Why Britain is ripe for a dealmaking rush

Watch and wait

For the first time in six years, the total value of private equity deals in Europe failed to top the $100bn (£78bn) mark in 2023, according to the Centre for Private Equity and MBO Research (CMBOR), leaving private equity deal making at its lowest since 2013.

A combination of high inflation, surging interest rates and wars in Ukraine and the Middle East have chilled the veins of private equity buyers.

Throw in warnings from Christmas past, such as the debt-fuelled takeovers of Asda and Morrisons, and questions are emerging about what will tempt private equity firms back to the table in 2024.

“Private equity has been very prevalent the past few years. Obviously they were less active last year but they do have a lot of capacity,” says Bank of America head of UK investment banking Peter Luck. “If your cost of capital is not predictable, it’s very hard to price the investment, but lower volatility and a change in rates will be key to giving investors a better understanding of their cost of capital.”

With the Bank of England raising rates 14 times over the past two years, from 0.1pc to 5.25pc, and the Federal Reserve keeping US rates high, private equity has been constantly reassessing how much they are willing to fork out for companies.

This moving target has forced firms to curb their spending, despite sitting on ample amounts of cash.

UK firm CVC Capital closed its latest fund earlier this year having raised €26bn (£23bn), the largest ever buyout fund.

That topped a new fund raised in 2022 by Advent International, which garnered $25bn of investor cash that private equity firms typically use to gain controlling stakes in companies.

In total more than $500bn was raised in new funds in 2023, only slightly down on the previous year, according to data provider Preqin.

Keeping their powder dry

The research company estimates that global private equity also has around $1.5 trillion of dry powder to throw at deals this year. Throw in the leverage from extra debt and that amount could be closer to $8 trillion.

“Taking a long view of the historical data, 2023 could well represent a low point, with the industry likely to witness a gradual uptick in activity next year,” CMBOR Professor Kevin Amess predicted.

Coupled with historically low UK stock market valuations, the time could be ripe for a rush of private equity money tempting firms to quit the UK stock market, according to another UK banker.

“Private equity firms are looking at plenty of deals and my sense is generically across the market they have plenty of files open but it may be they are waiting for the price dynamic to get into the right place before they press the button,” he said.

“We have some really excellent businesses in the UK, very well managed and international. My sense is there could be a reasonable amount of interest from US buyers for some very good quality assets. It just takes a little more confidence.”

However, that confidence has been dented by the fallout from deals struck when money was cheap.

The UK’s largest leveraged buyout in recent years, CD&R’s takeover of Morrisons, shows the risk of buying at the wrong time.

Morrison’s debt pile has swelled to nearly £7bn since the deal was agreed, leaving its interest payments heavily exposed to the even slightest nudge in interest rates.

Asda’s takeover by TDR Capital and the Issa brothers, which included the largest sterling corporate bond sale of all time, has also raised eyebrows.

Interest costs on Asda’s debt pile has been surging every year due the cost of servicing the debt.

The main bear trap for private equity titans to avoid now is striking a deal which in 12 months looks expensive.

From Dip Dabs to real estate

Before rising to become a $1 trillion fund manager, Blackstone backed cottage industries and the pivot away from traditional UK private equity is also hampering deals.

In the UK it owned retro sweet-maker Tangerine Confectionery, which owned Dip Dabs, Flumps and Wham bars.

But now Blackstone and its giant peers KKR and Carlyle are less likely to plough money into Dip Dabs and more prone to allocate their billions into esoteric credit and real estate investments.

This has led to a lack of jumbo dealmaking by private equity firms, leaving smaller players like CD&R and TDR Capital to keep the market ticking over.

Mega deals worth over $1bn accounted for less than half of all European buyouts for the first time since 2017, according to CMBOR, with smaller deals picking up the slack.

Still, one hope for a return to dealmaking is the pressure private equity firms are under to exit businesses and return cash to investors.

According to research from Baird, private equity exits hit a 10-year low in 2023, piling more pressure on firms to clear the mountain of companies backing up their books.

It could mean private equity firms may become more aggressive in seeking to offload these companies in 2024, Baird said.

Game changer

IPOs are the biggest laggard, so could see the largest revival. Just 82 private equity-backed IPOs came to market this year, versus 392 in 2021, according to Preqin.

“We have seen an upswing in activity and interest in moving on investments,” the senior UK banker said. “They have to churn their portfolios and prove they can make the money back. Generally the good quality assets are going out first.”

Interest rates are likely to remain the driver, however, for the amount of dealmaking in 2024.

Traders are betting that the Bank of England will slash rates by almost two percentage points to 3.5pc next year. That’s seven rate cuts.

The Fed is also expected to reduce rates, perhaps helping give more clarity for private equity firms hoping to make deals happen.

“2023 was a tougher year due to the uncertainty. No macro scenario prevents deals but it makes it very hard to write deals when you don’t know how that’s going to play out,” said Luck. “If we enter a period where there is more visibility and more certainty it will give people greater confidence to be proactive.”

Amen to that.

Source: YahooFinance