Debt scarcity, trade buyers hinder UK deals

Four consecutive quarters of declining private equity activity relates to a scarcity in quality assets, increased competition from strategics and a lack of available debt, according to a BDO study.

Third quarter UK private equity activity fell 10.5 percent compared to the previous quarter and 13.5 percent compared to the same period a year ago, according to research from BDO. It’s the fourth consecutive quarter that deal activity declined, which the international accountancy firm attributed to a scarcity in the number of quality business being put up for sale, fierce competition from trade buyers and a lack of available debt funding.

In the third quarter, there were 77 completed private equity deals, the lowest total since the second quarter of 2011, when only 68 deals were completed, according to BDO’s quarterly Private Companies Index (PCPI) and Private Equity Price Index (PEPI).  In comparison, there were 466 trade acquisitions completed in the third quarter, which is the highest total since the third quarter of 2011. 

Trade buyers are sitting on a lot of capital, Peter Hemington, an M&A partner at BDO, told Private Equity International. “Big corporates have the firepower to do deals. Because of the choppy economic conditions in Western Europe and North America particularly, they held off spending that money,” he said.

In addition, a lack of good quality assets coming to market has driven up prices, the study found. Private equity buyers paid an average price earnings multiple of 13.3, up 11 percent from 12.0 in the second quarter of 2012.

You have a lot of money chasing a relatively small number of deals that have the investment quality for the private equity community, which leads to very strong prices, but relatively low deal volumes

Peter Hemington

“There is imbalanced demand and supply,” Hemington said. “You have a lot of money chasing a relatively small number of deals that have the investment quality for the private equity community, which leads to very strong prices, but relatively low deal volumes,” he said. “Every good quality asset that comes to the market is auctioned and advisors are good in getting the maximum amount of money for good quality businesses being sold,” he said.

Some fund managers may find themselves under pressure to invest despite the limited supply and rising prices, he added. “Most funds have a five-year [investment period] and you either invest that money in five years or you lose your annual management fees,” Hemington said, noting however that so far he’d only seen private equity firms target quality businesses.

On top of these factors, private equity firms are also struggling to obtain senior debt, the study found. “There has been a huge shift in private equity deal structures in the past few years where deals, which once typically comprised of 60 percent debt to 40 percent equity, are now funded by around 70 percent equity,” Hemington said in the statement.  This will have a negative impact on returns, Hemington added, “as [fund managers] have to put more equity in to achieve a less good result”.