Friday Letter: How great is Britain?

It's all feeling a bit 2007 in UK private equity at the moment. Should we be worried?

There's no doubt that at this week's BVCA Summit, the annual event hosted by the UK trade body, the general mood was as bullish as it has been for some time. Certainly if the attendee count, lunch quality and freebie quantity are anything to go by – and they normally are – the UK industry is in a pretty good place right now.

In some respects that's not surprising. After enduring one of the worst recessions in the G8 during the financial crisis, the UK economy is currently rebounding at a faster rate than almost any other rich country.

UK-based private equity firms also enjoyed a great fundraising year in 2013: according to PEI's Research & Analytics division, 65 funds raised over $62 billion between them, which is a bigger total than was raised in 2008. After a couple of years of strong exit activity – thanks in part to the IPO market coming back with a vengeance this year – LPs have been receiving distributions at a rate of knots. So they've been actively looking to commit to new funds, and UK GPs have been able to take advantage of that. Fundraising has slowed this year (the running total was $32.6 billion at the end of Q3), but that’s partly because so many of the bigger funds have already been out and raised a new vehicle – which means they’re now sitting on a stack of dry powder and looking to invest.

At the same time, the debt markets are booming; helped by the entry of alternative lenders in the last few years, there’s no shortage of leverage available for new deals in pretty much every segment of the market

So if you put all this together – a growing economy, stacks of dry powder, receptive IPO markets and abundant leverage – it’s no wonder that a number of people were telling us at the event that it feels a bit like 2006/7 in the UK at the moment. And given what happened in 2008 and 2009, that ought to make a few people nervous.

The big problem in the UK at the moment is that there aren’t really enough new deals around to keep everyone busy. According to the latest figures from the Centre for Management Buyout Research and Equistone, the 89 UK exits in the first half of this year had a total value of €21.9 billion, while total buyout value was a relatively meagre €8.6 billion (although that still made the UK the busiest market in Europe, it’s worth noting).

With deals in such relatively short supply, and all this liquidity sloshing around, the inevitable consequence is that prices have been soaring. You’ll have a hard time finding anyone in UK private equity who doesn’t think pricing is frothy at the moment – but they still want to put all that dry powder to work, and that could have a damaging effect on returns in the medium to long term.

Then there’s the reputational problem. The row over Phones 4U (a BC Partners-backed retail chain that recently called in the administrators) demonstrated that all the old suspicions about private equity still haven’t been dispelled – and according to Endless boss Garry Wilson at the Summit yesterday, its reputation has already become a genuine barrier to getting new deals done. The industry hasn’t been directly in the cross-hairs of politicians for some time now, but with a General Election coming up in 2015 – one that’s likely to be bitterly fought and whose outcome remains highly uncertain – that could change very quickly.

There’s also the further threat of what might happen after the election – especially if the Conservative Party is still in a position to push through its pledge to hold a referendum on the UK’s membership of the EU. Some sage heads at the Summit were already feeling a little nervous about what that might entail.

In short: it’s good to see that confidence back. But given all the constraints above, any bullishness is likely to be tempered with a bit more watchfulness this time around. At least we hope it is.