The outcome of the UK referendum on EU membership last week has dashed the hopes of many in the private equity industry who were anticipating a Remain vote that would spur deal activity in the second half of the year.
The uncertainty that industry insiders had hoped would vanish is set to linger indefinitely as the UK begins a months-long process to install a new Prime Minister and a years-long negotiation process with the EU.
All those Private Equity International has spoken to since Friday’s result have agreed that deal volume in the remainder of 2016 will almost certainly be sluggish at best; one industry insider went as far as to say the rest of the year will be a “write-off”.
Callum Bell, head of corporate and acquisition finance at Investec, told sister publication PEI that from a dealflow perspective there “can be no positive” to take out of the referendum result “other than for people who are opportunistic and can still find a deal because it has to happen rather than because it wants to happen”.
“The one fundamental for investment is to have some certainty around what you’re buying and at what price, and if you don’t think it’s good value, there can be some adjustments, which we’ve already seen in the loan markets a little bit in the background,” Bell said. “But we’re very early stage and how it plays out over the next month is pretty critical.”
Industry participants are clear that this is not 2008: the market will not grind to a halt. However, after two very strong selling years in 2014 and 2015, there were high hopes for 2016 as the year of the acquisition.
“Last year all these private equity [houses] went out and sold everything they could. This year they said, ‘We need to buy, this year we need to put money to work,’” Simona Maellare, who co-heads the global financial sponsors business at UBS, told PEI in March.
“I think the volume of deals this year will not be what we wished for at the beginning of the year.”
Stewart Licudi, head of European financial sponsors coverage at investment bank William Blair, said buyers and sellers would be incorporating the referendum outcome into investment decisions as a risk factor.
“It would be naïve to think that deal volumes are not going to be affected. I suspect we’ll see slightly depressed M&A when you’re dealing with UK-based businesses,” he said. “But I don’t think it will stop. There’s always a market for good quality businesses.”
As well as concerns around macro-economic issues and their possible effects on potential portfolio companies, Gareth Whiley, a partner at pan-European private equity firm Silverfleet Capital responsible for UK and Nordic investments, notes that there is likely to be more of a mismatch between buyers’ and sellers’ expectations over the coming months as buyers look to take advantage of the dislocation.
“This normally takes much longer to settle than an M&A advisor will tell you. I expect deal volumes won’t pick up as quickly as expected,” he said.
Licudi agreed that asset-owners are generally not feeling overt pressure to offload portfolio companies.
“If somebody thinks they’re going to be able to come in with a strong dollar and buy good quality businesses cheap, especially from private equity, I’m not sure that’s going to happen. The people I’ve spoken to have said ‘we’re still willing to trade, but we’re not going to do it at a discount.’”
Volatility does, however, create opportunity for private equity. One industry insider suggested that when we look back on this period in 10 years’ time we are likely to find that those who invested now have outperformed.
“Some deals are not going to happen now, but private equity is likely to see opportunities amid the gloom, especially as UK asset prices come down with the fall in value of the pound and a possible dip into recession,” John Taylor, corporate partner at Herbert Smith Freehills, said in a statement.
It’s also generally agreed that now is a good time for debt funds with capital ready to deploy. With banks taking a heavy hit, it’s likely GPs looking to get deals done could turn to non-traditional lenders.
“Debt funds and flexible debt providers like Investec should like the look of a little increased uncertainty. It should bring yield back into play,” Bell said.
The increased cost associated with financing packages from non-traditional lenders may also result in a tempering in the use of debt.
“Where traditionally you might have put 50 percent of debt in, maybe you’re only going to put 30 percent debt in,” Licudi said.
“Private equity [managers] are professional deployers and collectors of capital. If, to do a good deal, you’ve got to put more [equity] in and less debt in order to deliver your return, these guys are quite well-versed at being able to do that.”