Over the last months you may have seen articles in the press stating that Spain is doing well again. Several private equity houses have opened offices in Madrid or are strengthening their teams and meanwhile, the Spanish government announces that the crisis is over, or at least that there is light at the end of the tunnel.

Some of this is true. The activity of foreign buyout firms is increasing. HIG is building up its presence and Apollo just won the purchase of NBG, the combination of former savings banks in Galicia, in competition mainly with other firms.

However, part of the news seems to be wishful thinking. It is true that the shrinking of the economy seems to have stopped, as shown by the Xmas shopping and subsequent sales period, which seem to have been better than last year. Car sales are also somewhat recovering: January 2014 closed at the same level as in 2008.

But at aggregate level, the growth of GDP is in the range of 0.1 per cent and unevenly spread over the country. Furthermore, the volume of new debt issues by the Spanish government is far above repayment. So the total public sector debt, today at nearly 100 per cent of GDP, continues to grow at a significant pace. Meanwhile, the reduction of the public budget deficit is slow. Even without considering the consequences of a possible Catalan independence on debt and deficit, this is a worrying situation.

And last but not least, unemployment remains at an extremely high level of over 25 per cent of the active population, second only to Greece in Europe.

Meanwhile, mid-market corporate Spain is not doing to bad and is creating investment opportunities. The companies that have survived the now five years of crisis are often in fairly good shape, efficient and not too indebted. Many have survived by growing in export markets and thus are now less dependent of their home market, but if the Spanish market starts growing again, their growth potential may be significant.

This growth will generate opportunities for mid-market funds, mainly because the banking system is still struggling with the digestion of the real estate bubble. The rate of nonperforming loans is in the range of 13 per cent. And the drain on the financial system by the government reduces the availability of funds for the private sector. Therefore, growth must be funded either by the cash flow generated by the companies, or by private investors.

However, if you are a foreign private equity or private debt investor, before buying a ticket to come and have a look at what is going on, you must bear in mind that mid-market Spain is different in size from the mid-market elsewhere. Even if we would be looking at “lower” mid-market (let’s say companies with Ebitda in the range of €3-8m, which is where international financial investors normally start showing some interest) there are not too many of them. And even most of the Spanish PE funds would not go below this.

It is not easy for an industrial firm with sustainable Ebitda in the range of €1-3m to raise capital, because they do not fit in the investment criteria of the equity or debt funds. These are the “lost” companies. At a lower level, start-ups and second rounds, the situation is better, because this segment is covered by a combination of private-public VC firms, business angels and similar investors.

This mismatch is size creates a huge opportunity for investors who would specifically focus on the “below lower mid-market” segment. The companies in this segment are looking for finance to grow, so these deals will often been structured as “money-in” deals, either in shares, but for this segment, private debt, convertible or not, can be an excellent option. These will not be huge deals, but they will also not require huge resources to perform and they will have an excellent reward, compared with the level of risk involved.

Another option would be to actively be looking for add-ons for current portfolio companies. In this case, however, the seller is likely to be preparing his retirement and deals will be 100 per cent purchases, occasionally with reinvestment by management of younger family members.

One of the complaints by many private equity investors with experience in Spain is that there are too few deals. My view is that there are lots of potential deals, but not in the segment where most investors are looking.

Source: by Maarten de Jongh, managing partner at Spanish advisory firm Norgestion