Luke Johnson: For all its troubles, Italy is still worth investing in

Serial entrepreneur Luke Johnson on why he took a punt on a business in Italy, the poor morale in the M&A community, and why we need a better stock market for small companies.

by Luke Johnson
Last Updated: 21 Dec 2012

By inclination, I am a contrarian investor and so I recently backed a mini-conglomerate with various assets in Italy - not a place which is exactly flavour of the month. The business owns a hotel, a water park and restaurants, among other assets, and appears good value on certain measures. Time will tell if I am clever or a fool.

It is easy to be bearish about Italy. Its economy has been stagnant for years, its banks are weak, its demographics are worrying, it has a reputation for poor governance, the state has enormous debts and the national mood is very gloomy. However, Italy also has huge strengths. Households are actually far more solvent than British ones. In areas such as design, fashion, food and drink, and manufacturing it has many outstanding companies. From Ducati to Ferrari, from Tod's to Prada, from Luxottica to Barilla, Italians are world-class exporters and brilliant engineers. Like much of Europe, it suffers from being locked into the euro at the wrong exchange rate - but that may change.

Meanwhile, the industrial base is highly fragmented - it has far more smaller, family-owned firms than almost any other comparable country.

This affects Italy's competitiveness, but also offers opportunities for consolidation. Given the extreme pessimism among the entrepreneur class in Italy, I believe there will be investments available on attractive terms in the coming years. Some might be distressed, some might be in the hands of banks, and others may well need capital expenditure and restructuring.

Whatever happens, I am sure the journey will be educational. There are many Italian citizens who are desperate for change and want to build a brighter future. I have already met a number of impressive, enterprising individuals who are working hard to build winning firms and help turn their country round. Europe needs them to succeed.

Let us hope this year is a better one than the last. For those who invest in private companies, it has been profoundly frustrating; one of the most disappointing I can remember. We found it extremely difficult to put new money to work profitably - and wasted lots of fees to accountants and lawyers on aborted transactions.

Meanwhile, corporate finance professionals are being laid off at many firms and morale in the M&A community is poor. The volume of deals has slumped to multi-year lows. But intermediaries and private equity executives I talk to say 2013 will be an improvement, and I am fairly confident they are right.

There are rational grounds for such optimism: eventually, businesses will want to raise capital to expand - while others will be unable to put off selling any longer. Meanwhile, many entrepreneurs are expecting their profits to recover further next year, which should mean the gap between buyers and sellers is reduced.

There have also been some real positives from a difficult period.

In 2012, four of my more substantial investments - Patisserie Valerie, APT Controls, Gail's and Giraffe - all increased profits by 20% or more. A clear demonstration that even in a sluggish economy, sound companies can still make excellent progress. Moreover, organic growth - rather than growth driven by acquisition - is generally of a higher quality. So, really, I should have no complaints.

I believe investment activity would recover if the stock market for smaller companies could be revived. This is a crucial funding mechanism for emerging firms, and for some years it has been moribund.

New issues in London - save for a few overseas mining companies - have fallen to levels not seen for decades. When I worked as a stockbroker almost 30 years ago, more than 150 businesses a year were being floated. Now, either domestic industry lacks the appetite to go public or investors see no attractions in backing British enterprise with fresh capital. Of course, the availability of private equity has increased dramatically, but the majority of this finance is for leveraged buyouts, not development capital. Most of the cash flows out of the business.

The stock market is important because it represents one of the most visible aspects of capitalism in action. Private investors in quoted stocks are pure capitalists. Britain needs more of them because they naturally become advocates for free enterprise and the private sector. And the most exciting and vital elements of the entire system are new firms going public.

Some might argue that there are no appetising situations to support. But I believe there are decent firms that would raise equity if the conditions were right - and institutional and private investors would surely get involved if the story was sufficiently compelling. Angel investors and venture capital trusts can only do so much. The big managers of money must get involved.

Regulation, taxation, high fees, fears over legal liabilities and the way pension and insurance funds are managed have combined to inhibit local, entrepreneurial companies from undertaking IPOs here. If this continues, it will have damaging long-term consequences for wealth creation, job prospects, exports and our overall economic standing.

A recent document called The Drury Report made some constructive recommendations on how to boost investment in so-called 'gazelle' companies that need equity, but do not want to sell out. And my friend Michael Spencer at Icap bought Plus Markets a few months ago. I sincerely hope he can revitalise it. Meanwhile, the London Stock Exchange must massively up its game at AIM, by doing whatever it takes - cutting red tape, fees and selling it hard to new entrants.

- Luke Johnson is chairman of Risk Capital Partners

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