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Investing in Italy amidst political turmoil, structural challenges and improving stakeholder dynamics – Conference Coverage

Italy, the political situation, its widening spread and the increasingly tense relationship with the EU are as topical as Brexit, these days.

While far-right, populist parties have been on the rise everywhere across Europe, Italy went beyond that when a coalition government by a right-wing League and an anti-establishment Five Star Movement was put in place before the summer, pushing the country under the spotlight once more. While the full ramifications of this, both on the domestic economy and abroad, are yet to be seen and Italy remains on the cusp of a new crisis, this can also translate into opportunities for alternative investors and restructuring advisers, panellists at Debtwire Week's Italian session last week agreed. 

The session dedicated to Italy was opened by a very vivid – despite the gloomy outlook – keynote speech by Wolfango Piccoli, Co-President at Teneo Intelligence.

“The transition that started on the 4 March has created and will continue creating volatility in asset pricing and friction with Europe, and will impose a higher risk premium on Italian assets,” Piccoli pointed out. “Coming back from this will take a very long time.”

Despite producing very thin results in the first 100 days plus of government, and with a lot of back and forth between the parties, the honeymoon between the coalition in power and the voters is still on. “They are still very popular, and they [League and Five Stars] are working surprisingly well together,” Piccoli noted.

“The budget is all over the place and [considering] the unrealistic projections [it is worked off], the only 'positive' is that the two parties are willing to compromise on things like tax amnesty to pursue their agenda,” Piccoli commented. “It will be more difficult though to find a compromise with the EU.”

Indeed, on Tuesday (23 October) the European Commission (EC) told Italy to revise its budget, an unprecedented move with regard to an EU member state. The EC voiced its concerns regarding the impact of higher spending on already high levels of debt in Italy, the eurozone's third-biggest economy. The country now has three weeks to submit a new, draft budget to Brussels, but the first reactions to the EC's rejection are suggesting a protracted arm wrestling will take place.

“The coalition government is riding a wave of euro-skepticism that is increasing across the whole continent, especially among young people. If you look at the Euro barometer [that came out last week] 60% of [Italian] voters still want the euro but only 44% of Italians would vote now to join the EU, the lowest level in all the 28 countries, including the UK. This is a worrying trend,” Piccoli said.

“Italy and the EU make good headlines, their fight will be protracted and has a potential impact on the rating agencies' decision but it is a fight over documents and papers. The real concerns for investors are domestic, in primis that no reform to improve the productivity of the country is set to be implemented,” he continued.

To finish off, Piccoli showed the outflows of portfolios, which reached EUR 33bn in May and EUR 42bn in June, bigger than in the summer of 2011, before Italy was dangerously close to losing market access in November.

“Who has been buying this stuff [Italian bonds]? The Italian banks, as usual. Also, since QE started in March 2015 Italian public debt has increased as of June by EUR 137bn, with the ECB buying EUR 273bn, locals selling EUR 78bn and non-locals EUR 59bn. Who is going to buy this debt after QE unwinds?” Piccoli questioned. “ECB will continue to reinvest as long as Italy retains investment grade. But still, there is a question left there,” he concluded.

Retail: highs and lows

Macro turmoil and an improving yet still fragile economy often mean opportunities for investors who are on the hunt for juicy yields and ready to do some extra work. In particular, the retail and consumer sectors have recently been on the radar of private equity firms and alternative investors, with a flurry of both performing and distressed deals.

Retail is faced with several challenges, not just in Italy. While both the consumer and the retail sector share potential high return on invested capital, the retail sector can boast relatively low barriers to entry versus the consumer sector, while its high volatility and fragmentation could keep potential investors at bay.

“Consumer and retail are two fundamentally different industries; while the former includes the Warren Buffet type of businesses – stable, strong brands with high barriers to entry – the latter is highly volatile and having lots of trouble worldwide. So it is fair asking the question: why bother with these things, especially in distressed?” Tripp Lane, Partner at Resegon, pointed out.

The answer, in simple words, is: “Because they can make you a lot of money,” Lane continued. “There are plenty of trading opportunities, and if you time the bottom correctly, you can have great returns.”

Data presented by Lane showed an IRR as high as 90% on the subordinated notes of Dutch retailer Hema, and a stunning 262% IRR on the group's PIK notes. “[But unfortunately,] not everything goes well. If you take Vivarte and look at where the equity is trading today after two restructurings, you would have effectively lost all your money if you bought before the first restructuring in 2013,” he warned.

Lane then went on to identify five characteristics of successful retail turnarounds. “First, you don't want to buy Blockbuster when Netflix is coming; you want something that is not going to be wiped out. Second, size matters: the bigger you are, the more important you are to your customers, suppliers, and landlords and they will give you a second chance to survive,” Lane said. “Timely intervention is also key, and closely related to that is having strong management. In turnarounds, this often means a new CEO as the person who fixes things is not usually the same one who has grown and expanded the business,” he continued. “Finally, valuation really matters: you have to buy at low multiples and have lots of potential upside [in order to offset the risk you take in this sector].”

“Looking specifically at Italy, I'd say this is not a generalised sector crisis – as opposed for instance to construction, which is really a sector crisis,” Jacopo Barontini, Partner at Deloitte commented. “Retail is a very diversified universe, and sometimes the issue is in the company, not in the industry, and you need to find there the main pillars of underperformance. For instance, a brand which is not interpreting the trends and responding to needs of customers, won't get many customers really.”

The fragmentation of the retail sector in Italy can also pose risks for prospective investors, as well as the scale of the economy, the length of the enforcement process and the relationship-oriented culture, with banks traditionally rolling on. On the last point, though, things have evolved and improved over the past few years, the panellists concurred.

“The legislator has acknowledged the speed of the [in-court] restructuring processes needs to be improved,” Barontini pointed out. “They have also finally understood that the [legal framework] needs to protect investors who are putting in new money.”

Governance tricks

The one thing that remains key when investing in Italy is the governance.

“Family-run businesses have some major advantages, especially because the shareholders have a long term interest,” Lane said. “But if there is a crisis, that can be a problem; it is hard to get a family to agree and reach a consensus on management changes, and they may take enormous risks to keep control of the company.”

“[On the upside,] second and third generations are becoming more accustomed to deal with new investors,” Guido Lorenzi, Principal at HIG Whitehorse commented. “Often you deal with a wider family, not just the founder; maybe the company is no longer their 'baby', but still their heritage, and you need to sell them an idea to get them on board. In the case of distressed situations, you can sell them the idea that you are giving them a second chance to run the company. Whereas, if the company is performing, we often come in as financial partner, not with equity control – we are somewhere between the [majority] shareholder and the banks, which may provide money but not other support.”

Various steps can be taken depending on how a company is performing, from a minimum of having a board observer to more serious measures in case of troubles. “If a company doesn't deviate from its plan, we regularly meet them and discuss with them, but that is about it,” Lorenzi continued. “But if it is not performing according to plan and they don't take action, then we do.”

Investors can also put in place LuxCo or UK/Dutch Co structures, which allow for faster enforcement. “There are a number of mechanisms that you can implement to get control very quickly, if need be,” Lorenzi added.

With consolidation going on in the domestic market and the country still lagging behind in some macro trends – such as the increasing popularity of casual dining – opportunities abound for institutional investors. As long as they do their homework, and time the entry right.

Chiara Elisei Co-Deputy Editor Acuris

Chiara joined Debtwire in February 2008. Since then she has been covering restructurings and distressed, with a focus on retail, construction and food & beverage sectors. In the past few years she has been expanding Debtwire's Southern Europe coverage, unveiling distressed opportunities in Spain and Italy. She is currently an Editor in charge of leading new coverage initiatives.

In Italy she worked as reporter at Corriere della Sera, Il Messaggero, RAI covering current news and international affairs.

Chiara graduated in Classics at Scuola Normale Superiore, Pisa, where she also got a PhD in June 2010.

Chiara Elisei Co-Deputy Editor Acuris

Chiara joined Debtwire in February 2008. Since then she has been covering restructurings and distressed, with a focus on retail, construction and food & beverage sectors. In the past few years she has been expanding Debtwire's Southern Europe coverage, unveiling distressed opportunities in Spain and Italy. She is currently an Editor in charge of leading new coverage initiatives.

In Italy she worked as reporter at Corriere della Sera, Il Messaggero, RAI covering current news and international affairs.

Chiara graduated in Classics at Scuola Normale Superiore, Pisa, where she also got a PhD in June 2010.

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