Our study "European Private Equity Outlook 2011" describes new challenges facing the industry

• Although the capital market has recovered after the financial crisis, the long-term prospects remain uncertain
• The volume of M&A transactions is rising, especially in the automotive, capital goods, business services and consumer goods industries
• The overall financing climate is improving, but major takeovers remain the exception; the focus is very much on medium-sized transactions
• Both strategists and Asian investors are stepping up their M&A activities in Europe
• Boosting value through financing levers is becoming increasingly difficult – the focus should be on developing innovative business models for the portfolio companies
• Refinancing pre-crisis transactions poses major challenges in the medium term

The European private equity market bottomed out in 2009 and has since been noticeably gaining momentum. For example, M&A transactions already rose 52% to EUR 36 billion in 2010, a positive trend that will continue in 2011. In this context, strategists and Asian investors are becoming more active. Transaction security in the mid-cap sector is improving thanks to better pricing and a better financing environment. In addition, more and more investors are deciding at the last moment whether to sell a company to a strategist or financial investor, or whether they should place their trust in an initial public offering (dual track exits). Medium-term challenges will include boosting value with innovative business models for the portfolio companies, and finding solutions to upcoming refinancing problems. These are the most important findings of "European Private Equity Outlook 2011," a study by Roland Berger Strategy Consultants.

"Fresh movement came into the private equity market in 2010 following the sharp downturn in 2009," explains the study's author Gerd Sievers, Partner at Roland Berger Strategy Consultants in the Corporate Finance Competence Center. "But we are still a long way from regaining pre-crisis levels." The transaction volume on the European private equity market had reached EUR 54 billion in 2008, after all – about 50% higher than in 2010.

Focus on medium-sized transactions

The limited availability of credit and the volatility of the market are still restricting acquisition opportunities and exit options. Leverage levels of around 3.5 to 4 times a company's EBITDA require high equity participations in takeovers. Major M&A transactions with volumes in excess of EUR 1 billion are therefore likely to remain the exception. At the same time, the European private equity funds have access to cash reserves of about EUR 170 billion. "This liquidity will lead to strong competition in the transactions, because in some cases these will have to be invested quite soon, before the funds expire. Furthermore, the competitive pressure is being increased by strategic investors who are increasingly returning to the table in transactions," says Sievers. "Particularly in the automotive, capital goods, business services and consumer goods industries, we expect a larger volume of M&A transactions this year."

Improved transaction security

In 2010, only about 74% of the acquisitions that were announced actually went through. In 2008 the figure had been more than 80%, in 2005 over 85%. This trend shows that banks are scrutinizing the M&A risks more closely. Improved general market conditions and the performance of many companies in the current year will now contribute toward a higher level of transaction security.

It seems likely that more private equity investors will – for security reasons – opt for dual-track processes when selling their portfolio companies. The idea is that investors don't decide until the last moment whether to sell the company to a strategist or financial investor – or to place their faith in an IPO. This trend is also a result of the current development on the capital markets, which have stabilized again after the crisis.

Investors from Asia and the Middle East are pushing onto the European market

In the crisis of 2009, it was clear that Asian investors were keeping a low profile when it came to takeovers of European companies. By 2010, however, their interest was already rising again. Strategic investors from China and India in particular are very active on the European M&A market: the number of M&A transactions in Europe involving Indian investors doubled in 2010 compared to the previous year, rising from 9 to 18; the number of Chinese investors in European acquisitions rose from 13 in 2009 to 18 in 2010. "The reasons why foreign investors are getting more involved in the European M&A market are quite obvious: by acquiring European companies, foreign investors gain access to important technologies and Western European customers. For buyers from Asia and the Middle East, this is an important step toward advancing the internationalization of their business," says Sievers. The transactions are a particular challenge for the sellers: they must not only overcome language barriers, but also adjust to a different approach to corporate acquisitions.

Long-term trends: solution of complex refinancing issues and development of innovative business models

More than EUR 100 billion of debt from pre-crisis transactions will probably have to be refinanced by 2015. "Yet the special challenge is not just the reluctance of banks and the capital market to get involved in large-scale financing; it's also that the number of funders and funding types has risen considerably in recent years. This makes it more difficult to find mutually agreeable solutions, bearing in mind the increasing complexity of transactions," says Sievers. "Mediation between stakeholders with different interests is becoming more and more important. In other words, refinancing plans will increasingly require more sustainable ideas in unstable environments."

In future, private equity funds will be able to master this balancing act only if they subject both their financing and business models to a fundamental review. "If private equity investors want better margins and sustained growth, they need to work on new business models for their portfolio companies, because good sales revenues can no longer be generated by quick buying and selling." Investors therefore have to get increasingly involved in the day-to-day operations of the portfolio companies; they may also need to enter new markets with innovations, which will require investments. Only then will investors be able to generate added value when they sell the company.