‘Hard’ assets in demand: Deals by City’s distressed private equity funds treble to £1.8bn in just one year

The leading mid-tier distressed asset private equity and debt funds in the UK made a total of £1.8bn of acquisitions of businesses last year, almost treble the £670m registered in 2020 and the highest figure for five years.

The 12 specialist funds acquired 26 UK businesses in 2021, up from 19 the previous year.

There are likely to be even more distressed acquisitions to come as interest rates rise and inflationary pressures reduce disposable incomes, investment specialists at audit and tax firm Mazars told City A.M. this morning.

However, these macro factors are creating opportunities for distressed asset funds to acquire businesses that could thrive if their debt burdens were restructured or alternatively act as a “bolt-on” for other similar businesses in their portfolio, the firm stressed.

‘Hard’ assets

Distressed asset funds are primarily targeting businesses with ‘hard’ assets that have a more predictable resale value, therefore providing more security to the distressed fund but also making raising debt finance easier.

Struggling businesses in sectors such as engineering and manufacturing have been particularly in demand as a result.

Software and technology businesses with recurring revenue streams – or subscription models – are also attractive propositions for distressed investors, according to Mark Boughey, a partner in the Restructuring Services practice at Mazars.

Boughey told City A.M. that another driver of the increase in acquisitions by distressed asset funds is uncertainty over whether businesses will be able to service debt accrued over the pandemic period, with repayments now commencing on CBILS and BBLS loans taken out during the pandemic.

“Macro headwinds in the UK have created a much more fertile landscape for distressed asset funds.”

Mark Boughey

“They are much more opportunistic than traditional private equity and have targeted undervalued assets, turnaround situations as well as non-core carve out opportunities from larger trading groups,” Boughey continued, adding that “they have been far more active in the last 12 months than they were at the height of the pandemic.”

“The huge increase in costs businesses have seen and new indebtedness they have had to incur, just as they put Covid behind them, has put a raft of fundamentally good businesses under financial stress and caused those which were weak, or trading as “zombie” businesses, to enter deep distress.”

“That is exactly the sort of situations that these funds specialise in acquiring,” he explained.

His colleague, Harris Waseem, director in the restructuring services practice at Mazars, added that “stressed market conditions create investment opportunities for distressed asset strategies.”

Harris added: “Whilst distressed debt funds have historically been associated with cut-throat restructuring, this isn’t always the case. The key distressed funds in the UK mid-market are increasingly reputation focussed and want to be seen as providing what we call ‘constructive capital’.

“The onset of the pandemic has accelerated this trend and increased the investment funds distressed buyers have access to”.

Harris Waseem

He explained that “this means avoiding hostile acquisitions, not committing to hasty cost reduction programmes but instead sourcing opportunities where companies require specialised expertise to recover and draw out unrealised value”.

Funds specialising in the acquisition of distressed companies, not distressed debt, are RCapital Partners, Better Capital, Rutland Partners, Endless, Alchemy Partners, ESO Capital Group, Maven Capital Partners, Ridgeway Capital, Inflexion Private Equity Partners, Greybull Capital, Sandton Capital Partners and AURELIUS Equity Opportunities.

Boughey noted that “whilst asset rich businesses or those with recurring revenues are attractive targets, the current cost of living crisis means that businesses that rely on discretionary consumer spending – particularly retailers – could be a riskier proposition for funds at present.”

He also said that there have been very few acquisitions of retailers by distressed asset PE funds during the past year as funds focused on asset-backed businesses.

Whist there have been winners and losers in the sector, Boughey pointed out there will be relatively low confidence in the ability of struggling retailers to deliver a sales-led turnaround during the UK’s cost of living crisis.

“As we move through these uncertain times, it appears that the distressed asset investors and those who advise them are in for a heightened period of activity in the coming months,” he concluded.