These are testing times for the UK’s private equity industry, traditionally Europe’s prevailing market within the asset class. Recent regulatory measures at both European and domestic levels threaten to impose an additional burden on firms at a time when most buyout executives would rather devote all their efforts to deploying, returning and raising capital.
Most bruising of the recent regulatory developments for British buyout firms were proposed changes to the Takeover Code, which would include a shortening of the put-up-or-shut-up deadline to four weeks; forcing acquirers to disclose details of their financing package; revealing to the market all bidders involved in a process as soon as just one of them goes public with a bid; and banning break-up fees and other protective measures offered to bidders.
The overwhelming impact of the Takeover Panel’s proposed changes will be to dissuade certain bidders altogether
“The overwhelming impact of the Takeover Panel’s proposed changes will be to dissuade certain bidders altogether,” the British Private Equity and Venture Capital Association said of the proposals. “Unfortunately, this will strengthen the hand of under-performing boards, as there will be less market discipline to regulate their performance. This is clearly not in shareholders’ interests.”
At the European level, the Alternative Investment Fund Managers Directive is striding inexorably towards enactment as it undergoes a final period of consultation. Its provisions include a passport system for marketing private equity funds. European firms will be able to apply for a passport allowing them to market to investors across Europe from late 2012 or early 2013. Non-EU firms are expected to be eligible for a passport from 2015. National private placement rules, which investors presently use to raise funds in individual countries, are set to be phased out in 2018.
The AIFM Directive also makes dividend recapitalisations – a method of extracting cash from a business via the means of a special dividend and injection of debt – much more difficult to carry out in the first two years of ownership, in an attempt by regulators to prevent “asset-stripping”. Enhanced disclosure requirements, rules governing regulation and a cap of the use of leverage at manager level round out the key provisions affecting private equity.
More troubling to UK-based private equity firms, however, has been the country’s slower-than-hoped-for economic rebound and how that’s impacting both the health of existing portfolio companies and the potential for future investment.
Michael Queen, chief executive of 3i Group, one of the UK industry’s most venerable players, is bearish about the firm’s domestic investments. In a pre-close period briefing at the start of April, he said: “Overall, the private equity portfolio has performed well. There have, however, been marked regional differences, with strong growth in Northern Europe counterbalanced by weaker performance from UK companies. This regional dispersion in performance is due to a combination of macro and company-specific factors.”
Some economists are concerned at the potential for so-called “stagflation” in the UK – when inflation is coupled with stagnant growth. The UK government's aggressive approach to deficit reduction has won praise in many quarters, but economic growth has been behind estimates.
In April, the International Monetary Fund cut its 2011 growth forecast for the UK to 1.75 percent, its third downgrade in the last 12 months. Last April, its growth estimate for the UK economy was 2.1 percent. The UK Chancellor of the Exchequer, George Osborne, also acknowledged when delivering his latest budget in March that the Office of Budget Responsibility had downgraded growth forecasts for 2011 to 2012 from 2.1 percent to 1.7 percent and from 2.6 percent to 2.5 percent for the following fiscal year.
Consumer spending is subdued, with obvious knock-on effects for retail businesses in particular. The British Retail Consortium said consumer spending collapsed in March, falling at its fastest annual rate in the last 16 years.
The healthcare sector, traditionally viewed as a defensive sector popular with investors, has not been immune to the ravages of a weak economy either. The Chancellor has announced public-sector spending cuts totalling more than £110 billion to date, including cuts to the National Health Service.
UK private equity firm HgCapital, which has a long pedigree in the healthcare sector, has reportedly been dissuaded from making further investments in UK healthcare companies by proposed reforms to the NHS.
Firms like 3i and Hg, which have flexible mandates to invest regionally or globally, are instead expected to turn their attention to other parts of Europe with more promising investment climates. Germany, for example, offers a wealth of potential investment targets that can capitalise on the country's strong recovery post-downturn.
But the outlook may not be as bleak as it seems – the UK continues to dominate the European private equity market in terms of deal volume, despite regulatory pressures and concerns over the economy.
It has been the top destination in Europe for three of the past four years in deal volume terms, leading the league table of European nations this year to date with 40 buyouts, ahead of France with 32, Germany with 18, and Italy with 12, according to data provider Dealogic.
And certainly the UK government, as well as British citizens with their characteristic resilience in the face of adversity, don’t intend to sit idly by while the country’s economy declines. In his most recent budget, delivered in March, the Chancellor set out plans to spark growth in the UK economy. Measures included a reduction in corporation tax and reforms to the Enterprise Investment Scheme and Venture Capital Trust regimes to allow the two fund types to invest in a wider range of businesses, as well as increasing EIS tax reliefs.