are not slightly embarrassed about now," says Andrew Cowley, head of investment strategy at Dresdner Kleinwort Capital.
On top of this, investors started expecting things to happen very fast - particularly in venture capital. "People began to think it was normal to fund a company in six weeks, do a B round eight weeks later and the IPO in four months' time," says Cowley. "So the enormous IRRs we were seeing were basically driven by timing."
Go back two years and some of the top names in venture capital were boasting of how they made the decisions about whether to finance a company or not during the preliminary meeting. Investors got caught by style drift and went into technology investing with no skills or understanding of it. A number of these firms, particularly Silicon Valley-based set-ups with young and inexperienced founders, are now nursing heavy losses as the companies into which they ploughed money turned out to be worthless shells. A number have been forced to cut their losses and abandon the business altogether because the general partners cannot raise another fund to dig themselves out of trouble.
In Europe, too, there are some funds that have drawn down all commitments and are now sitting on a portfolio worth less than when it was purchased - even among the more traditional buy-out firms. For every publicized case of a company going bankrupt, several more are being sympathetically restructured on the quiet.
Recently investors have moved away from the danger area of early-stage venture capital towards the less risky arena of buy-outs. "Venture capital were previously buoying the overall private equity returns and buyout returns started to look quite pedestrian," says Christian Dummett, head of private equity at Abbey National Treasury Services. "Now these have come down and there's heightened interest in the LBO market."
Several firms have cut their venture allocation in the wake of the tech crash while others have stopped doing venture altogether. At least half of the e4 billion fund raised by Apax earlier this year will go on buy-outs as will half of Schroder Ventures' latest fund. BC Partners, Candover and Charterhouse are also said to be out raising money for buy-out funds and Goldman Sachs is rumoured to be pulling out of the venture capital game.
In reality, though, despite the shift in emphasis, the European private-equity industry is in fairly good shape. Although one or two skeletons might fall out of the cupboard in the next six months, there's little evidence of the crash and burn that has characterized the sector in the US.
Yes, fundraising is more difficult. But the most highly regarded funds are still managing to get it done, even if it has become more time-consuming. "We'll finish fund-raising at the end of this year, which means it has taken around nine months," says Colin Buffin, managing director at Candover Partners, a UK buy-out firm that has just announced the first close of a e1.1 billion fund. "If we'd done it a year ago, it would have taken half that time." Moreover, not all of the money raised in 2000 has been invested. In fact, just under e35 billion has been spent, a much smaller percentage than in previous years.
European private equity investors are reaping the benefits of having taken a more cautious approach than their counterparts in the US over the past 18 months. They kept their heads during the tech boom and didn't give inexperienced managers the chance to do so much damage. Stories of European LPs refusing to be drawn down because they've lost faith in the investment manager, as has happened in the US, are groundless.
In fact, private-equity players in Europe are well poised to take advantage of what, according to many participants, will be the best buyer's market for 10 years. "I think the European market is perceived internationally as a good place to invest," says Candover's Buffin. "Returns overall will probably be higher in Europe than in the US."
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