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The French mid-market: bursting with opportunities or overcrowded?

After years of frustration and a worsening regulatory environment, many firms and investors are turning their backs on Germany in favour of France's mid-market. But does France deserve this new focus? And what makes this market attractive, ask Elvire Perrin and Jenny Finlay of Altius Associates.

The French mid-market has seen a resurgence in popularity over recent years. But what makes it so attractive? It's helpful to start by assessing the factors make any market attractive: good investment opportunities; a reasonable level of competition; and a favourable business environment.

Is the French mid-market fulfilling these conditions?

1. Good investment opportunities
The French mid-market segment has held up well since the end of the dot-com boom in 2000. Within the context of continental Europe, however, the French market has generally been noted for the large number of its mid-market buy-out activity rather than the value. Historically, unlike the UK, Germany and Sweden, France has not demonstrated an ever-increasing stream of E1bn-plus buy-outs. This is mainly because the restructuring of big corporate groups has happened later in France than in other European countries. Yet despite this, 2002 saw a raft of such deals.

Examples of recent large deals in France include: Schneider Electric's E5.1bn sale of Legrand to Kohlberg Kravis Roberts and Wendel Investissements; the E1.6 bn buy-out of Télédefusion de France from France Telecom; and the E1.6 bn secondary buy-out of Elis by PAI Management and BC Partners. As a result of these, France has overtaken Germany for the first time as the largest buy-out market in continental Europe. Buy-out value in France almost tripled in 2002 on the previous year to reach a record E16.4bn despite a drop in deal numbers.

Yet despite the development of this new breed of mega-deals, most in the market expecte that the bulk of the buy-out segment in France will remain firmly in the mid-market. There are a couple of reasons for this. First, France has a high proportion of family-run businesses within the mid-market segment and the majority of them face succession issues. At the same time, French attitudes to private equity continue to change. In marked contrast to other European countries, such as Germany, an increasing number of entrepreneurs in France are open to private equity capital, viewing it as a viable alternative to a trade sale of their company.

Last year, growth in mid-market buy-out activity in France was hindered by the economic downturn and the fact that vendors and purchasers could not agree on price. This year, as a result of the later restructuring of mid-sized groups and the revision of sellers' expectations with regard to valuations, the mid-market looks set to prosper.

2. Reasonable level of competition
So, the prospects for deal flow within the mid-market look good, but about the level of competition?

With the attractive conditions for private equity investors in France and an overhang of buy-out capital above that of the European average, the French market is starting to look crowded. This situation is unlikely to change for the meantime, either. Many domestic firms either raised funds last year or are now raising new funds. Examples of these include AtriA Capital Partenaires, Pragma Capital; Astorg Partners, ABN AMRO; and Activa Capital. There have also been a number of mid-market spin out groups appearing on the scene, such as the LCF Rothschild spin-off from Astorg and the MBO France spin-off from Initiative & Finances. All these have added further congestion.

And there are already some warning signs about how crowded the market is getting. Long established managers, such as TCR Europe taking longer than anticipated to raise their latest funds. LBO France has even found it necessary to drop the target of its White Knight FCPR from E500m to E300m.

The closure of some firms' German offices will only add to the perception of overcrowding. Legal & General Ventures, for example has decided to pull out of Germany and concentrate on their areas of strength, such as the UK and France. And then there are firms seeking to set up French offices. Duke Street Capital and Candover are following the trend set by BC Partners a long time ago, with the intention of creating integrated networks of offices. Other firms have opened an office in Paris, not primarily to invest in France, but as a platform to invest throughout Europe. An example is Vestar, which made its first European investment from its Paris office, not in France, but in the Nordic region.

However, despite this recent flurry of activity in France, some French managers are wondering what all the fuss is about. Out of the four investments made by Alpha Associés last year, three were in Germany and only one in France. Alain Blanc-Brude of the Alpha Group has said that opportunities at good prices are now quite rare in France because of the high level of competition; as the departure of managers from Germany, on the other hand, has brought competition l there down to a more acceptable levels.

Most fund managers echo this view - albeit more moderately. Many believe that there are still good deals to be done in France but that it is more difficult to be selective because of the high level of competition. The entry price into deals is expected to remain high as a direct consequence of the higher than average overhang of buy-out capital in France and the number of mid-market groups raising funds. In addition, investment pace is slower, because each deal is taking longer to complete and many deals are not coming to fruition.

And, although appetite among investors for the mid-market in Europe has encouraged this raising activity, they are nonetheless wary of follow-on commitments when previous funds are still largely unrealised. The problem at present is the lack of opportunity for exits - one that is not limited to the French buy-out market but extends to the European market in general.

3. Favourable business environment
A recent study by the European Private Equity and Venture Capital Association benchmarked the tax and legal environment in the fifteen European Union member states. France was ranked mid-way down the table. The inference is that there is still room for improvement. Anecdotal evidence suggests that the FCPR (the French private equity structure) is not as flexible as the English or Channel Islands legal structure of private equity funds. But new legislation passed in 2002 has streamlined and modernised the rules applicable to FCPRs. This is likely to broaden the appeal of the French FCPR for European investors.

In line with these advancements, the French entrepreneurial culture has clearly developed over the past ten years. There is more willingness to start companies and/or seek support for management buy-outs, and French entrepreneurs seem more open to private equity groups taking a majority stake in their company. This positive trend is developing and differentiates France from other European countries such as Germany and Spain. One of the reasons cited for this is the earlier development of private equity in France. Some French GPs feel that the business community in France is, as a result, more at ease and better informed about this type of financing. And, in contrast to large corporations such as France Télécom and Vivendi, where the French state still has some strategic or economic interest, corporate governance within mid-market companies remains independent.

The investors' perspective
The French market is arguably attractive. But how do investors view the current situation?

There are certainly opportunities within the French mid-market and this should remain the case for years to come. The general business environment is also moving in the right direction, even though there are still improvements to be made. Therefore, the main concern regarding the attractiveness of the French market is the current tide of strong competition that, with the number of mid-market funds coming to the market, looks set to continue or even increase.

The buy-out market in France has become the second largest in Europe by number of transactions and value. It cannot be ignored. But success in France from an investor's standpoint, as in all other private equity markets, will depend on the selection of the right team and its ability to source and manage the best deals. Some excellent deals have been done in France, but it would be foolish to invest there simply to pursue a geographical allocation. An investor looks to back the team that can make a true private equity return. If you can do that in France, all well and good. If not, as an investor, you'll look for a team that can do that elsewhere.

Elvire Perrin is principal and Jenny Finlay is associate of Altius Associates, a specialist private equity adviser for institutional clients.

Copyright © 2003 Altius Associates