Private equity in recovery from the pandemic
Having successfully weathered 2020’s COVID-19 storm, UK private equity has proven its resilience. Nicholas Neveling speaks to investors from across the Corporate Finance Faculty about the outlook for buy-outs, growth capital investment and exits over the next 12 months
The resilience of UK private equity during the pandemic is all the more remarkable given the 9.9% decline in UK GDP in 2020, and the near-shutdown of the deal market in the second quarter of last year as the country went into lockdown for the first time.
Guy Blackburn, partner at Mobeus, says: “The period from April to June in 2020 was unsettling for most people, because nobody knew where the market, or indeed the pandemic, would bottom out. The focus was naturally quite short term and conversations about new deals largely went on hold as neither buyers nor sellers could forecast short-term performance accurately.”
Since Q2 2020, however, deal activity has steadily recovered, boosted in recent months by fears of an impending increase in capital gains tax. Then, in Q4 2020, buy-out volumes almost trebled from Q2 levels to a total of 94 deals – the highest quarterly figure for more than a decade. And deal value more than quadrupled from Q2’s total to reach $26.36bn – also a 10-year high for a single quarter. “By the second half of the year, firms had more visibility on the health of their portfolios and understood that life had to go on. Investors were still keen to do deals for good assets,” explains Blackburn.
This momentum has continued into 2021 as buy-out managers move to get their deployment schedules back on plan. Globally, private equity reportedly has $2.5trn of dry powder at its disposal, as most recently estimated by Bain & Co.
Fund managers are also planning to clear exit backlogs, and this year bring assets back to market that had been slated for sale in 2020, but were put on hold. According to fund adviser Triago, the decision by a number of managers to put exits on hold in 2020 saw capital calls to LPs outpace distributions for the first time since 2011. Fund managers will be eager to put the ratio of capital calls and distributions back in balance, and that should provide a further boost to deal pipelines.
In cases where deals were put on ice, private equity vendors have given portfolio companies a window to stabilise their earnings and return to the M&A market in a stronger position, or at least having addressed some of the risks that came to the fore as a result of the pandemic.
ECI Partners managing partner Chris Watt says although the firm banked successful exits for premium pet food business MPM and cellular connectivity group Arkessa, it decided to hold off from other sales processes. “We will be looking to do between four or five exits this year, some of which were put on hold in 2020. Where there has been some earnings volatility through lockdowns, you want to allow a business to demonstrate its ability to trade through the disruption and get back on its previous growth path.”
Deal dynamics
Activity is expected to return to (or even surpass) pre-pandemic levels in 2021. However, the adaptations dealmakers made through the COVID-19 dislocation period will drive longer-term changes to the process of deal execution. Origination, the strategic structure of auction processes and due diligence have all evolved during the past 12 months. These changes will continue to inform the way firms approach transactions beyond the pandemic.
With respect to origination and target selection, firms on the buy-side have set the bar high. Only businesses that have demonstrated the capacity to continue trading through pandemic disruption, and give buyers clear visibility on future earnings, have transacted. Buyer interest has coalesced around these select assets, and has seen the market skew towards companies in the technology and healthcare sectors, where customer demand has been relatively undisturbed through lockdown restrictions.
According to KPMG’s analysis of UK mid-market buy-out deal flow, healthcare’s share of total deal activity in 2020 increased to 9% from 7% the previous year, as dealmakers took comfort in the sector’s resilience and long-term growth dynamics. Meanwhile, TMT’s market share rose from 12% in 2019 to just under a quarter of the total deal activity last year, as a result of the transition to remote working and online learning and shopping (see Platform premium, opposite page).
In addition to technology and healthcare, other industries that have performed well include financial services and essential consumer goods. In the financial services sector, for example, Mobeus sold invoice financing provider Advantedge in an exit that netted a 30% IRR and 2.7x money multiple – a deal that was completed at the end of November 2020.
Paying for quality
Only assets that have cleared the highest-quality thresholds have transacted and vendors, aware of the scarcity of businesses with these attributes, have been able to keep running competitive auction process and demand high prices. This has ensured that overall valuations for closed deals have held up well, despite the uncertain macro-economic backdrop. According to PitchBook data, this trend has seen average European multiples remain unchanged when compared with 2019 at 10.2x EBITDA.
Also completed in November 2020, ECI sold pet food producer MPM to 3i, generating a return of 4.4x money from the exit, after four years of ownership.
“Pet food has been a very resilient category,” says ECI’s Watt. “MPM traded very strongly and was ahead of budget. That meant that as soon as we could, we were able to run a competitive process and secure a buyer.”
ECI’s sale of internet-of-things-managed services provider Arkessa in December locked in a 2.1x money return and an IRR in excess of 30%. “It all comes down to the quality of the asset. Neither MPM nor Arkessa missed a beat through the pandemic,” Watt says. The ability of a buyer to pay the highest multiple for a quality asset, however, hasn’t been the only factor deciding who vendors have opted to sell to.
“A key change to auction processes during the pandemic has been the additional attention given to deliverability,” says Blackburn. “In an uncertain market it has been important to have an upfront conversation with a buyer about what they can do, their view on the target, and certainty of funding. Auctions are still competitive, but vendors are more selective about who they allow into processes.”
The focus on asset quality and deliverability is expected to remain a dominant theme in deal markets for the next 12-18 months. Although vaccine roll-outs are fully under way in many countries and equity markets have stabilised, the risk of mutant strains of the virus and uncertainty around how long it will take to fully reopen society will see buy-out investors continue to cluster around the small pool assets that offer a combination of growth and mitigation against downside risk. Vendors will remain focused on securing good pricing from buyers that can demonstrate deliverability.
In December 2020, WestBridge acquired a 75% controlling stake in Eque2 for £29m from LDC, which had backed a £16m secondary buy-out of the construction software company in 2017. “Eque2 traded to forecast in 2020 and is positioned in sectors with strong defensive characteristics. It also has significant growth potential,” says WestBridge investment director Peter Barkley.
There are hopes, however, that as businesses directly impacted by lockdown show evidence of rebounding, deal volumes will pick up and companies from a broader range of sectors will begin to gain traction with buyers. “The market was binary in 2020. Businesses were either struggling and didn’t come to market, or were robust through COVID-19 and sold for high prices,” says ECI’s Watt. “What we hope to see in 2021 is more volume from a broader range of assets, including some where there has been COVID-19 impact, but there is scope to gauge the trajectory of recovery and find opportunities to invest at appropriate price points.”
About this article
This is extracted from the cover story of the Corporate Financier April 2021 edition - exclusively for Corporate Finance Faculty & Faculties Online members - who can access our highly regarded magazine in its originally designed form, as well as our extensive archive brought to you by the ICAEW Corporate Finance Faculty.
