This week’s blog comes from Paddy Moser, partner in UKI Transaction Advisory Private Equity.
We recently highlighted the continuing attraction of UK assets for corporate buyers – but what about private equity?
In this week’s blog, I’ll explore the tension between opportunity and uncertainty for PE buyers in the UK and how it’s affecting deal activity. The UK is an exceptionally resilient economy with attractive assets; but a high number of economic and political unknowns could raise the bar on many deals.
The story so far…
Any debate about the UK’s attractiveness is inextricably bound up in the fallout from the EU Referendum. The UK’s economic and political watershed is still a work in progress. Almost three years to the day since the historic vote to exit the EU, the UK awaits its third post-referendum prime minister and no-one knows what trade and finance agreements will be in place with the EU and most of the rest of the world by November 2019. The splintering and unpredictability of UK politics also stand in stark contrast to the relative stability we saw before the vote.
How much is this uncertainty affecting deal appetites? Not as much as you might think. EY’s Global Capital Confidence Barometer (CCB20) shows that UK remains a highly attractive destination for domestic and overseas corporate dealmakers. For the first time in a decade, the UK is named as the most attractive M&A destination by global executives. At the same time, UK executives have also signalled their highest transaction appetite in the survey’s history.
In CCB20, we set out three potential drivers for UK M&A activity:
- The UK’s changing trade, financial and regulatory relationship with the EU, which could require companies to invest in UK assets to sustain supply chains and maintain regulatory and market access.
- The growing trend for companies to buy, rather than build, combined with the UK’s reputation for innovation and its attractive globally-oriented assets in technology, life sciences and the creative industries.
- The UK’s economic challenges and opportunities. Slower organic growth encourages consolidation. Labour market pressures could open opportunities for labour-saving technologies.
To this mix we could also add the UK’s continuing advantages, such as its geographical situation, its globally spoken language and business-friendly legal system. Meanwhile, slower global growth has perhaps lessened the relative perception of UK challenges. A weaker pound also helps some valuations stack up; but any advantage here could be lost in the long-term if overseas acquirers repatriate sterling earnings into stronger currencies.
The PE context
Some of these drivers translate directly for private equity; but PE deal dynamics can often be subtly and crucially different. Private equity general partners (GPs) have a fundamental requirement to do deals, which should encourage continued deal activity. US and European funds currently have an estimated record $800b-plus in dry powder to deploy, with pressure from investors to employ it promptly. The Financial Times drew attention this week to European PE groups latest round of fundraising, which is larger – but also earlier – than expected, reflecting high demand for the asset class amongst investors and a possible move to seek protection before a downturn.
Nonetheless, large European or internationally focused GPs typically have significant flexibility in terms of how and where they deploy this capital. More so than UK-centric mid-market firms and more so than companies, who are already tied into locations – and often trade routes and supply chains. GPs with a European or global geographical focus have the potential to focus their capital in areas where greater visibility gives them more certainty over valuations.
Moreover, there’s the exit question. There has been a recent trend towards longer investment lifecycles, but there is still a need for GPs to plan how and when they will realise their investment. This is clearly harder when there is little or no certainty as to the medium-term regulatory or market environment and where there is a question mark over UK-based companies’ ability to attract and retain talent. This labour issue is quickly moving up the agenda as other nations – most notably France – look to make themselves more attractive to PE investors.
So, could the UK lose its long-held position as PE’s favoured location within Europe? Before we write-off the UK, we need to cycle back to the advantages that it continues to offer. The UK remains one of the most attractive locations in the world to do business. Its assets have many qualities that appeal to private equity investors in terms of their culture of innovation, their track record of developing new technologies and original content, and their pools of talented individuals. The UK’s flexible and adaptive economy is still one of the largest within Europe and one that is hard for any PE firm to ignore.
It’s these strong draws that helps to explain why, until recently, UK PE deal activity has shown such resilience. Volumes and values slipped back slightly in 2016 from historically high levels, but they recovered into 2017. UK respondents to our CCB20 survey still expect considerable competition for assets from PE buyers.
CCB20 Corporate Responses
But, the UK’s attractiveness as a deal destination does appear to be reacting somewhat under intensifying political uncertainty. The recent decline in deals is even more noticeable when we look at UK transactions as a percentage of the European whole. The UK remains the number one destination for PE investment in Europe. But, many of the biggest PE deals in 2018 came on the continent, with a marked increase in activity in the Nordics. In 2019, volumes have also slipped.
To some extent, this reflects a maturing European market. But, I also think the bar for doing UK deals has moved higher in 2019. UK-based targets with niche technologies or markets or strong overseas revenues are still attractive. For example, the recent Apax Partners/ Warburg Pincus deal to buy Inmarsat, which is headquartered in the UK, but receives most of its revenues from overseas. There is also some interest in areas of the market where Brexit may bring some upside from import substitution, regulatory changes or increased demand for labour-saving technologies. But UK activity has certainly dipped in areas exposed to the slowing domestic economy, such as retail and real estate.
UK Attractiveness Survey
There are interesting parallels here with EY’s recently released UK Attractiveness Survey.
The UK remained the number one destination for foreign direct investment (FDI) in Europe in 2018, with its third-highest number of FDI projects in 20 years. However, this represented a 13% drop in FDI projects compared to 2017, as perceptions of the UK as an FDI destination weakened.
Here too, investment in digital sectors has remained high, but there is a notable fall away in retail and other consumer areas since 2015.
The UK market is still active. If we go back to the charts above, almost 25% of European PE deals still involve UK assets. This is an incredibly resilient market that will continue to see deals. But, there is undoubtedly more food for thought for an industry that thrives on numbers, given the lack of visibility beyond the end of October in many sectors.
Should uncertainty lift, we could see a considerably release of deal activity in the PE space and beyond. Should uncertainty remain and UK asset prices fall, could we could see more investors taking a chance and more distressed investing? There is growing interest in areas like retail real estate, which is the target of a new PE-style JV fund between Pimco and New River.
Meanwhile PE firms are putting more emphasis on their existing portfolios and we expect to see more bolt-on acquisitions in the UK as well as increasing numbers of minority stake investments, as PE looks for more ways to put capital to work.
Edited by Kirsten Tompkins