New World Financiers, Old World Startups
Francesco Caio is one of Italy's best-regarded young executives. He made a name for himself at mobile operator Omnitel in the mid-1990s. Then, in 1997, he took the helm of white goods manufacturer Merloni Elettrodomestici and helped make it a serious European player. Last year, he decided to try to repeat the performance, but this time in the tech industry. So he moved to a fledgling Internet service provider code-named Excalibur.
So far, no big surprise. Like many of Europe's rising stars, the 42-year-old Caio took a chance and responded to the strong lure of the New Economy. Less obvious, though, is the partner who will be bankrolling Caio's new company. American investment bank Morgan Stanley Dean Witter is talking about putting up as much as $300 million in return for a major stake.
Increasingly, the Old World is where financiers from the New World are duking it out. The big American banks--from Morgan Stanley to Goldman Sachs and Chase Manhattan Corp.--are starting to put money directly into businesses in hopes of earning Silicon Valley-style returns of 1,000% or more. Or they are hurriedly raising cash so that they can (table). The sources of the funds vary. Morgan Stanley usually puts in about 10% of its own money and secures the rest from wealthy individuals and institutional investors. Chase, though, largely relies on its own resources.
NO MATCH. American investment houses already dominate European corporate finance. Until now, though, their emphasis has been on restructuring mature corporations. But today, they think, the big money is in high-tech investing. And it's the American banks, again, that are capitalizing on this shift. The likes of Goldman, Credit Suisse First Boston, and Morgan Stanley have built up a great deal of New Economy expertise by working with Silicon Valley companies. Besides, they have lots of cash. So far, the European banks have proved no match. "We have a huge advantage over indigenous players," says Jonathan C.C. Meggs, a partner in Chase Capital Partners in London.
Morgan Stanley, for one, is now putting 80% to 90% of its available European private equity capital--or about $1.5 billion--into younger businesses rather than traditional leveraged buyouts of older companies. "Bidding for mature companies is generally less interesting than for growth companies," says Bernard Gault, an executive at London's Morgan Stanley Dean Witter Private Equity.
Maybe. But there's still plenty of profit in leveraged buyouts. The recent European merger boom means that lots of companies are selling off noncore businesses--the usual LBO fodder. European companies also are less tightly managed than their U.S. counterparts, leaving more scope for cost cutting. And with the launch of the euro last year and the advance of the single market, there is a once-in-a-lifetime opportunity to create huge regional companies. "Europe represents a far richer opportunity to execute LBOs of mature companies than the U.S.," says Richard Sharp, co-head of European principal investing at Goldman Sachs.
But the traditional buyout business is dominated by LBO firms. Major American outfits--such as Kohlberg Kravis Roberts and Hicks, Muse, Tate & Furst--all have European operations, which compete with established locals such as BC Partners and Schroder Ventures. In the past three years, the American firms have raised about $60 billion to pursue deals in the region.
Luckily for the Morgan Stanleys of the world, fast-growing industries such as e-commerce and telecom now offer potentially higher returns just as LBOs are becoming more expensive and, therefore, riskier. In fact, Europe is turning out to be a much hotter tech market than many bankers had hoped even two years ago. It leads the world in mobile-phone technology and is spawning plenty of respectable Net competitors. And because there are far fewer European tech players, bankers say that local initial public offerings are likely to fare better than those in the U.S.
European tech investing is also less competitive than in the U.S. While California is crawling with venture capitalists, there are still relatively few of them in Europe. The big banks, which all maintain offices in the main capitals, are well-positioned to spot promising deals. Morgan Stanley, for example, invested $140 million in Paris-based Equant, a private data communications service for airlines, in 1995. Over four years, it built the company into a global data communications network. The bank has sold most of its stake for a $3 billion gain. Caio, who was an Equant board member, was suitably impressed. "It would be nice if Excalibur can achieve anything close to that," says Caio, who is investing some of his own money, too.
Deals are now flowing thick and fast. Goldman Sachs recently bought into the European rollout of Sports.com, a sports Internet portal. J.P. Morgan & Co. is backing flamboyant entrepreneur Richard Branson's bid for a third-generation mobile-phone license in Britain. It's also putting in a $40 million bid for a Spanish wireless data network license. Chase has backed PrimaCom, now the third-largest German cable system. It is also funding a $100 million London-based venture called Episode-1 that will go after Net deals. Of course, not all the deals are winners: Morgan Stanley lost all of the $45 million it invested in Ionica, a British wireless-technology company, when the firm went bankrupt in 1998.
All the same, investment banks are eager to fund fast-growing tech companies because it's a good way to lock up future business. If a bank controls a company or has a major stake, it is likely to have the inside track on a future IPO--where fees can amount to 6% to 7% of the money raised.
The banks' increasing involvement in tech investing has made European venture capitalists wary, though. Ronald Cohen, chairman of London-based Apax Partners & Co., believes that the banks could be putting some of their IPO business at risk. He says he would think twice about sharing confidential information about a startup with an investment bank that might have a stake in a competing company. "This begins to put a different perspective on banks like Lazard" that stay away from private investing, he says.
CONFLICTS OF INTEREST? The investment banks' growing participation in the private equity business makes LBO firms nervous, too. They have traditionally been key clients of the investment banks and sometimes invest with them in deals. However, the buyout specialists worry that banks will compete with them for the more conventional turnaround deals--or skim the cream for themselves. Concern about such conflicts of interest is one reason why Merrill Lynch & Co. has been slow to launch its private equity effort in Europe.
For now, however, most American banks aren't all that worried. They know that high-tech companies still feel more comfortable with firms such as Goldman or Morgan Stanley in charge of their IPOs. And the banks are willing to bet that venture capitalists such as Cohen will trust them to keep information confidential when necessary. The reality is that the European investment opportunities are just too big to pass up.