M&A activity was held back during the past year by continued caution from banks, but in the absence of traditional lending, companies are finding creative ways to do deals.
No-one expects the M&A market to return to 2007 levels for some time. But the past year has offered some grounds for the hope that things are at least improving.
In the first three quarters of 2010, UK M&A totalled £62.8 billion, more than double the £30.5 billion for the same period in 2009. The total number of deals also rose to 647 over the period, 186 more than in the first three quarters of last year, according to data from the research group mergermarket. The third quarter of the year alone saw £26.3 million worth of deals, the highest value recorded since the last quarter of 2008.
In the mid-market, one of the highest- profile acquirers has been the telecoms group Daisy, which has made ten acquisitions in the past 18 months. For Daisy, at least, there has been little suggestion of a slowing in pace. In November it completed its largest deal to date, with the £27 million purchase of the business telecoms provider SpiriTel.
‘We were consolidating a consolidator,’ says Daisy’s dynamic chief executive, Matt Riley. ‘It had been a target for a while, and we were starting to see them compete with us on deals, so we killed two birds with one stone.’
The acquisition was funded from a £75 million loan that Daisy agreed with its banks in June. Despite his own success in raising bank funding, Riley says feedback from the company’s SME customers confirms that businesses in general are still finding it difficult to get debt.
‘Work closely with your bank and don’t let them get any surprises,’ Riley advises fellow entrepreneurs. ‘We have regular reviews and meet them every month.’
Sweat your assets
With the continued dearth of bank lending, others have begun to step in to feed market demand. During the second quarter of 2010, asset-based lending to businesses in the UK rose 2 per cent on the same period last year to £14.6 billion, according to figures from the Asset Based Finance Association (ABFA). This was at a time when HM Treasury figures showed that net lending to UK businesses declined by £3.5 billion in June, representing a fall of 8.1 per cent from the previous year.
Though asset-based finance is traditionally used to plug holes in cash flow, there are businesses using it to do deals, such as East Midlands-based Drivetrain, a supplier of reconditioned diesel and petrol engines, which employed a lending facility of £2.5 million to fund a management buy-out from US parent ATC Technology. The facility is also expected to generate working capital to help Drivetrain expand.
Return of the buy-out
Private equity lending has returned to drive the M&A market this year. In the first half of 2010, private equity buy-outs accounted for 73 per cent of all UK M&A transactions by value, according to research by the Centre for Management Buy-Out Research (CMBOR). The total value of private equity buy-outs in the UK rose to £4 billion in the third quarter of 2010, an increase from £3.4 billion the previous quarter.
David Whileman, a partner in the growth capital team at private equity giant 3i, confirms that there has been a shift from trade purchases to secondary buy-outs in 2010. He adds: ‘The overall trend is that M&A has picked up quite significantly, particularly in the last quarter. In 2009, there were about 15 deals done in the UK of more than £100 million [enterprise value], and it’s getting nearer to 40 for this year.’
When bank debt isn’t as plentiful as it was, private equity firms are ‘over- equitising deals’, Whileman adds. ‘So where traditionally equity would be less than half of the overall money raised, we’re starting to see deals that in some cases are almost fully funded through equity.’ An example is the all-share acquisition of discount retailer Poundland by US private equity firm Warburg Pincus last May.
Another trend Whileman has spotted is incumbent private equity investors looking to take on investment partners to add capital to portfolio companies. ‘More than ever, big companies and primary investors are looking for growth capital, and for one reason or another they’re encouraging these kinds of deals.’
A pressing need for cash is also behind another theme of the past year, which Rhys Phillip, a partner at accountancy firm Ernst & Young, sees continuing into 2011.
Phillip states that the reluctance of banks to lend has led some big companies to dispose of ‘non-core’ subsidiaries in order to raise money for other projects.
‘The most active sectors this year have been technology and pharmaceuticals, where there’s been quite a lot of non-core disposal,’ says Phillip, who runs Ernst & Young’s M&A practice in the UK. He adds that larger deals of this nature will in turn ‘pull’ the SME market with them as the companies that have been spun out seek to make their own acquisitions.
Another driver of this type of deal is regulation. The acquisition of US eyecare specialist Alcon by Swiss pharmaceutical giant Novartis meant that a portfolio of around 20 products had to be sold off thanks to the intervention of the EU monopolies and mergers commission.
Although tricky trading conditions and stretched finances can suppress appetite for deals, in some circumstances they can make CEOs keen to build size and volume to make the most of thin profit margins.
Simon Embley is the CEO of LSL Property Services, which in January bought the estate agency chain Halifax Property Services from Lloyds Banking Group for £1. He says, ‘Scale is important. If you’re not in the top three in this marketplace, you won’t be able to make money because it’s a small market.’
The non-core subsidiary, with 206 branches across the UK, was making a loss of around £15 million each year, and as part of the deal LSL received £25 million in cash from Lloyds to help restructure the business.
Embley says that the acquired business is currently on target to make a profit in the second half of this year after the trimming of around £25 million of operating costs and the removal of all of the corporate office and middle and senior management.
The healthcare sector has also seen consolidation activity over the year. Mike Benton is the CEO of Medicals Direct Group, which in March bought three subsidiaries of Company Health Group from administration. Medicals Direct provides outsourced insurance medical services to corporate clients, but Benton says that the acquisitions provided a platform to expand into the broader UK health market.
He adds, ‘Increasingly there’s an opportunity for us to enter the SME market. Ideally, we want to grow organically in 2011, but we have a couple of small targets that we might go for.’
Benton believes that the announced public sector spending cuts will have a positive effect on the private healthcare sector as they will create opportunities to offer outsourced services back to the NHS.
As a by-product of the financial crisis, state lending to banks across Europe has also started to create M&A opportunities. In July this year, the financial services company KBC Peel Hunt announced a £74 million employee buy-out from Belgian parent KBC.
Simon Hayes is the chief executive at Peel Hunt, and says that the bank was selling non-core subsidiaries in order to fund repayments to the Belgian government: ‘We offered all 125 members of staff the opportunity to invest, and over 90 have, including secretarial and admin staff.’
The deal gives the employees 75 per cent ownership of the company and 25 per cent to external investors. Hayes predicts that 2012 is going to be a crunch year for a lot of companies with debt facilities that expire: ‘The next 12 months are going to be about companies refinancing those facilities, and those that can’t looking to the equity markets or alternative sources of funding to do so.’
The year ahead
Phillip of Ernst & Young agrees that there is still ‘quite a lot of pent-up distress within bank portfolios that is getting shaken’ and this ‘will drive deal activity’. But it won’t be the only factor. ‘The austerity measures in the UK have been broadly well received by the business community as a necessary evil,’ comments Phillip. ‘I think the steady progression in deals is going to continue, and I would expect us to see the banks being a little freer with cash post-Christmas.’
Whileman also expects to see activity levels increase steadily over the coming year, especially within the resurgent secondary buy-out space: ‘I suspect that this trend of looking for new money and new partners to grow existing investments will continue, and I think we’ll see some landscape-changing acquisitions of corporates backed by private equity.’
From the perspective of Daisy’s Matt Riley, the resurgence of private equity means increased competition for deals, with buy-out firms active in the telecoms sector. ‘I think it’s probably because of the strong cash flows in businesses like these, which private equity like,’ he comments.
‘They also need to put the money to work that they’ve been sitting on for the past two years waiting for the market to trough.’