Service industries set to generate dealflow

Financial News

January 4, 2004

Buy-out firms hope to make a mint from the financial services industry in 2004 as they turn away from the pubs, leisure centres and shops that have long formed their staple diet.Acquisitions of insurance companies and mortgage lenders are set to grow across Europe as their viability as buy-out targets has been proven in the UK.

John Cole, a partner in Ernst & Young's corporate finance practice, said: "The sector offers growth opportunities as well as stable cashflow and there is a greater acceptance among its participants that it needs restructuring. It's getting a lot of attention from private equity firms and, if they put the effort in, they will generate deals."

Owen Clarke, a director at Barclays Private Equity in the UK and a specialist in the financial services industry, helped generate a 40% annualised return on Preferred Mortgages, a mortgage lender that Barclays bought in 2001 and sold in December 2003. Barclays is thought to have received around [pounds sterling]100m ([euro]143m) after multiplying its original investment by a factor of 2.3.

Clarke said: "Financial services is a large sector and it is complex - it is highly regulated, has complicated accounting and is capital-intensive. The risks are quite high if you do not have a good handle on the key issues."

Barclays Private Equity's financial services deals have mainly been in the UK but last year it bought a French financial services company from Axa. Tom Lamb, managing director at Barclays, said: "It was a French deal but we were able to bring in Owen to help our understanding and give us credibility in front of the vendors."

Kevin Reynolds, a partner at Bridgepoint, a rival mid-market firm, said: "We keep coming across financial services companies that can generate real organic growth by having an innovative business model. Perhaps it's to do with the conservatism of the banks, which tend to be black and white about who they lend to. This gives scope for other companies to make high margins by lending to people who are just over the line the banks have drawn."

ABN Amro recently joined the party by setting up a specialist unit, FI Private Equity, to focus exclusively on financial services. Private equity firms that concentrate on larger buy-outs have also been active in the sector. Kohlberg Kravis Roberts (KKR) has long experience in the insurance market. Apax and Warburg Pincus have not shied away either.

Business services is set to be another busy sector for private equity. Cole said: "An asset in the business services sector will always attract a lot of attention. Continental European dealflow in this sector has been less developed than in the UK but there is plenty of opportunity in back office outsourcing, catering and cleaning."

Leisure and retail - pubs, fitness centres and shopping chains - have served the buy-out industry well in the past few years, but firms think they may have exhausted the sector. Cole said: "There may be a couple more throws of the dice left in pubs but I can't see there is much more to do than tidy things up."

There may be some secondary buy-out activity left in the pipeline, however. Morgan Grenfell Private Equity is expected to look for an exit from Laurel, and observers noted BC Partners' interest in Mitchells & Butler last year.

Retail generated one of Europe's largest buy-outs in 2003, the [euro]2.5bn ($3bn) takeover of Debenhams by CVC, Texas Pacific and Merrill Lynch Private Equity in the fourth quarter. PricewaterhouseCoopers said smaller shops, especially those that sell clothing and groceries, may take heart from seeing the larger buy-outs and turn to private equity for growth capital.

However, private equity firms said they were wary of retail. Amaury de Seze, chairman and chief executive of PAI, said: "Consumer spending is depressed. You must only enter a business that you are sure can survive hard times."

Michael Rosenlew, a partner at Industri Kapital in Sweden, said: "I expect the Nordic region to behave differently from elsewhere in Europe in 2004. I am expecting more activity in the retail sector."

Rosenlew also anticipates more deals in service industries and in general manufacturing. Some observers had predicted an improvement in the telecoms sector, but Rosenlew added: "I am not 100% sure the telecoms sector will pick up."

Telecoms companies have generated many of Europe's largest deals since 2000 but there are increasing signs that the spate of transactions is reaching its end. The dealflow was driven by the companies' need to repay debt and their balance sheets are now in better shape. Telecom Italia may have led the way by making an acquisition in 2003.

Private equity firms, such as Blackstone, have been gearing up to take a part in longer-term consolidation they foresee in the telecoms sector. They are not banking on it starting this year, however.

Paper and packaging is also expected to fall from fourth position among the top 10 industry sources of dealflow in 2003. The total was boosted by Montagu Private Equity's [euro]1.26bn acquisition of Linpac, but this is seen as a one-off.

Similarly KKR's acquisition of Legrand, the French electronics group, for [euro]5.1bn in 2002 gave that sector a temporary boost that has already failed to make a reappearance.

Rosenlew expects the chemical sector to provide a few deals. He said: "Dealflow will pick up in 2004. Chemicals is a cyclical industry. It's now been going through a trough for three years and I expect an uplift to come in 2005 to 2006. That makes now a good time for private equity firms to buy assets. And it is still a fragmented industry in Europe, compared with the US."

De Seze feels more cautious about chemicals: "Because it's cyclical, you need to buy at the right time. Then you need someone to sell it to."

Germany has Europe's highest concentration of chemicals companies. Hanns Ostmeier, who played a leading role in Blackstone's recommended [euro]3.1bn offer last month for Celanese, the German chemicals company, warns against expecting too much from the sector. He said: "We are seeing structural change in what has been a conservative, traditional German industry. But it's a good example of a step-by-step process of change rather than a landslide."

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