22/01/2007
Fundamentals article - European Private Equity
European private equity
Private equity is newsworthy at the moment, particularly for listed equity investors. In the first nine months of 2006 the total value of private equity transactions in Europe reached a record €119 billion, up 28% on the comparable period in 2005 and close to the total for all of 2005. Such growth is a continuation of the upward trend for private equity since the lows of 2001. Private equity now accounts for more than 25% of all mergers and acquisitions activity in Europe.
Interestingly, over 93% by value of all private equity transactions in Europe are buy-outs. In fact contrary to popular opinion, private equity in Europe is dominated by buy-outs, with venture capital and, in particular start-up capital, only forming a small part of the industry.
As well as growth in private equity generally, the biggest shift in recent years has been the rise in the value of individual deals. This has been a function of the increasing size of funds raised by private equity managers, with Permira raising a European record fund of €11.1 billion in 2006, and a growing number of opportunities for private equity deals, particularly in continental Europe. This has been driven by European companies disposing of businesses as they seek to focus on shareholder value, corporate governance and their competitive position in Europe. There is also an increasing number of large family owned businesses for sale.
Unfortunately, for many the image of private equity is one of gearing up and asset stripping. While there is an element of this, to suggest that this is how private equity investors make most of their money and returns is inaccurate. The main drivers of value are sales, and hence profit, growth and free cashflow generation.
A recent Ernst & Young study found that private equity backed companies in western Europe grew in value at twice the rate of more traditionally owned companies. Incentivising the management of private equity companies through meaningful equity and options, as well as being able to control the speed and nature of decision making and the capital structure of a company are key to the success of private equity.
Private equity is an alternative asset class and should be viewed by investors as an opportunity to enhance potential returns and provide diversification. However, accessing the asset class can be difficult for many small institutional investors and private individuals. Due to significant demand, most of the larger, and better known, private equity funds in the US and Europe are only available to experienced investors who have invested with the underlying manager for many years and/or are able to make sizeable monetary commitments.
A solution for smaller investors is available in the form of one of the London listed private equity investment trusts. These investment trusts are broadly divided into those that focus on the investments of one private equity manager and those that allow access to a number of private equity managers through a fund of funds structure. These investment trusts have the advantage of daily pricing and liquidity in the trust's shares.
We encourage investors to be long-term in their time horizon when considering private equity and that five years should be viewed as a minimum holding period. While this may seem a long time, it should be remembered that a typical private equity investment is held by its manager for 3-5 years.
As for the outlook for 2007, subject to unforeseen changes to the macro-economic and political climate, we would expect to see a continuation of the trends in European private equity witnessed over the last couple of years.
Peter McKellar is Chief Investment Officer, Private Equity, at Standard Life Investments
First published in The Herald on 27 January 2007
Standard Life Investments Limited, tel. +44 131 225 2345, a company registered in Scotland (SC 123321) Registered Office 1 George Street Edinburgh EH2 2LL.
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