Only the fittest survive. Yet in a truly global economy it is often only those with the cash to expand that thrives and survives. And Italian companies, often small to medium sized concerns, usually know this better than most. Yes, says Roberto Zanchi from Milan legal firm Pavia e Ansaldo, the credit crisis has seen a general tightening of capital investment, but private equity deals are still being done he says. “Much of the deals we are seeing are for heavy industry projects. Energy. Heavy industry. But Italy is always a bit special in this regard. We have so many more modest sized companies so that, in a sense, means the targets are much wider.”
Yet on home ground, more unpredictability is underfoot. Romano Prodi’s limping left-of-centre government is expected to be replaced shortly, possibly by Berlusconi once more. The euro’s strong rise has also piled pressure on Italy’s exporters. (Some critics even suggest Italy could be tempted to leave the eurozone – but such a move could also bring huge economic instability).
So, given that Italy remains in dire need of an economic overhaul, private equity and mergers are probably even more likely.
Sector lowdown
Italian M&A/private equity activity predominates in several sectors, notably energy, fashion and heavy industry. Despite the difficult of raising capital, the fractured nature of Italy’s industries – namely a lack of cohesion and collaboration also aids opportunity for investors. Taking the long view, Italy’s economic woes are also nothing new – and perhaps investors should also take comfort from that, despite Prime Minister Prodi being voted out of office, subsequently unleashing a political power vacuum.
But international investors do gain from Italy adopting much of its M&A modelling from the US and the UK says Zanchi. Many M&A agreements resemble Anglo-Saxon practices. Also the level of Italian legislation is highly developed when it comes to tender offers he adds. General principles of Italian law, including the issue of good faith, also protect investors within the Italian legal framework.
The EU has also had a positive influence, particularly with its Directive on Crossborder Mergers, making acquisitions easier.
A good time to buy?
It’s difficult to know the implications of a return to power by Silvio Berlusconi. Zanchi says that even if Berlusconi’s Forza Italia party returns to power, he doubts the economic climate will change dramatically. “Really, the ability to make more or less deals is linked, we would say, to the general economic conditions, rather than by a specific approach or line taken by the political parties.”
However Italian growth was only 1.5 percent last year – little more than half the eurozone average of 2.7 percent. Which means the eurozone’s third largest economy continues to underperform, affecting valuations. Productivity remains low across many Italian industries and the unofficial black market economy remains frighteningly high. Part of the problem for many Italian companies is being tied to the euro. Without being able to periodically devalue its economy – as Italy regularly used to do with the lira – it has become much more difficult to keep its exports competitive.
Certainly with the current credit uncertainty, those international investors electing to buy now could be a canny move says Mr Zanchi. But Roberto Zanchi warns that striking the right balance between a fair price and valuation for assets – not to mention getting the right mix of capital and debt – needs careful weighing. “Banks are being more prudent these days with their lending. There is a different ratio of debt and capital required.”
Personal relationships are key
Despite some economic gloom and more political uncertainty, many Italian small businesses are increasingly feeling more confident about the economic opportunities available says Zanchi. “Certainly in the last nine months or so, we’ve seen a lot private equity interest and that means that these smaller companies correspondingly feel a greater sense of opportunity.”
Hanging on though for the highest bidder is not typical behaviour for many Italian family-run companies however. Because of the often huge family sensitivities about their business, any sell is often based on good personal relations between the parties, not just hard cash says Zanchi. “Often it’s about having a good personal feeling between the parties. So a deal is not always about reaching the highest price. It’s also often about making sure there is a minority stake too, so that family interest is retained.”
Italian business has also become particularly sensitive to previous private equity operators buying up businesses only to sell them on, dismembering the less profitable parts quickly. “What is important is to give the seller the sense that everyone gains – all the shareholders –from a deal. It’s not just about the money.”
Given the increasing rise of M&A and private equity deals, many Italian companies are also feeling more confident about just how negotiations are structured. Increasingly it is about the seller’s priorities reminds Zanchi, not just the buyer’s priorities. “We have had so much competition now from private equity buyers that many Italian businesses are becoming more adept, more confident at handling their own interests. It also makes the transaction easier when all parties are aware of just what everyone is getting into.”
Negotiating the hoops
Despite the obvious attractions of many Italian businesses to the private equity community, there remain considerable obstacles to navigate warns Zanchi. For example, a wave of new Prodi-led business regulations has attempted to force companies to restructure. Some companies are still in the stages of revamping their own internal workings which could mean problems further down the line.
However, leveraged deals are growing in acceptability and there is a growing acceptance of employee financial instruments, even if the Prodi administration deliberately held back progress back here.
Specific pitfalls
Labour relations are critical, with many Italian companies taking a ‘freestyle’ approach to company and employment law. Differences can be stark between north and south in terms of interpreting the law, and the input of the unions are always critical
Italian privacy legislation can be obstructive, especially for international investors wanting to dig deep below the surface
On-going social security responsibilities can be onerous and complex to understand, especially for overseas investors. The Prodi-led administration has done much to shore up workers rights, making it harder to employ part-time and temporary staff warns Zanchi
Be aware that Italian business legislation has made more progress in ensuring agreements do reflect all the terms of a deal says Zanchi. This means more flexibility for dealing with existing by-laws and provision against third parties. “And it means more protection around issues such as lock-up and rights of minority and majority shareholders, plus veto powers.”
Debt level and management control is critical
The current credit crisis has certainly made a difference to possible lending routes. But a private equity deal using a leveraged structure will mean a level of indebtedness. “That’s probably one of the most important issues for Italian companies now. Can the target company continue to repay the debt following such a move?”
Zanchi adds that any international buyer will need to look very carefully at how they retain management. “It’s such a critical aspect. One issue is how to create or structure an incentive package for the new management and to what degree it uses cash or stock options. But be aware that stock options have become less attractive under the current [Prodi] administration.”
Do be aware also that though Italian administrations can often talk enthusiastically about reform and investment incentives, following through is often less predictable. In other words, it’s important to factor in a certain amount of unpredictability, not to mention maximising your own personal protection too.
Planning your exit
Who decides when the time is right to exit? It’s a tough issue acknowledges Zanchi. “The exit issue is always a big consideration and a big part of the discussion for the parties. Often in the past, the prospective purchaser and seller would often differ substantially in how they approached this, however I would say that now it’s widely accepted that if a seller wants to take profits from their private equity transaction, then so be it, within a certain time frame.”
It’s also an issue of Italian culture points out Mr Zanchi. “The whole issue of taking profits or the consequences of an IPO is more widely accepted. But if the domestic Italian company is convinced of the private equity player’s professionalism, then that gives you a different perspective to the deal. To see it from their side. But if you don’t trust the private equity player, or their capacity to maximise returns, then you should not go with them. Full stop.”
For further information
Tel: +39 02 85 581
Email: info.milano@Pavia-Ansaldo.it
www.pavia-ansaldo.it
