The UK’s third-largest supermarket chain, Asda, is known for a number of things: being the first discounter in the country; its 1970s ‘pocket tap’ television adverts; and its Tickled Pink breast cancer charity programme. One thing it is not typically associated with is a vegan butcher counter.

To coincide with Veganuary 2021, the Leeds-headquartered company launched an expanded range of meat-free alternatives in a trial that ran for six months at its Watford location. The counter sold out over a single weekend, a source familiar with the supermarket chain tells Private Equity International. “None of that stuff happened under Walmart,” they add.

In February, mid-market firm TDR Capital and UK-based entrepreneur brothers Mohsin and Zuber Issa completed the acquisition of Asda for an enterprise value of £6.8 billion ($9.1 billion; €8 billion). The deal was reportedly financed with about £6 billion of debt. Walmart, which has owned Asda since 1999, still owns a stake in the supermarket chain.

TDR – the owner of Dutch fleet management company LeasePlan, UK pub operator Stonegate and restaurant chain Pizza Express – has mapped out a £1 billion, three-year growth plan for the acquisition. This includes accelerating the grocer’s omnichannel offering, setting up Asda convenience stores, sourcing more food from UK farmers and ensuring Asda remains competitive in the supermarket fuel sector.

The company’s previous owner was focused on “everyday low prices and a one-size-fits-all prescriptive approach”, the PEI source says. “The job is to ensure Asda becomes more convenient and more valuable to its customers.”

The source adds that Asda’s new owners want to “do something differentiated”. “The market’s crying out for it. Grocery retail has been the same forever and the retail landscape is changing. And a lot of that is linked to availability of capital.”

TDR declined to comment on the deal.

Deal boom

The Asda deal is among the 534 PE-backed deals recorded in the UK from January to October this year. UK private equity deal activity smashed records in both volume and value in 2021, with £85.5 billion-worth of transactions, according to data from DC Advisory. That’s more than double the whole of 2020 by both total value and count.

Allan Bertie
Allan Bertie, Raymond James: ‘Whether it’s a big capital expenditure programme for a rollout or an investment in refreshing your technology base… the public markets do not like companies that have quarterly, semiannual and annual disruption to their growth trajectory’

Most of the action was in deals in business services, technology, media and telecoms, accounting for about one-third of the total number. The largest deal was US private equity firm Clayton, Dubilier and Rice’s £7.1 billion bid for supermarket chain Morrisons – the biggest buyout in the UK since KKR’s £11.1 billion acquisition of Alliance Boots in 2007.

Following a three-round auction and four-month battle for the grocer, CD&R’s latest offer – representing a 60 percent premium to Morrisons’ share price before takeover interest emerged in mid-June – outbid a consortium of investors led by New York-based Fortress Investment Group. TDR and I Squared Capital’s £2.3 billion acquisition of Glasgow-based power provider Aggreko, which subsequently de-listed from the London Stock Exchange in August, is another mega-deal that took place in the UK in the past 12 months.

The hallmark of dealmaking this year has been public-to-private transactions. In the 12 months to July 2021, the value of take-privates tripled to £28.6 billion, from £9.4 billion in 2020, according to research by law firm Mayer Brown.

PE giants Blackstone, Carlyle and KKR have been gearing up for the opportunity and expanded their UK teams in recent years, with senior appointments focused on sourcing and executing investment opportunities in the market.

When PEI met with Blackstone president and chief operating officer Jon Gray in London in February 2020, he said the UK was “probably the most compelling developed market in the world” at the time. In his view, the relatively depressed valuations in the UK relative to the US have made British companies more attractive to investors.

Blackstone itself has made several deals in the UK this year: in February it completed the acquisition of UK holiday company Bourne Leisure for an undisclosed sum, and in May agreed to take over St Modwen Properties for £1.2 billion.

In February, research by investment bank Liberum exposed the widest valuation gap between London and Wall Street markets in three decades. At that time, the UK traded at a 30.4 percent discount to the US.

“If you look at what has happened since the impact of the pandemic has eased, the earnings performance of UK companies has rebounded more strongly than their US or European counterparts,” says Harry Bacon, a partner at Slaughter and May who worked on the Morrisons deal on behalf of Fortress and a consortium of investors including Canada Pension Plan Investment Board, Koch Real Estate Investments and Singapore’s GIC.

“So, we’re in a world where our assets are performing better, the economy is doing pretty well and UK economic forecasts are reasonably strong – yet we’re still in the doldrums when it comes to UK public valuations.”

Sources that PEI spoke to agree the undervaluation of UK-listed companies is linked to a structural problem: the investor base in UK equities (often UK pension funds) is focused on dividends rather than growth.

By comparison, a higher proportion of investors in US public companies are growth-focused and are less bothered about the income stream than capital appreciation. As a result, the investors drive very different behaviours over the companies. One is cash-generative and returns value to shareholders on a regular basis; the other is more likely to take greater risks and do more to grow.

“If you’re having to pay out a steady income stream and you’re very much focused on dividends per share, that looks more like a business in stasis focused on maintaining its position,” Bacon says.

The biggest thing that the public markets don’t support is companies needing change, adds Allan Bertie, head of European investment banking at Raymond James. “Whether it’s a big capital expenditure programme for a rollout, or an investment in refreshing your technology base or rewriting the core code in some of your software products, or building a new shipyard, the public markets do not like companies that have quarterly, semi-annual and annual disruption to their growth trajectory.”

Bertie says that being taken private is in the best interest of the company, because it can get capital from investors that will take a three-, five- or seven-year view.

“Undoubtedly, there are going to be cases – as there have been in the past – of massive gains being made in very short periods of time by a smart private equity firm that spotted a piece of arbitrage,” he adds. “But it’s always about supply and demand. If you think the company’s undervalued, you should be buying some more shares because it’s a value opportunity, rather than simply say, ‘They’re stealing our company at low prices.’”

Investors are also taking notice. Caisse de dépôt et placement du Québec is planning to invest C$15 billion ($12 billion; €10 billion) into the UK and Europe over the next four years across private equity, infrastructure and private credit.

Speaking to PEI, Albrecht von Alvensleben, head of private equity Europe at CDPQ, says the investor wants to increase private equity exposure in sectors including healthcare, business services, technology and financial services. “We also want to increase our footprint in infrastructure and then, to an extent, overlay energy transition and sustainability across asset classes – those are key priorities for us,” he adds.

Within private equity, CDPQ has a 25 percent exposure to UK and Europe, which can move to up to 30 percent depending on deal activity and realisations in the portfolio, von Alvensleben says.

The UK is a focus because it’s the most advanced capital market in Europe and provides opportunities to allocate significant amounts of capital across asset classes – something that is not necessarily the case for all European countries, says von Alvensleben. Targeting industries that are less prone to potential significant impacts resulting from Brexit has also been a priority, he adds.

In addition to its relatively cheaper valuations, the UK’s flexible labour laws and takeover rules are factors others point to when considering what makes it easier to acquire and restructure companies and allow investors to see a relatively clear route to the finish line.

The low-interest-rate environment, volatility in public markets and the potential for high risk-adjusted returns in alternative markets also continue to boost the confidence of LPs and, consequently, private equity allocations, Andrew Strudwick, managing director at DC Advisory, points out.

Future targets

The UK’s split from the EU took full effect as 2021 began, yet it is not denting sentiment over investment opportunities in the UK, a report from data provider Ansarada revealed. Ninety percent of the survey’s respondents believe the number of M&A deals in the UK will increase in the next 12 months, including 54 percent who believe it will increase significantly.

In addition, dealmakers anticipate rising insolvencies in the UK as British businesses face the twin challenges of the pandemic and Brexit-magnified supply chain issues. This will deliver more opportunistic dealflow for private equity buyers, especially in sectors such as industrials and manufacturing. More than half of respondents expect the number of distressed deals to rise in the next 12 months.

Slaughter and May’s Bacon notes that private equity firms are also likely to target mid-tier banks, as well as fintech and insurance platforms, because they offer opportunities to release value and create platforms that firms can use to deploy more capital in the future.

At the time of writing, Carlyle was reported to have pulled out of talks to take over Metro Bank. In April, JC Flowers and Bain Capital Credit snapped up an approximately 10 percent stake in the Co-operative Bank for an undisclosed sum.

Clean energy and clean infrastructure have become increasingly popular among investors that want to integrate climate considerations in their portfolios. Oil and gas, as well as industrials, will also draw interest with some opportunities for turnaround situations.

Deal activity in 2022 is going to look a lot like 2021, Bacon says. “Deals like Morrisons will have sparked interest from people who might not have traditionally looked at UK public takeovers as a potential source of assets. They’d ask, ‘What’s the noise? What opportunities are there for us here?’

“PE firms can pretty much do a rundown of the FTSE 350 and say, ‘What’s interesting?’ All of these companies are technically up for sale on the right terms.”

Overcoming challenges

Despite the surge in deals, the industry must remain conscious that the post-lockdown recovery may be short-lived in certain sectors and could threaten the overall market momentum, adds DC Advisory’s Strudwick.

He notes that the supply chain squeeze is also feeding into higher costs for businesses, which in turn are being passed onto consumers, giving rise to inflation concerns and other knock-on impacts such as future interest rate rises and the cost of debt increasing substantially. Data from the UK’s Office for National Statistics certainly supports this argument, showing that in the second quarter, the level of GDP was 3.3 percent lower than pre-pandemic (Q4 2019).

What’s more, investors continue to chase performance. Alex Koriath, head of European pensions for Cambridge Associates, says: “What could derail the UK private equity’s momentum? I think about that in terms of what could derail overall returns in the asset class.”

Harry Bacon
Harry Bacon, Slaughter and May: ‘The earnings performance of UK companies has rebounded more strongly than their US or European counterparts since the impact of the pandemic has eased’

eFront’s Fourth Annual Global Private Equity Performance Series found that the UK is among the 10 highest-performing countries for private equity funds globally.

Investment-to-date performance of UK deals – measured as weighted average money on invested capital, gross of fees and based on both active and realised deals – stood at 1.57x. That compares with 1.68x for the US and 1.67x for France.

Koriath notes that potential external shocks in the US-China relationship are also a concern. “We are observing what the Chinese policy will shape up to be. It’s a very interesting environment [and] we’ve seen some policy strands, but we haven’t seen them brought together into the next five-year plan.”

Increasing intervention by the UK government via the Competition and Markets Authority, as well as the National Security and Investment Act is also a worry.

On 4 January, the UK will activate an enhanced foreign investment regime that – if applied too stringently – could be a deterrent to doing business in the country.

“The UK has a history of being pragmatic, and I think that is an objective after Brexit – to show the world that this is an open economy and not owned by bureaucratic process,” Koriath says. “There’s a political desire to show pragmatism, that it’s open for business and that it’s participating globally.”

Stewardship over profits

High-profile transactions such as Asda and Morrisons have come under attack this year from shareholders, unions and politicians who have been anxious about the wave of private equity takeovers of UK companies.

They worry that the companies would be stripped of assets and piled with debt, and that a “household name with a proud history will fall into foreign hands… that will hoover the profits from communities and sweep them overseas”, according to a statement about the Morrisons deal by Steve Turner, assistant general secretary of trade union Unite.

Alex Koriath
Alex Koriath, Cambridge Associates: ‘What could derail the UK private equity’s momentum? I think about that in terms of what could derail overall returns in the asset class’

“Critical to building support for transactions of this nature is transparency around the value creation plan,” a source close to CD&R tells PEI. “One of the main lessons from Morrisons, and other recent take-privates, is that the form of ownership – private capital, public markets, entrepreneurs or families – is far less important than what the owner plans to do to help make the business more valuable over the long term.”

In the takeover documents of such transactions, PE owners sought to underline their continuing commitment to supporting domestic suppliers and small businesses and safeguarding pensions, often declaring that they have “no intention of making any material changes to the conditions of employment” at the target company.

Nonetheless, the source close to the Asda deal says there is work to be done at the supermarket, and it will take time.

“They’re not trying to break the thing apart and rebuild it – nor are they trying to reinvent the wheel. If they do their job right at Asda, that will be a huge accolade for private markets and private ownership. If they are able to execute against that strategy and genuinely do something that is differentiated and market-leading, that should be a great case study for what is achievable and what responsible investing is about.”

The National Security and Investment Act will bite

Reforms to the UK’s foreign investment screening regime have been long in the making, and will have far-reaching consequences in M&A

The National Security and Investment Act will be enforced on 4 January 2022. The bill introduces a standalone Committee on Foreign Investment in a US-style foreign investment regime for the first time in the UK, which will be aimed at both domestic and non-UK investors looking to acquire or increase stakes in a range of sectors including communications, defence, artificial intelligence and other tech-related areas.

The government will also have retroactive powers to call in for review as of that date, or potentially up to five years thereafter, any qualifying transaction completed between 12 November, 2020, and the commencement date in January.

This imposes greater regulatory surveillance on a lot of the bilateral private processes that never had such levels of scrutiny applied to them previously, says Anu Balasubramanian, a partner at law firm Paul Hastings. She adds: “From an advisory perspective, we need to make sure that we’re fully up to speed to ensure that our clients on the buy-side have the best ability to acquire the asset, and on the sell-side have the comfort that they have execution certainty in terms of being able to sell the underlying asset.”


UK DC pension opportunity

Higher fees have traditionally kept pension schemes at arm’s length from private equity, but that’s changing

Over the summer, prime minister Boris Johnson and chancellor of the exchequer Rishi Sunak called for an “Investment Big Bang” among the country’s institutional investors to help bolster the UK’s recovery from the covid-19 pandemic. The government is also setting the groundwork for the launch of its Long-Term Asset Fund, which is designed to invest in long-term, illiquid assets.

More than 80 percent of UK defined contribution pensions funds’ investments are in mostly listed securities, which represent only 20 percent of the UK’s assets. The higher fees associated with investments in illiquid assets, such as private equity and infrastructure, have traditionally hindered pension fund managers from investing in these asset classes.

That is gradually changing as more DC pension schemes push into private equity. The National Employment Savings Trust (NEST), which manages £20 billion of AUM on behalf of 10 million members, has been steadily increasing its investment into private markets, from issuing private credit to mid-sized companies in 2019 to investing directly into infrastructure projects. NEST said in August it is set to invest into growth and mid-market private equity, with a target allocation of 5 percent of its assets in private equity, or £1.5 billion, by the end of 2024.

NEST’s head of private markets, Stephen O’Neill, tells PEI that the pension scheme is looking to provide capital to “platforms with a large amount of high-quality co-investment dealflow”. And it will pay managers a “reasonable fee” for the service which is “not remotely near the two-and-20 that one would have to pay for a commitment to a traditional blind-pool fund”, he adds.

In November, TPT Retirement Solutions, a £13 billion workplace pension scheme, said in a statement it will deploy £54 million into listed private equity assets such as investment trusts and the stock of listed PE firms.

DC pensions assets are set to reach £1 trillion by 2030, according to the Financial Conduct Authority.