Workshop on Structured Finance
Leveraged and Acquisition Finance
LBOs changed dealmaking in America. Will they change Europe, too?
So far, Europe hasn't produced a counterpart to U.S. junk bond king Michael Milken. But recently, Germany was host to what some are calling a version of Milken's annual ''Predators' Ball'' during the 1980s, when his clients gathered to gossip about their latest deals. On May 4, Europe's growing tribe of buyout experts congregated in Munich. The occasion: a dinner celebrating the first anniversary of the founding of Allianz Capital Partners, the buyout arm of the Munich-based insurance giant. ''There were tens of billions of dollars around the table,'' says Thomas Putter, Allianz Capital's chief executive.
Buyout pros from both sides of the Atlantic have their sights set on Europe. Although its economy is bigger than that of the U.S., it remains fragmented and inefficient. So buyout funds foresee many more years of consolidation and restructuring--which they think will provide a mother lode of deals over the next few years. Already, globalization, the single currency, and other competitive pressures have triggered a huge merger boom in Europe. Companies are combining to get bigger, taking over competitors for synergy, and selling off businesses that don't make money or don't fit in with their strategy. This relentless process leaves behind dozens of corporate orphans, some of them underperforming companies in need of capital and a turnaround strategy.
Enter the buyout boys. Almost a cottage industry a few years ago, leveraged buyouts--or private equity deals, as they are known in Europe--are becoming big business. Financiers who hope to make a killing on the leftovers of Europe's consolidation feast have raised $30 billion since 1996 from pension funds and other institutional investors--three times the money that existed for such activity that year. That may be parlayed into $100 billion worth of deals in Britain and on the Continent, figures Alan Jones, head of leveraged finance at Morgan Stanley Dean Witter(MWD) in London. Financiers hope to borrow money to buy up unwanted companies, turn them around, and take them public at profits up to several times their original investment.
FUELING THE GAME. The LBO mavens couldn't pull this off were it not for another new trend in Europe: investors' appetite for riskier and more rewarding securities. With interest rates at postwar lows on the Continent, demand for high-yield instruments is picking up. The capital suddenly available for junk-bond issues is fueling the buyout game. ''All the stars are lining up for a very exciting marketplace,'' says Richard T. Warner, a management committee member at London LBO firm Investcorp International Ltd.
Indeed, buyout funds are already scrapping with one another. When Britain's Zeneca teamed up with Sweden's Astra to create a European drug behemoth last year, Zeneca's specialty chemical businesses fell outside the new giant's focus. The company tapped J.P. Morgan & Co.(JPM) to find a new home for Zeneca Specialties, and the bank spent weeks dickering with potential buyers in the chemical industry. But when it came down to final bids on Apr. 16, the only players left in the game were four LBO firms. Investcorp and London-based Cinven Ltd. won the auction with a bid of $2.1 billion, beating out U.S. buyout star Kohlberg Kravis Roberts & Co.
That sort of head-butting among LBO heavyweights for choice European properties will become increasingly common. To be close to the action, just about every major U.S. firm is setting up offices in London and raising funds of $1 billion or more. They're going head to head with well-established European buyout pros, such as Schroder Ventures and BC Partners. Although the Europeans enjoy better connections on their home turf, the Americans have greater financial sophistication. ''If the Americans can adapt themselves to a different culture, they will be strong players,'' says Allianz Capital's Putter.
But first, the Americans have credibility problems to overcome. Many companies remember abortive forays into Europe a decade ago by swaggering U.S. outfits, such as Wasserstein Perella, which failed in a high-profile effort to take over British supermarket chain Gateway(GTW) in 1989. KKR scrubbed a deal to buy Herberts, the paints subsidiary of German chemical giant Hoechst, when credit dried up last fall. And Dallas-based Hicks Muse Tate & Furst has hurt its image by breaking an $860 million agreement to acquire business publishing subsidiaries from London-based media giant Pearson PLC. Pearson(PRSNY) is suing Hicks Muse in the U.S. Hicks Muse says the subsidiaries' performance deteriorated sharply after it agreed to buy them last year.
But even some missteps won't halt the flow of buyout money. The presence of financial buyers makes it easier for such conglomerates as Germany's Siemens or Vivendi in France to shed noncore assets or for merged companies to shed businesses they no longer want. And the buyout firms are useful vehicles for private owners and others who worry that their companies will be eclipsed because of shortcomings in management or size. ''What drives people to sell is not money but fear of changing industry structures,'' says Friedrich von der Groeben, a Schroder Ventures partner in Frankfurt.
Britain is by far the most active market, with almost $14 billion of the total $35 billion in European buyouts last year, according to J.P. Morgan. The funds also have high hopes for Germany, since it is Europe's biggest economy and has plenty of consolidation to do. Yet although the country chalked up a solid $9 billion in deals last year--second in Europe--local experts caution that it is not yet an LBO paradise. Indeed, there has been only $250 million worth of deals this year. ''The German market is attractive, but it will not explode from one day to the next just because private equity money has turned up in it,'' says von der Groeben.
But the banks are betting on a big upsurge in deals. Morgan Stanley and other investment banks have established new departments to house their buyout specialists and design and market the high-yield bonds and securitizations that finance them. Banks love the LBO business because they earn fat fees, first for arranging and financing the deals, then for selling the companies. A bank that advises on a $1 billion LBO and then arranges $750 million in financing can earn well above $20 million in fees on the deal. High-yield debt is particularly lucrative. Banks typically rake in 2.75% to 3% of a bond offering, or about $3 million for every $100 million of a high-yield issue.
WAX MUSEUM. Thus, American banks, such as Morgan Stanley and Merrill Lynch, have created a European high-yield market from scratch. Having a pack of bankers on hand to arrange such financings is just as important to boosting the deal market as is the growth in available buyout capital. ''The American banks have brought much greater understanding of what can be achieved in the capital markets,'' says David Gregson, a Briton who heads the buyout wing of Donaldson Lufkin & Jenrette Inc. in London.
In financing big buyouts, the banks' creativity is far from limited to junk bonds. In one of the most innovative deals to date, BT Alex. Brown Inc.(BT), which has been acquired by Deutsche Bank(DBK), and its client, Charterhouse Development Capital, recently raised $370 million in securities collateralized by the cash flows of Tussauds Group, the wax museum and amusement-park concern. The buyout pros even convinced Moody's Investors Service and IBCA Fitch that a hefty chunk of these bonds deserved investment-grade ratings. That helped lower Charterhouse's interest rate on its financing of Tussauds, which it bought from Pearson PLC last year, from about 10% to less than 7.4%. The savings: roughly $8 million a year.
Buyout funds are opportunistic, typically seeking businesses in mature industries with solid cash flows. They figure that they can improve performance by cost-cutting and rejiggering strategy once a unit no longer has to contend with a much larger parent. Manufacturing, financial services, consumer products, and retailing are all popular hunting grounds for buyouts. For instance, London-based BC Partners recently acquired one of Ireland's leading beverage businesses, Cantrell & Cochrane Group, from alcoholic beverage giant Allied-Domecq PLC for $734 million. BC partners will be likely to give the Irish company more freedom to build through acquisitions.
After acquiring a business, funds often finance up to 75% of the company's capital with debt. That amplifies returns. If a fund buys a company for $1 billion, finances the new company with $750 million in debt, and then sells it for $2 billion a few years later, the fund earns four times its original $250 million equity investment. Such home runs partly explain why funds are able to deliver 20%-per-year returns. Of course, if the business goes sour, the heavy debt burden magnifies the fund's downside risk.
HOLY GRAIL. One London-based buyout firm may be about to realize a beautiful payback on a leveraged deal. In 1997, Schroder Ventures bought an 85% stake in family-owned Swiss apparel retailer Charles Vogele for about $600 million. Schroder encouraged management to sell off a shopping center and focus on its retail apparel stores. Analysts now view Vogele, with its big presence in Switzerland, southern Germany, and Austria, as a potentially hot cross-border retailing concept. When the company goes public on June 7, Schroder could make more than seven times its original equity cost of about $100 million.
Exclusive deals such as this one are the Holy Grail that buyout funds covet. The alternative is to compete for deals at auction--a tough way to make money. But the days when a seller cuts a deal with a single firm may be waning. For instance, between 50 and 100 buyout firms and industry buyers are said to be fighting for an electrical components subsidiary that Siemens is planning to spin off. Potential bidders wonder how they can possibly acquire the unit at a price that will offer them much leeway for future profit.
SAVVIER. The deal market is likely to become even more competitive. Until now, the field has belonged to the Americans and the British. Scandinavian players, such as Nordic Capital and EQT, the buyout firm set up by Sweden's Wallenberg family, have been the most active outfits outside London. But Continental players, such as Allianz Capital, are beginning to make waves. Allianz made a splashy debut last year by acquiring Tank und Rast, the German service-station network, with a partner for an estimated $1 billion.
That means the Americans will have to master the eccentricities of the European market--or suffer the fate of Hicks Muse Tate & Furst. On May 14, the firm announced that it had reached an agreement to buy British grocery and furniture producer Hillsdown Holdings PLC for $1.2 billion. It made the deal with the company's independent directors. But Hicks failed to get management on board, and managers encouraged a $1.3 billion counterbid by British buyout firm Candover, which Hicks Muse says it will top. Thus, Hicks Muse, which now has almost 30% of Hillsdown, finds itself in a bidding war for a struggling company that it may pay a high price to win. John Muse, a principal who runs Hicks's office in London, insists that Hicks has handled the deal well.
American funds that stay the course will probably get savvier about the rules of the game on European turf. And the merger boom is likely to continue for some time. For serious buyout players, there will be plenty of action to go around.
By Stanley Reed in London
LBO Trailblazer Conquering the Continent
It certainly doesn't have the same renown in financial circles that New York powerhouse Kohlberg Kravis Roberts & Co. enjoys. But in its own quiet way, BC Partners, a London buyout firm, has done as much as any group to usher in the age of the European leveraged buyout.
John D. Burgess, a Briton, and Otto van der Wyck, a Dutchman, founded the firm in 1986 with a minority stake from the ill-starred British merchant bank Barings. Since then, BC Partners has participated in some 40 deals worth about $10 billion. Of those investments, 27 have been sold or taken public. And unlike other LBO shops with little track record on the Continent, BC Partners pursued deals there from the start. It has offices in Paris, Milan, and Hamburg. With Europe's business culture changing to favor buyouts, the focus is paying off for the firm's 17 partners. According to Burgess, returns are ''well in excess'' of 20% per year.
Burgess, a graduate of top French management school INSEAD who began his career at Boston Consulting Group Inc.'s Paris office, uses long-cultivated contacts to ply his trade. Hostile takeovers are not part of his approach. The firm's first deal on the Continent, in 1987, was the purchase of French steel-spring maker Allevard. The company came to BC Partners' attention through Michel Guillet, a Frenchman whom Burgess was recruiting at the time. Allevard was later sold to steelmaker Usinor for about five times its purchase price.
FAMILY AFFAIRS. Local connections paid off again in 1997, with the purchase of a controlling stake in Elis Group, France's leading provider of hotel and restaurant linens and work uniforms. Guillet, now a BC senior partner, persuaded Elis' septuagenarian owner to sell out for an estimated $1 billion. BC Partners is developing the business by adding acquisitions in the U.S.
Springs and bed linens are good examples of the steady, low-tech businesses that appeal to Burgess. He likes to work with existing management, although bringing in a new chief executive or chief financial officer is often part of the deal when family owners sell out. Other recent investments include SEAT, the Italian yellow pages publisher; Neopost, a French supplier of postal equipment; and Ludwig Beck, a Munich retailer.
In Burgess' latest coup, he landed Cantrell & Cochrane Group, an Irish liquor and beverages subsidiary of spirits giant Allied Domecq PLC. C&C was slated to be spun off in a stock issue. But market choppiness killed the offering, which Goldman, Sachs & Co. was handling.
Goldman then tried the auction route for C&C, a market leader in such businesses as mineral water and cider in Ireland. Burgess interviewed C&C's management team and came away impressed. ''We felt they would do better as an independent company,'' he says. Allied agreed to Burgess' $860 million plan in January, after he came up with guaranteed financing from Donaldson, Lufkin & Jenrette Inc.
Burgess plans to build up C&C through acquisitions, then take it public. Meanwhile, BC Partners will press on, uncovering the unglamorous, money-making companies that bigger, flashier firms might overlook. That's a smart route to LBO success in Europe.
By Stanley Reed in London
ONLINE : JUNE 14, 1999 ISSUE