At the annual symposium of the Italian Venture Capital Association, AIFI, the prevailing mood was one of optimism grounded in a domestic private equity market that is currently manifesting record levels of activity.
Statistics for 1997 unveiled at the meeting showed that private equity investment broke through the L1,000 billion (ecu 510 million) barrier for the first time in 1997, corresponding to a 17% increase in investment rates, while new funds raised topped the L2,000 billion mark, a 45% gain on the previous year. AIFI also announced an average 31.2% gross IRR on realised investments over ten years from 1986 to 1996 – the first time the association has made performance data public.
AIFI collected statistics from 56 investment groups, of which 51 of whom are members of the association and 39 were active on the investment front during the year under review.
Investment Activity
In 1997, Italian private equity investors provided L1,164 billion of equity to 209 companies in 234 separate investments. This level of activity represented a 17% increase in total investment value and an 18% rise on the number of companies backed in 1996 (Table 1).
Buyouts for the first time absorbed a greater proportion (32.4%) of the total invested than either replacement capital or expansion capital investments, which stood at 29% and 26%, respectively (Table 2). Early-stage deals lagged well behind all other categories in value, accounting for only L142 billion, or 12.2% of the total invested. If deal distribution is analysed by the number of fundings undertaken in each stage category, however, this ranking is completely reversed, with early-stage deals accounting for almost 40% of investment activity during 1997 and buyouts a mere 11.5% (Table 3).
This discrepancy between the importance in number and value terms for both early-stage deals and buyouts is a pattern common to virtually every private equity market in Europe. The relatively high proportion of early-stage deals being funded in Italy is encouraging. However, the very small average deal size in this category, L1.5 billion, suggests that the trend for larger start-up and early-stage fundings becoming apparent in other European markets has not yet been felt in Italy. Nevertheless, early-stage investment rose appreciably in both absolute and relative terms between 1996 and 1997.
The proportion of total capital flowing into Italian technology companies, at 6%, was also low in relative terms. The comparable figure for the UK in 1996, for example, was 16% of total equity investment.
Analysis of 1997 activity by investor type (Table 4) reveals international investors as the most active group in terms of investment volume, accounting for just over 30% of total market value. International investors were involved in only 16% of 1997’s total deal population; as one might expect, investments by these groups were concentrated at the top end of the market.
Italian banks and bank-related vehicles were the second most active group in terms of investment volumes, providing 28% of total equity invested in 1997. Their 22% share of the market in terms of number of deals, however, was slightly higher than that of the international investors, reflecting the banks’ greater access to, and involvement in, the Italian middle market.
Public sector groups and Italy’s cooperative sector were the most prolific investors in terms of the number of companies backed and were active principally in seed and start-up investments, dominating that market segment to much the same extent that international investors dominated the buyout sector.
The domestic banks and investment companies were the principal sources of finance for the expansion and replacement capital deals, which combined make up the greater part of Italy’s private equity market.
Realisations
The Italian private equity industry’s cumulative investment portfolio stood at L3,500 billion at cost invested in 819 companies at the end of last year, an increase from L2,700 billion commitrted to some 710 companies in December 1996.
During the course of 1997, AIFI recorded 126 divestments with a value at cost of L377 billion. These figures represent an 8% increase in terms of exit numbers and a 1% increase in divestment value at cost over 1996 divestment activity.
Trade sales remain the most important exit route for Italian private equity investors, as for their European counterparts (Table 5), and here 74 investments were sold to trade purchasers during 1997, compared with 51 the preceding year. There was also a slight increase in the number of write-offs, to 21 from 17. The average value at cost of the investments which were written off was substantially smaller than for any other exit category, bearing out AIFI’s statement that start-up investments accounted for the bulk of write-offs during 1997.
In preparation for a major marketing exercise to international institutional investors in May, AIFI commissioned KPMG to survey the performance of Italian private equity investments over the ten years to 1996. The average gross IRR of 31.2% announced by the association is based on a sample of 100 exited transactions carried out by 14 investment groups. Although this is a relatively small sample, the headline average IRR is an encouragingly high result for a population encompassing all stage categories of investment.
Fund Raising
New funds raised for unquoted investment in Italy surged to L2,069 billion in 1997. The total represents a 45% increase over 1996’s fund-raising total, which in turn was more than double the tally for 1995. This rapid acceleration in fund raising for the Italian private equity market mirrors unprecedented flows of capital into the industry throughout Europe.
The banks, which have historically been the principal source of capital for private equity in Italy, retained their leading position last year, accounting for 46.5% of funds raised (Table 6). The proportion of capital raised from pension funds – all non-Italian – reached 12.5%, double the 1996 share.
This in turn reflects the most significant development on the Italian fund-raising front last year; domestic capital sources, which provided more than 86% of the total raised in 1996, saw their share of the market decline to 47% (Table 7), a 26% drop in terms of cash committed. Twenty-four per cent of funds raised in 1997 came from institutions elsewhere in Europe, while non-European investors, which were completely absent in both 1995 and 1996, re-entered the market, providing 29% of total funds raised.
The increased contribution of non-Italian investing institutions is symptomatic of the pan-European or global, rather than country-specific, private equity investment strategies increasingly adopted both by management companies and by institutional investors.
Outlook
Commenting on developments during 1997 and looking to the future, AIFI chairman Marco Vitale pointed to the vitality of the domestic merchant banking sector, but emphasised that these groups still needed to improve their understanding of the nature and needs of quality family-run businesses. “If they wish to attract business from this [family-run] segment of the market, merchant banks must offer more than finance”, he warned. “Over the next few years, the distinction between merchant banks with purely financial expertise and those which take a more creative, open and imaginative approach will become more clearly marked”.
Although the flow of venture-backed companies seeking IPOs has been slow to date, middle-market role models have emerged. Marco Vitale predicted that the Italian Stock Exchange, which he said “has finally rid itself of its “illegal gambling house’ image” following recent reforms, could now play a major role in the development of Italy’s private equity market.
Italy’s venture capitalists are still waiting for the government to improve the tax regime in a way that will have a significant impact on the private equity market. The Super DIT (Dual Income Tax) legislation, which was expected to provide a real impetus for private equity investment, has in fact had very little effect.
Marco Vitale said “a strong fiscal stimulus could give a significant thrust to the development of the unquoted investment market in Italy, a development which would be of social, as well as economic, importance”. The effects of such a measure would be particularly beneficial at the smaller, early-stage end of the investment spectrum.
The statistics for 1997 suggest that the Italian private equity market is beginning to fulfil its much-vaunted promise, particularly in the buyout arena. There is sufficient capital, from both domestic and foreign sources, currently available for investment in Italy to fund further increases in investment levels in the immediate future.
The 40% increase recorded in AIFI’s membership during the course of last year is a further encouraging sign of the growing dynamism of the unquoted investment sector in Italy. It is to be hoped that the success stories now emerging, combined with the increasing dominance of international investors in certain market segments, will encourage the rest of Italy’s domestic investor community to participate more enthusiastically in the private equity market in the coming years.
Table 2: Stage Distribution of Italian Private Equity
Investments, 1996 – 1997
% of total investment 1996 1997
Seed/Start-up 8.9% 12.2%
Expansion 43.4% 26.4%
Replacement 17.5% 29.0%
Buyout 30.2% 32.4%
TOTAL 100.0% 100.0%
Source: AIFI
Table 5: Distribution of Divestments, 1997
Value at Cost
(L billion) % Number %
Trade Sale 249,006 66.1% 74 58.7%
IPO 43,337 11.5% 4 3.2%
Other 68,166 4.3% 27 16.7%
Write Off 16,340 18.1% 21 21.4%
Total 376,849 100.0% 126 100.0%
Source: AIFI
Table 6: Origin of 1997 Funds Raised for Italian Private Equity
Investment
Amount
(L billion) %
Banks 964,766 46.5%
Pension Funds 258,044 12.5%
Private investors 214,556 10.4%
Insurance companies 114,495 5.5%
Corporate investors 69,796 3.4%
Other 87,862 4.3%
Reinvestable capital gains 359,958 17.4%
TOTAL 2,069,447 100.0%
Source: AIFI
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