Private equity may once again corner UK businesses
On Thursday, national repair company HomeServe Plc agreed to be taken over by Brookfield Asset Management for £4.6 billion, including assumed net debt. HomeServe shares had fallen so much that the offer fell short of their high a year before the offer despite its 71% premium.
Days earlier, KKR & Co. reached a £4.9bn deal to buy ContourGlobal Plc, offering shareholders slightly more than the price of the utility’s 2017 initial public offering. Shares have traded below this level for the past four years. Founding shareholder Reservoir Capital Group, which still owns 71% of the company, has given the green light.
UK assets are now much more affordable for dollar funds. The pound is down more than 10% against the greenback since May 2021. The FTSE 250 index of mid-sized companies (whose constituents are ideally sized for buyouts) is down more than 25% in dollar terms from its peak in September. That’s almost as much as the Nasdaq Composite’s fall from its recent high.
Morgan Stanley analysts believe the UK market is extremely cheap on a historical basis. Last month, they looked at the earnings multiple at which stocks have traded since 1980 (taking into account the economic cycle): UK stocks were around 1% below their average, US stocks 58% above above.
Regardless of macroeconomic conditions, the main focus of a buyout business will be whether an individual asset is generating enough cash to service the debt used to acquire it. This box seems easy to check. Graham Simpson, an analyst at Canaccord Genuity Quest, recently identified 255 London-listed stocks with a market cap of less than £1.5 billion that were generating extremely attractive levels of free cash flow relative to their enterprise value on the market.
“The days of buying failing companies and turning them around or stripping assets are over,” Simpson says. “It’s way too much work. Why not just buy the right companies at bargain prices instead? »
The question is whether shareholders will be willing to sell what private equity wants to buy. Right now the resistance is probably falling.
Given the deal for ContourGlobal, as well as some rejected approaches for beauty and nutrition retailer THG Plc, consider the recent crop of underperforming new issues in the UK. A year after the IPO, hopes of a re-pricing of the IPO will likely have faded and some of the original investors will have been replaced by new shareholders with lower expectations. Founders or others with very high stakes might object, but they might be offered the chance to stay invested in the buyout.
The biggest hurdle is probably the predicament of most other sunken IPOs. Food delivery company Deliveroo Plc is listed as a beneficiary of the pandemic, but now appears to be under pressure on discretionary spending. Rail ticket provider Trainline Plc has been hit by a regulatory asteroid threatening its dominance in the UK, putting more focus on Europe for future growth. TI Fluid Systems Plc must reinvent a company that traditionally supplied parts for internal combustion engines.
Others among the failed IPOs were quirky members of the UK market from the start. Semiconductor company Alphawave IP Group Plc chose London despite its Canadian origins. It has been criticized for related party transactions. Network International Holdings Plc, meanwhile, is a payments business in the Middle East and Africa with no revenue in Europe.
What about investor resistance in the wider UK market? Last year, investors began to say no to offers – or to demand higher offers – despite recommendations from the target company’s board to take the profit from private equity. Shareholders squeezed sweeteners from Blackstone Inc. and Clayton Dubilier & Rice LLC.
The difference this time is that stock markets are much weaker. The offers are going to be increasingly attractive to asset managers as they approach the end of the year and they are looking to increase their annual returns. For private equity, still sitting on a lot of cash and incentivized to put it to work, it’s going to be tempting to test the waters.
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Chris Hughes is a Bloomberg Opinion columnist covering the deals. Previously, he worked for Reuters Breakingviews, the Financial Times and the Independent newspaper.
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