While private equity activity dropped during the first half of 2022, KPMG’s latest UK Mid-Market Private Equity Review reveals that bolt-ons – accounting for 62% of all UK mid-market deals – achieved the highest half-yearly proportion on record. Bolt-ons have made up the majority of UK mid-market firms’ investment for more than five years now.
There were 241 UK mid-market bolt-on deals in H1 2022. This is lower than in H1 2021, but above the number completed in H1 2018 or 2019. The aggregate value of bolt-ons in H1 2022 was £12.7bn. Again, this was down on H1 2021, but notably higher than the levels achieved in both H1 2018 and 2019.
Buy-and-build strategies are becoming ever-more commonly deployed by mid-market UK private equity and it’s a trend that is predicted to continue for the foreseeable future. A buy-and-build strategy with bolt-on acquisitions is, in the majority of cases, a lower-risk route to supporting growth of an existing platform business. Private equity houses put further investment into management teams and industries they know, leveraging potential cost synergies to drive value.
Jonathan Boyers, vice-chair of KPMG, who until the end of last month was head of corporate finance in the UK firm, says: “Bolt-on deals are continuing to show up as the most common type of deal involving private equity houses. The basic model of buying into a platform and then adding on further acquisitions typically at lower price earnings multiples than the original deal has several attractions.
“Most significantly, in an uncertain economic period, it is more comfortable and less risky for private equity houses to invest in businesses they already own and back a proven management team they know to buy businesses that they can improve.”
Many bolt-on deals are completed off-market, avoiding upward price pressures of an auction process. Private equity firms will look to create value instantly through multiple arbitrage by paying a lower multiple for the bolt-on than they can achieve for their platform business. The number of minority investments has increased in the first half of 2022, reflecting a continuing trend for private equity firms being comfortable with taking non-controlling stakes and supporting acquisitions for growth. Business owners seeking to release equity without losing ownership or control, while benefiting from private equity investment, is also an increasing trend.
“The alternative is always investing in new and less-known businesses and teams,” says Boyers. “This strategy normally reduces the average earnings multiple paid over the life of the investment. Many private equity houses will now also provide the corporate finance expertise to support their investee companies in executing this strategy. The buy-and-build model used to be quite a specialist private equity strategy, practised by a few houses that made a virtue of their willingness to do it. These days, however, almost everyone is doing it.”
Another aspect of bolt-on deals has been how they fit in with the environmental, social and governance (ESG) agenda. In H1 2022, bolt-ons represented 59% of deals with an ESG aspect (an ESG business or an ESG-advanced competitor) as private equity looks to scale platform investments and drive further value from ESG investing. Traditional buy-outs with an ESG angle (‘ESG-advanced’ businesses) accounted for 30 deals, and there were 27 minority deals with an ESG component in the first half of 2022.
Private equity expert in bolt-ons
LDC estimates that it supports two-thirds of its portfolio’s growth through acquisition. In August 2022, LDC made a significant minority investment in Midlands-based international warehouse equipment supplier IWS. The investment was led by Chris Handy, partner and head of the West Midlands at LDC.
IWS had expanded through organic growth and acquisition, completing four deals in the past four years.
LDC will back the management team, led by CEO Jeroen van den Berge and director Tim Lacey, to continue its acquisitive growth strategy.
A month earlier, LDC supported Kerv, a digital transformation services provider, to acquire the communications compliance practice business of TDS Global Holdings.
Kerv itself was formed in July 2020 when LDC backed management to merge three cloud-based managed services businesses. The bolt-on takes Kerv’s turnover to more than £60m.
The PE adviser
Neil McManus, partner and head of business services M&A at KPMG
How has buy-and-build grown in the sectors you advise?
There are a number of subsectors within business services, and among some of the platforms that have been created there is a trend to deploy capital into bolt-on acquisitions. A buy-and-build strategy can create a lot of value and is a relatively low-risk way to deploy further capital. The buy-and-build strategy will continue into the future.
About four or five years ago, you could segment the private equity community into those who were buy-and-build houses and those who took a more traditional, organic growth approach. But now I think you’d struggle to find a private equity house not doing buy-and-build. It’s generally accepted as a successful way to create value across multiple sectors.
How will that impact private equity strategies?
Hold periods have got longer and there’s an increasing trend of moving assets between funds. Where successful platforms have been created and a buy- and-build strategy implemented, the PE house might take a view that it really likes the management team and the market dynamics, and can see a significant runway to further growth in an M&A market where demand for high-quality assets significantly exceeds supply. So rather than sell it to someone else to take the next steps of growth, it moves it into its next fund.
It’s likely that we will see assets moving between funds more often, and then having to go to market to buy assets that private equity might not understand as well, often in really competitive situations.
You have to test market pricing if shifting from one fund to another. You cannot have a cosy deal because you have different investors across different funds.
What are the challenges in acquiring stressed businesses?
There will be more opportunities to acquire them as the economic environment deteriorates, but the challenges of acquiring distressed businesses go back to the fundamental causes of the stress. If it’s short-term market disruption, and the stress is primarily due to the financial or the capital structure of the business, then you can reset the capital position quite quickly. You must have confidence in the management team and the long-term market position.
If the business model is found wanting by the change in the economic environment, that’s more difficult to address because it requires a significant investment of management bandwidth to correct something that may not be right within the business. The question becomes one of allocation of management resource, rather than capital resources. You need the management bandwidth to integrate and correct the business in the new entity. You need management time and capability.
How will pricing be affected?
A lot of the small bolt-ons have been funded through debt facilities and debt markets are tightening. That might require increased equity investment from PE funds. I think they will be comfortable with that, but it will mean the cost of capital becomes greater for bolt-ons than it has been historically and that may impact pricing.
Private equity firms that are willing to equity underwrite an acquisition will have a significant advantage in a competitive process and that advantage will increase as the debt markets become increasingly volatile.
Which sectors will be busy and which won’t?
Business services will be busy, and tech will continue to be an area where there’s a desire to deploy capital. Similarly healthcare and energy, especially renewables. I think there will be less activity in retail and in leisure and travel.
Anatomy of a deal:
a mid-market PE view
Mehul Patel is a partner at August Equity. August Equity’s last four exits – Zenergi, Dental Partners, Pet Cremation Services and Berkeley Home Health – all made bolt-on acquisitions over the period of August Equity’s investment, to accelerate growth.
Will hold periods be stretched?
That depends on the industry. Our portfolio largely comprises essential services, such as cyber security, IT managed services, healthcare and nurseries, which are all more resilient during a downturn. There will be some sectors where hold periods will definitely increase – retail, for instance.
Will your portfolio be increasingly investing in bolt-ons?
We do expect to deploy more capital in bolt-on type acquisitions. We have a number of buy-and-build platforms in our portfolio and they are definitely looking at acquisition opportunities over the next 12 to 18 months.
How do you originate bolt-on deals?
We source bolt-on opportunities in a variety of ways – a combination of internal origination efforts, origination from portfolio companies themselves and, of course, from third-party advisers that understand our buy-and-build strategies and what we are looking for. The nature of the bolt-ons we are looking at might change a little with changing economic conditions, but the fundamentals will remain. Clearly, we will continue to favour targets that have higher quality earnings, such as a combination of recurring and contractual revenue, lower customer concentration and low customer churn.
Will deals arise from stressed situations?
Opportunities for bolt-on targets will undoubtedly arise from stressed businesses becoming available. Our larger platform businesses achieve higher operational leverage, which allows them to deliver services at a lower cost base and more efficiently, which could become an issue for smaller businesses in the same sector during a downturn, when facing staff shortages and cost inflation.
It is important to understand why any such target is in a stressed position. Usually if it is related to non-optimal service or culture, rather than a non-optimal capital structure, it will create more issues in the short to medium term, which will negate any value creation.
