Brogue traders

The Irish economy has been hit by the cold light of reality following the economic downturn. David O’Donnell reviews the activity in the corporate market

The global economic slowdown has forced the Irish economy to climb down from the dizzy heights reached in 2000 to a more realistic pace. After almost a decade of hectic growth, the Celtic Tiger has caught a cold – but it has not gone into meltdown.

A favourable corporation tax regime, a well-educated workforce, the switch from a reliance on manufacturing to high-tech and international financial services, and the return to Ireland of experienced Irish professionals from all over the globe, are among the factors that have contributed to the growth of Ireland’s economy.

Activity in the M&A, venture capital and stock exchange sectors has grown steadily since the early 1990s, with a slowdown becoming evident from around mid-2001.

As we head towards the end of 2002, the year can best be described as a wake-up call for all the participants in the market. There were no initial public offerings (IPOs); instead, there was a healthy stream of candidates ready to abandon the markets. Venture capitalists concentrated on their existing portfolios. Distressed sales and restructurings were the order of the day.

In mainstream mergers and acquisitions, 2002 followed the pattern of slowdown experienced in the second half of 2001. Valuations fell, fundraising on the public and private markets collapsed and many companies were squeezed tightly, especially those in the technology sector. Those companies that did not react quickly found themselves having to restructure or going in to receivership and/or liquidation. Many companies in this environment became potential acquisition targets for those in the business of feeding at the bottom of the market.

Foreign companies continue to see Irish businesses as a good buy, especially state-owned undertakings. Acquisitions from the state in 2001 included the Bank of Scotland’s purchase of ICC Bank, the US-based petroleum company Tosco’s purchase of the Irish National Petroleum Corporation and Dutch bank Rabobank’s purchase of ACC Bank. US acquirers are estimated to have spent in excess of e3.53bn (£2.25bn) on Irish acquisitions, with UK companies spending in excess of e500m (£319.3m).

Foreign acquirers remained busy in the Irish market in 2002. German multinational Gehe acquired Unicare, an Irish chain of pharmacies, for around e110m (£70.2m) and the Dutch group VNU bought a majority stake in directory company Golden Pages for e185m (£118.1m).

Irish companies were also busy on the acquisition trail, with CRH spending more than e630m (£402m) in the first six months of the year and retail group Musgraves splashing out e367m (£234.2m) on its Budgens acquisition. Allied Irish Bank (AIB) is about to complete the disposal of the now infamous All First Bank to M&T Bank, with AIB ending up with just over 20 per cent of M&T as part of the deal.

This year, Bank of Ireland has touted a merger with AIB and made an approach to acquire Abbey National in the UK. Neither has become a reality so far.

IPO activity was non-existent in 2001. The proposed flotation of national airline carrier Aer Lingus never materialised, although the Irish government had invested significant time and money in the project. The only equity listing on an Irish equity market in 2001 was Conduit on the ITEQ (the technology market of the Irish Stock Exchange). Conduit had already listed on the now defunct Neuer Markt in June 2000, raising e56m (£35.7m) to fund its information service and software businesses.

The first half of 2002 was not by any means a good few months for the Irish Stock Exchange. The two candidates for flotation – namely major Irish drinks company Cantrell & Cochrane and videoconferencing business Spectel – both failed to get off the blocks, being jilted at the IPO altar. Indeed, there is a major shortage of new companies coming to the Irish Stock Exchange.

There has been a significant number of companies delisting over the last few years, 11 having delisted last year, and this trend does not look like it will be reversed in the short term.

Many of the companies listed on the Irish Stock Exchange seek a dual listing on the UK Listing Authority (UKLA), with technology companies opting for their dual listings on Nasdaq or the Neuer Markt. Recently, however, there has been a trend in secondary stocks dropping their UKLA listing and, in the case of educational software player Riverdeep, leaving Nasdaq.

Originally a unit of the old International Stock Exchange, the Irish Stock Exchange is now fully independent of London, but uses the UKLA Listing Rules along with some local rules in its ‘green pages’.

Ireland has its own takeover panel, established by statute in 1997 and active on that basis since 1 July 1997. Its rules (the Green Book) resemble the City Code ‘Blue Book’, with some differences of substance and presentation. For example, the notes to the rules are not presented with the rules themselves, but are in separate orange pages at the back of the rules.

The key substantive difference between the London panel and the Irish Takeover Panel is that the Irish panel is established by statute and expressly subject to judicial review. It also means that a mandatory Rule 9 bid can be enforced by court order.

While sceptics may well question, in light of globalisation, the long-term feasibility of the Irish Stock Exchange for quoted Irish companies, it is worth noting that the Irish Stock Exchange is now recognised worldwide as a leading centre for the listing of investment funds. Since it began listing funds in 1989, it has listed in excess of 1,300 funds and sub-funds. The funds do not have to be domiciled or incorporated in Ireland to be listed on the exchange. Given that the Irish Stock Exchange is long-established (since 1793) and a well-regulated and reputable European exchange, it has proved an attractive listing in helping to expand the potential investor base of a fund.

The Irish Stock Exchange launched a new service in 1999 for the listing of asset-backed securities, securitised bonds and warrants. So far this listing service has proved popular, with 95 new issues in 2000 and total listings of 150 to 30 June 2001. Issues to date include Bear Stearns’ commercial mortgage securities (the underlying asset was a mortgage on a resort and country club) and Hobart Property and Hobart Leasing (where the underlying assets were some Sainsbury’s supermarkets).

So where is the Irish Stock Exchange headed? As the European stock markets embark on a consolidation process, it is difficult to see how the exchange will remain attractive for its listed companies wanting to reach a wider market.

One clear trend is the increase of public-to-private transactions. Ireland’s largest ever takeover of a public company took place in 2001 at the price of e2.92bn (£1.86bn). This involved the former state-owned telco Eircom, which was floated by the Irish government in 1999 with the sale of the state’s 50.1 per cent in what was a major windfall for the state’s coffers. After demerging its cellular network to Vodafone for e4.4bn (£2.81bn) in the largest private deal of the year, Eircom was back on the market in 2001 attracting significant interest from international players. In the final shakeout, the Valentia consortium, headed by former Heinz boss Tony O’Reilly and backed by private equity from Goldman Sachs, Providence and Soros, won the day.

With Eircom setting the stage in 2001, public-to-private transactions became the only game in town in 2002. Paper giant Jefferson Smurfit went private when acquired by Chicago-based private equity house Madison Dearborn in a deal worth e3.7bn (£2.36bn). Green Property also left the market in a management buyout (MBO) deal worth e1.5bn (£957m).

Riverdeep is now also in MBO mode with the search on for a private equity house to back the existing chief executive. Riverdeep recently left Nasdaq in a surprise move and for the last two years the company has been under attack for short selling.

In the same week as the announcement of the Riverdeep MBO, management at electronics transactions group Alphyra announced its intention to take the company private. Media speculation suggests that there are numerous small caps about to exit the Irish Stock Exchange on MBO tickets. All the indications are that private equity players will be kept busy in 2003 in public-to-private transactions. This presents real opportunities for foreign players in light of the dearth of Irish private equity houses capable of funding big-ticket buyouts.

Ireland is a particularly deal-friendly environment, especially when it comes to public-to-private deals. The squeeze-out percentage is 80 per cent, as opposed to the 90 per cent in the UK, and offers can be structured so as pre-existing holdings can be used to get to the 80 per cent. In addition, it is possible to structure a deal by way of a scheme of arrangement, which is pretty much the same as in the UK.

The venture capital industry in Ireland is a recent player in the corporate finance sector. Prior to its arrival on the scene in the 1980s, the only source of funding for the entrepreneur was the traditional loan from a bank.

The entrepreneurs who sought bank funding in the pre-venture capital days rarely got it, and when they did it was inevitably small when compared with the size of some of the first-round funding which now occurs. Typically, start-up businesses had to fund themselves from revenues, with possibly some minor bank loans. It is ironic how the requirement for revenue has come full circle in such a short period. What banks once required before funding, venture capitalists are now demanding. A far cry from 2000, when the investor was on the IPO bandwagon and the expectation was to go public within 18 months or less, in some cases without the company having generated revenue.

While the industry is still very much in its infancy, it has experienced rapid growth since the mid-1990s. Towards the end of the 1980s there were less than five players in the market and these were all domestic, although there was the rare intercession by a foreign player.

With Ireland’s technology boom in the late 1990s, the venture capital market experienced rapid change. The number of domestic venture capitalists increased and international players started to dip their toes into the Irish market. Today there are approximately 15 Irish venture capital houses in operation in the Irish market, and a small number of these have also made a number of investments in the UK. International players in the Irish market include Siemens, 3i, Benchmark, Viventures and B-Business Partners, to name but a few.

Today the investment landscape for entrepreneurs – in particular those involved in technology – has changed for the better. First-generation Irish tech entrepreneurs who embarked on the fundraising path in the early 1990s will tell you they had to go to the US to get their venture capital funding. These first-generation entrepreneurs, who have been through the cycle and are now embarking on their second or third venture, can now raise significant funds from Ireland. The fact that they have been through the cycle makes them attractive to both Irish and foreign venture capital houses, both of which appear happy to syndicate deals.

The US influence has been steadily creeping in to some aspects of the Irish venture capital market, which was inevitable with the spread of the US venture capital houses beyond the US. For example, the Irish venture capital market has started to embrace the down round and liquidation preference concepts.

However, the Irish market to date has not followed the US into areas that it might be ultimately beneficial to do so. Two such areas are investment documents and the attitude towards failed entrepreneurs. The use of standardised investment documents is the norm in the US, but this is not the case in Ireland. Using standardised documents would obviously speed up deal time frames and reduce the scope for negotiations. In the US, the view seems to be that failure of an entrepreneur in a particular venture is valuable experience for the next venture. In Ireland, the failed entrepreneur is not looked upon in the same way. Failure in a previous venture does not seem to be an ingredient that will attract funding in a future Irish venture.

The rate of investment by venture capital houses has slowed significantly in the last 18 months, thereby reflecting global trends.

As some investors got burnt in the tech meltdown, this has resulted in a more cautious strategy by all. Entrepreneurs were forced to have lower valuations and accept that a revenue-generating ability was now important to the investor. The day of one man and a business plan was truly buried.

Looking forward, it will be difficult for start-ups to get first-round funding from the traditional venture capital funds. Friends and family will more than likely be prevailed on to produce first-round funding. The early stage seed capital funds will once again be a sought-after player in the first-round market. There may be real opportunities for those venture capital houses prepared to take the early stage risk and which can follow their money in subsequent rounds.

For those companies that have already managed to get first-round funding and have some revenue, second and further rounds of funding should in theory be easier to obtain. Syndication of second and third-round funding among investors is on the increase. If a lead investor can be found, then it is likely that other venture capital houses will want a slice of the round. Syndications can sometimes prove tough going and require patience by all. This is often the case where investors have not worked together before and have varying investment terms on which compromise is required.

The Irish venture capital market has gone through a globalisation process over the last few years. The traditional Irish domestic players now have to compete for the deals with the overseas players. These overseas players are willing to fund the right Irish companies. The process is made easier for US and UK venture capital houses, given that English is the common language and businesses’ practices are not radically different.

The Irish Venture Capital Association (IVCA) has published statistics over the last few years that make interesting reading in relation to investment by the Irish venture capital houses. Total investment by domestic venture capital players in 2000 was e208m (£132.7m), showing an increase of 429 per cent since the first year that the survey was carried out in 1997. The domestic players also claim to have funds to invest, but the second half of 2001 saw many of them concentrating on their existing portfolios rather than leaping into new investments.

Statistics just released by another industry source indicate that, for the first six months of 2002, the level of investment by venture capital funds into technology companies has fallen by more than 30 per cent to e147.5m (£94.1m), compared with e220m (£140.4m) in the first half of 2001.

Big-ticket private equity is very much in its infancy in Ireland. Foreign private equity houses usually fund the larger deals, as evidenced by the Eircom takeover in 2001 and the MBO of Cantrell & Cochrane a few years ago, which was backed by BC Partners. If the trend towards big-ticket MBOs continues, there should be increased opportunity for private equity players in the Irish market.

Next year is not going to be an easy ride for any Irish business. For some, such as AIB and Elan, two of Ireland’s premier performing public-quoted companies over the last few years, 2002 has been a very shaky time.

AIB has been rocked to the foundation by the trading fiasco at its US subsidiary Allfirst Bank. Currency trading losses in the amount of e691m (£440.9m) have come to light as a result of allegations that a trader at Allfirst, John Rusnak, had exceeded his limits. Several investigations are now ongoing to determine how the losses occurred and several class actions against AIB have been filed in the US.

The Elan share price has taken a hammering since The Wall Street Journal queried its accounting policies. Elan might also find itself the subject of a takeover bid following the recent reshuffling of top management, which saw key management figures depart.

Other public-quoted companies, mostly in the technology and property sectors, have experienced a significant drop in their share prices due to trading conditions and are now potential acquisition targets at bargain prices. Many quoted companies are trading at a discount to net asset and are not showing any signs of making any meaningful returns to investors.

In the private company sector, casualties of the technology downfall are being purchased at prices significantly lower than the valuations they procured on their last round of funding. There will be a busy market in this graveyard sector as the technology industry consolidates in some key areas and existing investors call it a day in those companies.

Growth through acquisition will no longer be the preserve of the big players. Medium-sized companies can now consolidate their positions by buying weaker competitors and thus acquiring new customer and product bases with revenue streams. There may be a real opportunity to grow rather than waiting for organic growth.

MBOs will be used to purchase non-core or struggling businesses. Such businesses, once unshackled from the central overheads allocation of the big company, can focus on delivering real return.

M&A activity looks set to remain steady in 2003, with bidders expecting real value at the bottom of the market.

Some economic commentators claim that the Irish Minister for Finance Charlie McCreevy appears not to have helped the cause of the Irish economy. In a short period of time he has reversed out of his pre-election (June 2002) budget figures and wielded the axe with the November book of estimates. At the time of writing, the December budget looks like being a further hatchet job, with some economists urging McCreevy to take a macro approach to public finances and to consider some government borrowing, especially with the current level of growth running at around 3 per cent.

It is highly likely that the government will privatise some of the state’s companies in 2003. Candidates include ESB, Bord na Mona and Aer Lingus, which now appears to be emerging from troubled waters. The method of privatisation remains to be seen, but it is unlikely to be a high-profile flotation such as that of Eircom. A programme of privatisations will obviously generate significant activity for all involved in this arena.

David O’ Donnell is a corporate partner at Mason Hayes & Curran