UK buyouts review
Real Deals, 27 January
The tide seems to have finally turned for the UK buyout industry. After several years of frustrated optimism, 2004 turned out to be a very good year for many private equity players. "I think we'll look back on 2004 and say that was a year when the stars were aligned," says Jonathan Russell, head of buyouts at 3i. "It was a cracking year for us - probably the best I can remember."
KPMG's private equity group recorded over 145 buyouts worth over £10m in 2004, with a total value of £19.35bn - the highest value and number of deals since 2000.
"I think 2004 was a terrific year for buyouts," says Darren Redmaine, associate director at Close Brothers Corporate Finance. "The overall state of the market I would describe as among the best environments you could have."
That environment has been underpinned by a liquid debt market, low interest rates, continuing consumer confidence, and a relatively calm geopolitical scene. The life cycle of the private equity industry has also spurred activity after several fallow years. "You've got equity managers with money to put to work, under increasing pressure as they approach a big fundraising year," Redmaine notes. "People have been very keen to invest their remaining funds and to realise some investments, in what was a very good year for exits as well."
The larger mid-market (£50-250m) saw the strongest activity, while the top end of the market saw CVC and Permira's £1.75bn buyout of the AA and Charterhouse's £1.35bn bid for Saga. Other household brands that made headlines as they passed into private equity hands included Weetabix, Odeon Cinemas and DFS.
At the lower end, where small buyouts are increasingly funded by debt facilities and vendor finance, the private equity recovery is not so obvious. A survey by the Centre for Management Buy-Out Research (CMBOR), backed by Delotte and Barclays Private Equity, found that around 660 buyouts of all sizes were completed, down slightly from 2003.
Caution remains across the board. One feature of 2004 has been what Kevin Reynolds, head of UK investment at Bridgepoint, calls a two-track market. "There are certain assets which attract significant attention and are incredibly competitive aggressive processes, where you don't just have to pay a fairly full price but have to be pretty flexible as well," he says. "Then there are other assets which are not so attractive where the process has dragged on, as has become usual."
The prospects are generally good for 2005. "Because of the amount of money outstanding with a lot of these businesses, particularly in the large buyout section, there will be more deals done, mostly secondaries which won't enamour the investors much," says Mike Fell, managing partner at Granville Baird Capital Partners.
Secondary buyouts, in which one private equity firm sells to another, reached record levels in 2004, representing over a third of total deal value. Refinancing deals also shot up, from £2.1bn in 2003 to over £8bn.
"Secondaries are now a mainstream private equity activity," says Hugh Lenon, managing partner at Phoenix Equity Partners. Phoenix has been at both ends of secondaries in 2004, with deals such as the acquisition of Palletways and Jaycare from 3i, and the sale of Jimmy Choo to Hicks Muse and Baxi Group to BC Partners. "Figures show that UK mid market secondaries have generally performed well - they've certainly been more successful than the sceptics thought they would be."
The demand for secondaries is largely driven by the weight of money in many buyout funds chasing too few good original deals. On the supply side, there's the need to make realisations and exits from bulging portfolios at a time when IPOs and trade sales are still difficult. Fund managers also point to the more mature US market, where secondary and tertiary buyouts are a matter of course.
"Ten years ago, few of us ever bought businesses from other private equity firms, but people are used to it now" Lenon notes. "But in the long run, we all need trade buyers. Otherwise, we would look like antique dealers selling each other our old stock."
Some limited partners and institutional investors remain unhappy with the number of secondaries, especially in cases when they're backing the funds on boths sides of the equation. The performance of 2004's crop may be the acid test for the class as a major part of the UK market.
Keeping the investors happy will be a major theme for 2005, with close to two dozen mid-market houses on the fundraising trail. While some players are confident that all will be able to reach their targets, others reckon there will be winners and losers. Sceptical investors will not be reassured by surveys showing that most firms are predicting a fall in IRRs over the next three years.
UK mid-market funds are also bracing themselves for an expected influx of bullish US competitors into London. Many are likely to raise Euro-denominated funds.
In terms of hot sectors for 2005, little change is expected: business and financial services, healthcare and media are still keenly watched. The retail sector, one of the busiest in recent years, may fall out of favour if the poor reports of the Christmas season continue.
The ICT sector is also back on the agenda, as several players predict a wave of buyouts to consolidate the class of 2000. The odd deal in 2004, such as the HgCapital's £102m secondary of financial software group IRIS from LDC, shows the appetite for the right tech offering.
UK subsidiaries of US corporates are also tipped to be a fruitful source of buyouts in 2005, as the parents take advantage of the exchange rate to get top dollar for their assets.
The exchange rate may also be putting off US trade buyers. Exit-wise, 2005 looks less certain despite 2004 being a record year. A CMBOR study showed 258 exits worth over £17bn in the year to November, boosted by the wave of secondaries.
Another CMBOR study shows 24 flotations from private equity portfolios, and just 18 delistings in PTPs the first year since 1997 that private equity houses brought more firms to the public market than they removed. There is a pent-up demand from the public market for good businesses, notes Fell. "The use of public markets to find secondary funding was a very useful tool 12 months ago, but now the investors are looking for quality businesses that are going to stay on the market," he says.
Senior debt providers are also optimistic. After staying cautious for most of 2003, the banks have regained their appetite for private equity transactions, creating a highly liquid market. "We expect to see more activity in 2005 than in the last few years," says Daniel Myers, director of acquisition finance at Fortis. "The banks are relatively bullish, which is why they have liquidity and are willing to use it."
Bank appetite has been particularly strong in larger buyouts, with multiples of seven or more becoming commonplace. "We are seeing much more aggressive structures in terms of multiples," notes Myers. "I don't think we'll see multiples start increasing at the lower end, but it will continue at the upper end."
Any upset on the debt side could seriously hamper the market's recovery, however. "We're certainly roaring out of 2004 but you just wonder what might burst that bubble - the first big deal that fails to get syndicated properly will have an impact on that," Reynolds says. "I think 2005 will probably be another active year, although there is probably more frugality around than may be obvious."