French election rattles private equity nerves
Nicolas Sarkozy is anxious to win the first round to gain some much-needed momentum
Even by the fiery standards of French electoral politics, François Hollande’s recent attack on the private equity industry’s debt-fuelled buyouts stood out for its vitriol.
Speaking at a forklift factory facing impending job losses following a private equity takeover, the Socialist candidate and frontrunner in Sunday’s presidential election vilified “financial groups who swoop to take the substance of a company and then sell it on”, calling for new laws to ban leveraged takeovers.
His tone was reminiscent of private equity’s boom years, prior to the 2008 collapse of Lehman Brothers, when buyout funds were branded as “locusts” by a leading German politician. Regulations were put in place there to restrain the industry.
Parisian private equity executives are now trying to establish whether and how their sector – by most measures the most active in continental Europe – would change should France swing to the left.
Patrick Sayer, head of Eurazeo, an investment group, says the rhetoric should be taken with a pinch of salt. “There has always been a big gap between political discourse and subsequent impact,” he advises.
Though no-one expects a moratorium on buyouts, most are realistic that the industry faces disruptive new rules should Mr Hollande be elected.
One widely expected measure would curtail the tax breaks available to companies whose profits are lowered by outsized interest payments linked to buyout debt.
Already revised by Germany and Spain, the way borrowing is considered for tax reasons is especially important for private equity-owned companies, whose balance sheets are typically heavily loaded with the debt used to fund their own acquisition.
Denis Ribon, a Paris-based partner at 3i, the London-listed private equity group, points out that leverage has in any case dried up in the wake of the financial crisis, but the measure could nonetheless curb the industry’s buyout powers.
“If you reduce the deduction of interest, it will ultimately be reflected in the valuation of target companies,” he says. “That could give an edge to industrial buyers vying to take over the same assets.”
Other tweaks to the tax code may be afoot, notably around how capital gains are taxed. This would impact “carried interest”, the profit-sharing scheme that has turned many of the industry’s top executives into millionaires.
Ahead of the elections, the private equity industry is trying to paint itself as a job-creating backer of French business, funding politically popular small and medium enterprises.
“Private equity plays a useful role in providing liquidity to shareholders,” says Hervé Schricke, head of Afic, the French private equity trade body. “It also helps keep companies in France by allowing them to finance their development locally.”
Most of the €6.5bn raised last year by French funds to pursue buyouts came from foreign investors, he says.
Senior executives also point out that with banks curtailing lending to meet new regulatory requirements, capital from private investors is doubly important.
Despite some high-profile rhetoric by Mr Hollande against the world of finance, the Socialist economic team is seen as well plugged into the workings of Paris as a financial centre.
If the sector is tapped for tax revenue, “it will be more out of necessity than out of ideology”, says Lionel Zinsou, head of PAI Partners, a Paris-based fund, who has served as an adviser to Socialist ministers in the past.
That could change if legislative elections in June result in a coalition, which includes far-left parties, whose candidates got more than 13 per cent of the votes in the presidential ballot.
Ultimately, the uncertainty is what could have most impact, at least in the short term. Private equity firms rely on elaborate models to value their target companies, and even a small change in tax rates or regulatory costs can have a big impact over the life of an investment.
“The more instability there is around those elements, the more investors start to worry,” says Arnaud Mourier, at Paris-based law firm Taj.
Should private equity investors be spooked, France’s loss could turn into a gain for its neighbours.
“The climate is such that if the same investment opportunity came up in Germany and in France right now, that would tip the scales in favour of Germany,” says a senior European partner of a large US fund active in both countries.
“Other economies, notably the UK, are making far more investor-friendly sounds right now,” the investor adds, pointing to the planned 5 per cent decrease in the top rate of income tax, to 45 per cent. By contrast, Mr Hollande has proposed a 75 per cent tax rate for those earning more than €1m.