Europe may look dangerous to many investors but to private equity firms and the arbitrage funds they feed, economic malaise and Brexit spell opportunity.
Private equity firms have record dry powder and are converging on underperforming and cheap stocks across Europe — pushing the value of leveraged buyouts toward post-crisis highs. The deals could transform corporate laggards into stars, and turbocharge event-driven hedge funds.
"The headlines are bad, the reality is good," said David Marcus, the head of asset manager Evermore Global Advisors in Summit, N.J., whose Global Value Fund is up 15% this year. "There's so much value in European businesses."
European firms haven't seen such appetite from private equity since the buyout boom just before the financial meltdown, which sent animal spirits into a deep slumber. Pending and completed deals targeting Western European companies this year now total $51 billion, according to Bloomberg data, entrenching the buyout recovery.
If the deals come off, stockholders could be in line for big gains. The sale of U.K. defense and aerospace company Cobham to U.S. buyout firm Advent International Corp. for about £4 billion ($4.8 billion) on July 25 sparked a 35% one-day stock surge. That followed proposed deals for the owner of Legoland theme parks and Osram Licht, a German lighting manufacturer.
There may be more to come. Thyssenkrupp is considering selling a stake in its elevator unit amid interest from buyout firms, and Altice Europe is attracting plenty of private equity interest for its Teads advertising technology firm.
"A lot of equity investors have shied away from European situations because Europe is perceived as this tomorrow-story forever," Mr. Marcus said. "Valuations have come down so much."
The EurekaHedge Event Driven Hedge Fund index rose 6.1% in the first half — the third-best performing strategy among hedge funds — compared with 1.9% over the same period last year.
BNP Paribas reckons underperfoming value stocks in Europe this year could get a lucky break in the buyout bonanza. Few investors riding the allocation style seek out companies for their acquisition potential, but the bank's bullish conviction on the cycle spurred it to introduce a new trading strategy in recent research.
The firm touts a basket of value stocks ripe for LBOs, made up of 30 members of the Stoxx 600 index. It's skewed toward the U.K. by origin where the pound and equity valuations are plumbing multiyear lows. The bank sees echoes of early 2006 to September 2007, when the BNP Paribas Equity Value Europe index rose 46%.
"We believe a similar situation could play out in this late stage of the post-crisis economic cycle, with public-to-private transactions acting as a value catalyst," said BNP Paribas strategists led by Edmund Shing.