The euro-zone crisis may have clouded investors' visibility with negativity but the continent still offers attractive corporate investment opportunities if identified by the right sourcing and screening process with a view to long-term investment.
In advance of considering corporate investing in Europe, one must consider the dynamics affecting three key participants today - sovereigns, banks and private equity.
The euro zone became the focal point of the global financial crisis when some of its member states required foreign assistance to refinance their debts.
The euro-zone constitutes both the debtors and lenders. More than 60 per cent of the exposure to peripherals (Greece, Ireland, Italy, Portugal and Spain) is owned by France, Germany and the United Kingdom; and just under 90 per cent of this total exposure is owned by all of Europe - so this is a European issue to solve and not one that is easily separable from the continent as a whole.
Solutions to improve the financial condition of the euro zone are difficult to implement; and virtually all proposed put pressure on GDP or put further strains on balance sheets in the near and medium term. Those in debt can address it by: increasing receipts/taxes tied to GDP; austerity measures, sale of assets (privatisations) or by assuming further leverage. Indebted peripheral countries can only push so hard before social unrest threatens their economic programmes.
Europe's ability to resolve the crisis is complicated by having so many parties at the decision-making table. While there are talented people continuing to work on solutions, sovereign dynamics should create sustained downward pressure on the euro-zone economy - an important factor when thinking of corporate investing.
Banks also play a leading role in the corporate investing dynamics. In an effort to decrease the chances of another crisis such as 2008, Basel III was created requiring increased capital requirements. To achieve this, banks must do one (or more) of the following: sell assets; raise equity (this is unlikely given the difficult economic conditions currently); generate income (this is most unlikely to contribute adequately in near term); and/or tighten financing standards.
One should expect disposition of assets and tightening of financing standards will continue for the foreseeable future.
These will continue to put downward pressure on GDP in Europe making it more difficult to find companies with adequately attractive projected growth for corporate investing.
However, since default rates correlate to tightening of financing standards, there should be arising number of opportunities as companies seek alternatives to the lack of available refinancing.
To more completely understand the dynamics affecting the environment for corporate investing, one must also assess the asset flows of private-equity (PE) participants. PE firms' dry powder (uninvested capital) is at 90 per cent of their all-time highs.
This is because 2006 to 2008 were huge fund-raising years and PE firms were not able to deploy as usual due to the lack of financing in the market. PE-backed deal volumes decreased since the crisis.
Over the past year, Europe has experienced a 50 per cent-plus decline in deal volume to US$12 billion (Dh44.08bn). A record number (1,800 plus) of funds are attempting to raise almost $1 trillion.
Capital committed to investment in corporations in Europe typically has five years to invest. Therefore, there should be willingness to deploy of capital over the next three years. This factor demands caution over the next couple years.
However, if the current conditions continue, it would be difficult to imagine market dynamics changing to facilitate deployment. This, in part, is why so many entities are raising funds now as their deployment performance is unlikely to materially change in the near term.
It is also difficult to see how it is possible to raise such amounts. A potential counter to this is that relatively attractive PE returns may create allocation shifts to the asset class as investors seek returns.
However, if that does not happen, we may well see a reduction in the number of PE participants. This means corporate investing is likely to get advantaged with time.
Interestingly, a high-level comparison between the economies of Europe and the United States shows the European Union is a $17tn economy, slightly larger than the US with $15tn. Additionally, the US is arguably experiencing the slowest economic recovery in more than 50 years of recessions based on cumulative GDP growth and job creation.
While one may invest predicated upon the continuing fall or near-term rebound of the euro zone, we believe it is more prudent to invest on opportunities without requiring such risk.
There are a range of specific, targeted strategies including: recession-advantaged industry segments; and companies domiciled in Europe without dependence on the European economy.
In the UK, there are a number of very high-quality participants in highly fragmented sectors of the education space that are well positioned to capitalise on strong international appetite.
This creates both organic and add-on acquisition growth possibilities. There are also a number of participants that benefit from well established and advanced technology or processes but whose principal markets are outside Europe.
Europe is the largest economy in the world with a strong and reliable framework for investors. It has stood the test of time and will continue to do so.
Corporate investing has slowed to a trickle yet the timing is right with an understanding of the market and asset class dynamics, thoughtfulness in sourcing and discipline in assessing opportunities.
While corporate investing in Europe can be interesting in this environment, many factors indicate it will get more attractive.
Scott Freidheim is the chief executive of Europe for Investcorp