The boom in European private equity activity will continue this year, but it is continental Europe that will drive the growth, making up for the slowdown in the UK.

Michael Stevens, UK head of MBO services at KPMG, says: "The UK buy-out market may have peaked in 1999 and although 2000 will see strong continued activity, it is hoped that the potential of the continental European marketplace will enable the London-based private equity houses to continue to enjoy the boom conditions they have seen for the past two years. The London market is focusing on the Continent much more strongly than it has ever done in the past.' Figures released by the Centre for Management Buy-Out Research confirm that the UK buy-out market turned towards bigger deals in 1999, with average deal size up 66% on 1998 at over £35m (E55.7m), but the volume of transactions was down from 669 deals in 1998 to 428 deals in 1999. The total value of deals was a record £15bn. Stevens calls the trend towards bigger buy-outs a "flight to quality'. According to KPMG Corporate Finance, the value of £100m-plus UK deals increased from £3.5bn in 1995 to over £10bn in 1999. "People are going for larger deals that have higher quality management, more security from a better spread of blue-chip customers, which in turn provides for better gearing and, one hopes, a better return for the equity.' One buy-out player that focused increasingly on big deals in 1999 is Morgan Grenfell Private Equity (MGPE). Graham Hutton, chief executive, says: "1999 was our most active year by far, with over $1bn (E0.9m) of equity invested in the past 12 months. Our new fund, Deutsche European Partners IV, has a target of E1.5bn and is closing next year with E1.3bn already raised. "Continental Europe provided a number of large deals as spin-offs from corporate restructuring and it will continue to be a growing hunting ground for new deals.' The bigger deals MGPE led in 1999 included the £400m buy-out of Coral, the SFr1.85bn ($2.9bn) acquisition of Ciba Specialty Chemicals, the $751m acquisition of Piaggio motorcycles and a 12.5% stake in Formula One Holdings for an undisclosed sum reported to be in the region of £300m. Tom Walker, head of financial sponsor coverage at Chase, sees the trend for big deals growing this year: "We think that as a percentage of total deals, there will be a significant rise in Germany and France this year. There will be more E1bn deals and we see the funds being raised over the next 18 months continuing to grow.' Walker cites Kohlberg Kravis Roberts' $3bn European fund which will be looking to do $1bn-plus deals. "KKR is by no means alone and there will be a number of $2bn-plus funds out there next year.' Walker is very bullish about the prospects for the buy-out market this year: "All the conditions are right for a big buy-out market in 2000. There are growing funds under management which are looking for deals there is a growing acceptance of leveraged buy-outs and financial buyers there is a strong financing market and a strong exit market. "For the first time on a sustained basis the new issue market for high-yield in Europe is stronger than in the US. The bank market in Europe is as strong as ever with plenty of liquidity.' Graham Clempson, co-head of European investment banking at Deutsche Bank, points out that financial sponsors will always ensure that traditional industrial sectors are not ignored in the rush towards high-technology companies: "A real two-tier economy is developing, from a valuation perspective, between technology and telecoms on the one hand and the older industrial sectors on the other. It's like a rocking boat: as soon as valuations in the older industries get depressed, financial sponsors start looking for opportunities and valuations shoot up again.' A report on alternative investing by Goldman Sachs and Frank Russell shows that the amount of money committed to alternative assets by large North American tax exempt institutions had increased from $58bn in 1995 to $152bn in 1999. The proportion of this capital that went into West European private equity increased from 3.4% to 9.8%. Charles Sherwood, partner at Schroder Ventures, points out that this implies an increase in commitment to the region from these investors from $2bn in 1995 to $15bn in 1999 – an increase of 7.5 times in four years. "This represents an astonishing growth in commitment. The US has led the way but we are now beginning to see similar investment patterns among domestic European institutions. This started in Holland, spread to Scandinavia and is now happening for the first time in Switzerland.' Sherwood believes the huge increase in supply is mirrored by a rapid growth in investment opportunities in Europe driven by the current industrial restructuring. The private equity market has changed in character as a result of this growth. "The larger the market gets, the more efficient it becomes. This poses a critical challenge to private equity groups: how to differentiate their offering from other competitors. More money and more deals also means more pain for those groups unable to differentiate themselves from the mass.' As an example of a distinctive approach, Schroder Ventures invested E88m this year into the acquisition of AU System, a Swedish wireless internet company. This was an almost unleveraged investment in an industry growing at 40% per annum – a very different type of deal to that typically associated with the leveraged buy-out industry. Simon Wildig, partner at Close Investments, believes that the flight to continental Europe and to the higher end of the deal spectrum has left open opportunities for mid-market players in the UK. "Figures show that deal flow in the sub-£50m market has been consistent over the past 10-12 years and shows no sign of letting up, particularly with the IPO market being largely closed other than to technology businesses. "Over the next 12 months I see more secondary transactions as venture capitalists look for exits following two to three years of very strong investment activity. These exits could provide new acquirers the opportunity to develop buy-and-build strategies which are an attractive way to build shareholder value.' Ian Armitage, chief executive of Mercury Private Equity, had a very active 1999 with deals that included the £463m taking private of Greycoats property group and the acquisition of Pipetronix. The latter deal was a buy-and-build strategy acquired through Pipeline Integrity International (PII), a 1998 acquisition. Looking back at last year Armitage says: "The overriding feature of 1999 for the private equity market as a whole was technology and this will continue into 2000. "Technology has two aspects. The first aspect relates to investment activity: technology investments are producing stunning returns. "The second aspect is the impact of enabling technologies, such as the internet and cheap broadband communication, on the business models of the companies we buy.' Another important factor, he points out, has been the death of inflation in the market for goods which has made buy-out structures more difficult. "In flat markets you have to work harder to get the same returns. How many of the large buy-outs are going to come back to market showing great returns? When you add to this the closing down of mid-caps, you're going to see a lot of inventory in many houses' funds.' This year will be a time for patience, says Sherwood. "Much has been made of sector focus but buy-and-build should be buy-and-improve. Firms should look for cost reductions at the centre and enhanced sales opportunities. By merging Pipetronix with PII, we increased the market share of PII from 33% to 53%.' The war chest of money that has been stockpiled by funds seeking investments in Western Europe has so far not had the effect of flushing out more deals and Germany, in particular, has not proved to be as active a market as many participants had hoped. It is difficult to know whether firms are paying over the odds in their eagerness to complete transactions as performance can only be measured on exit. What is clear is that financial buyers have become significant players in even the largest deals and that restructuring European conglomerates have started to take the private equity market seriously.