Analysis: Smaller UK firms attractive targets for PE buyouts
05/06/2023 09:00
By Shristi Achar A and Johann M Cherian
June 5 (Reuters) - Even as higher costs of borrowing
continue to choke dealmaking, fund managers and bankers believe
smaller UK-listed firms remain attractive to private equity
players flush with unspent funds of nearly a trillion dollars.
Central banks have been battling high prices by hiking
borrowing costs for more than a year now and market participants
expect the Bank of England to lift the benchmark rate to over
5%.
While this has put pressure on dealmaking overall, Britain
has recently witnessed multiple proposals for takeovers
including Network International Holdings NETW.L , Hyve Group
and Medica Group MGPM.L .
Among the most talked deals was the takeover of veterinary
drugmaker Dechra Pharmaceuticals DPH.L by Swedish private
equity (PE) firm EQT, which is now near completion at 4.46
billion pounds ($5.57 billion).
The companies in discussion are largely small- to mid-sized,
making them achievable targets, as opposed to firms listed on
the FTSE 100. Market analysts believe higher interest rates may
not be a wall high enough to halt PE dealmaking entirely in the
UK.
'DRY POWDER'
One of the contributing factors for PE firms' abundance of
cash, or "dry powder", is the continued buildup of uninvested
capital during the pandemic, according to fund managers.
Globally, the availability of unspent funds is estimated to
be around $2.5 trillion as of May, according to data provider
Preqin, with about $922 billion earmarked solely for buyouts.
"Private equity houses have had reasonably strong balance
sheets through COVID in the past 2 to 3 years. So, there is
money in the system looking for returns," said Richard Bullas,
portfolio manager for Martin Currie UK Equity team with Franklin
Templeton.
During the first five months of 2023, nine listed firms on
the London Stock Exchange were approached by PE firms, exceeding
the number of targets in the same time period last year,
according to Refinitiv data.
Since then, central banks have hiked interest rates, with
borrowing costs in the United States and the UK at more than
four times when compared with the levels in May 2022.
The nine takeover approaches in the UK by PE firms this year
have a potential aggregate deal value exceeding $8 billion,
which is more than half the value of PE deals for each of 2021
and 2022.
However, some of the proposals have also been taken off the
table, like Apollo Global Management's APO.N bid for John Wood
Group WG.L , but not before the PE firm submitted five separate
bids to take over the oil services provider.
"PE funds have significant 'dry powder' and a robust
pipeline of deals, so we expect to see selective deals get done
in 2023 ... there will be a continued overall slowdown in
momentum for the rest of the year compared to prior years,"
Kirshlen Moodley, head of UK advisory for BNP Paribas, said.
ATTRACTIVE VALUATIONS
The other side of the coin is valuations of UK equities also
took a severe beating in 2022, with investors wary of a looming
recession as major central banks raised rates at a pace not seen
in years.
In 2022, the FTSE Small Cap index .FTSC and mid-cap FTSE
250 index .FTMC fell nearly 16% and 20%, respectively, marking
the worst performance since the 2008 financial crisis.
In terms of valuations, the mid-cap index is trading at
11.4x forward earnings, while the small-cap index is at 10.2x.
The valuations are less compared with their U.S. and
European counterparts. The S&P 400 mid-cap index .IDX is
trading at 13.6x forward earnings, while the STOXX Europe Mid
200 index .MCXP is at 13.2x.
Among those out shopping for firms, many seem attracted to
these lower valuations of small- and mid-cap firms.
"The UK stands out as being undervalued, in particular, down
the small- and mid-cap end," Bullas said.
"And that valuation opportunity at the moment is being taken
advantage of by overseas capital looking for the best return and
risk-adjusted opportunities, and the UK is one that's relatively
low risk on a global scale."
Though firms listed on the smaller UK indexes are more
domestically focused than their larger counterparts, analysts
point out that nearly half of their revenue is from their
international presence, making them an even more attractive
purchase for PE firms.
"When you look at the FTSE 250 and the 100, these are global
companies. They may be listed here in the UK, but their revenue
is quite global and diversified, with revenue pools in the U.S.
and across Europe," Moodley said.
($1 = 0.8010 pounds)
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UK vs US vs EUR index valuations https://tmsnrt.rs/3WLXbog
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(Reporting by Johann M Cherian and Shristi Achar A in
Bengaluru; Editing by Shounak Dasgupta)
((johann.mcherian@thomsonreuters.com;
shristi.achara@thomsonreuters.com))