Private Equity Buying the Best of Britain
2021 is already a record-breaking year for U.K. private equity deals. Private financiers have targeted undervalued British firms, pulling them out of the public equity London Stock Exchange. Private Equity or P.E. are finance firms that invest in private businesses or acquire public firms and take them private. P.E.’s usual targets are underperforming companies which they will turn around then sell for a profit. In the past, P.E. has had a reputation for layoffs and selling assets, but this is evolving more recently.
The current dream environment for the global P.E. market is due to continued low interest rates; P.E. relies heavily on borrowing to fund deals. Pregin data says P.E. raised record funds in the first half of the year and now has pressure to spend it. According to London-based P.E. firm Hult Private Capital’s, Mark Johnson, “The U.K. is attractive for local and international investors. Brexit’s legacy and the FTSE, heavy with industrials and legacy businesses, means international investors have avoided the country. The result is that many U.K. stocks are cheap compared to international companies.”
The FTSE 100 is in last place for major equity index performance since Brexit in 2016 and when compared to the Nasdaq or S&P500, is probably undervalued.
According to Refinitiv 401 U.K. P.E., deals have been done to date totaling nearly $50 billion. It was the highest since Refinitiv started collecting data 25 years ago, and well past the 297 that went private in the first half of 2018, the second-place result. British companies from supermarkets, mechanics, infrastructure, properties, financial fund administrators, private jets, insurers, aerospace, and even an Asian takeaway have all been taken private in 2021.
Morrisons grocery chain is the most recent deal to hit the headlines with P.E. firms, Fortress Investment Group, Apollo, and Claton, Dubilier & Rice (CD&R) all making bids for Morrisons’ takeover. If a deal is reached, over 1 million British workers will be employed under P.E. firms, 3% of the British workforce.
In the past, P.E. raised concerns about asset stripping, where a company’s value is below the sum of it’s parts or its book value. The P.E. company sells the good parts, such as its real estate, factories, and equipment, while leaving the remainder with the debt, a quick way for the P.E. company to make money. However, more recent P.E. Strategy has changed, a more recent trend is for P.E. firms to combine new purchases with already owned assets called “Bolting on” to take advantage of economies of scale and make the combination more valuable than the parts. A process that could be done with a typical merger but a company’s board or management may be resistant.
Other parts of the E.U. have implemented rules to prevent asset stripping, with internal reviews for all types of loans or credit exposures when the borrower is owned by financial sponsors. The lack of such rules and a much more “business-friendly” environment found in the U.K. make a P.E. investment there more preferable. Labor laws in France are much stricter, and the government has a hard-line approach to foreign investment.
HULT Private Capital’s Mark Johnson thinks that the funds interested in the Morrisons takeover are looking at it for the wrong reasons, “When an acquirer makes strong returns, they can do it by making a company better. It does not have to be from just buying the real estate portfolio cheaply and saddling the company with debt, which lowers the tax bill. Asset stipping of Morisons’ petrol stations, factories, stores, and warehouses, is not possible with the current offer price. Morrisons has a unique supply chain system where they produce much of the fruit and vegetables they sell and have slaughterhouse facilities. This is a unique value that is lost if the assets are sold.”
While all of these deals continue, there is anxiety regarding the merits and drawbacks of Private Equity. Parliament members of the U.K.’s Labour party such as Darren Jones, chair of the House of Commons Business, Energy and Industrial Strategy Committee, and U.K. union heads worry of job losses, due to high debt levels used for purchases. Current shareholders are stating that the companies are being sold too cheaply.
Private Equity companies will fund takeovers through borrowing, but the deal’s structure will put debt on the target company’s balance sheet. Refinitiv data shows that debt is around six times a company’s earnings, which is significantly higher than a company’s typical debt levels. High debt can be risky if the economy changes, but the low interest rates available currently make these deals much safer.
In the past, job cutting was a worry, a Harvard Business School study found that on average, within two years of the closing of a P.E. deal, the target firm’s employment shrinks by 13% to reduce costs and increase efficiency. They also found that the takeover target’s productivity rose an average of 8%, compared to controls. The question remains that if there were no takeover, would the often distressed target company have survived?
Those invested in firms such as HULT Private Capital see quick gains. Data collected by Russ Mould, investment director at A.J. Bell, show that the average bid premium of Private Equity firms is 36%. However, more recent deals have been below this level, and with lower debt levels required for purchases, the possibility for returns and success is even better. Hult Private Capital’s Mark Johnson said, “when the stock is undervalued for a good firm, and a bid is made that does not even reach book value, it is a guaranteed immediate return. This is no different from what Warren Buffett and Berkshire Hataway have done for decades; find undervalued companies that are easy to understand and buy them.”
This year is already record-breaking for the number of P.E. deals done. We have just 3 months to wait to see how high the record will go. For those fortunate enough to be on the buying side of P.E. deals like HULT Private Capital, they will continue to search for the great undervalued British companies.
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