The coronavirus pandemic has left a number of UK-listed companies scrambling for cash, with private equity firms tempted to swoop as the crisis develops.
PE firms are eyeing opportunities as they move to deploy more of their dry powder into public entities as the economy starts to reopen in the wake of the coronavirus crisis.
Data from Private Equity International shows the capital raised for Europe-focused buyout funds alone has inched up in recent years, with $49.54bn raised in 2019.
This year just $2.69bn has been raised in the first quarter. But this is likely to rise as funds close towards the end of the quarter, including private equity giant CVC’s VIII fund, which is targeting €18bn (£16.1bn).
This huge amount of capital paired with depressed valuations is likely to accelerate the increasing number of take-private deals.
Last year saw a new record for UK take-privates, according to Pitchbook data. The momentum of those deals was responsible for half of 2019’s record deal value reading, Pitchbook’s data showed.
The combination of billions in dry powder, a depressed market and the looming deadline of Brexit is a perfect storm for take-privates.
Dominick Mondesir, EMEA private capital analyst at Pitchbook, predicts activity to remain healthy in the medium to long-term “as general partners look to take advantage of the market dislocation across both main and AIM public markets”.
Lessons learned from 2008
While much has been made of comparisons with the 2008 crisis, private equity funds are certainly looking to apply the lessons learned during the crash to the current economic devastation.
Ed Stead, head of private equity at law firm Pinsent Masons, says: “I’ve heard quite a few houses generally say they want to act more quickly as they recover from this crisis compared to 2008.”
Indeed, KKR, one of the world’s biggest private equity firms, started to deploy capital as soon as the pandemic took hold, buying waste-management firm Viridor from Pennon Group for £4.2bn in March.
“A number of limited partners criticised PE firms for being too cautious while some firms that were a bit more bold made great returns,” Stead adds.
KKR, one of the world’s biggest PE houses, has been the most active firm globally since the pandemic took hold, deploying $12.7bn (£10.05bn), according to data compiled by Bloomberg.
Simon Wood, partner at Addleshaw Goddard, predicts a rush of activity in the second half of the year. “You almost could see a herd mentality. When one or two deals go it might mean everybody feels more comfortable.”
A recent survey by Addleshaw Goddard found 26 per cent of private equity firms were more likely to carry out a public to private transaction if they saw others doing so too.
As firms compete to raise funds from institutional investors, Addleshaw partner Mike Hinchliffe suspects firms are realising that if competitors complete a few take-private deals and “they show they were good deals because they’ve bought a good business at a low valuation and sell them on… that could be something that makes them more attractive.”
Private equity will circle AIM market for coronavirus stakes
So where will the private equity firms focus their attention once a semblance of normality returns in the wake of coronavirus?
As the valuation gap between the main and AIM market continues to grow, Mondesir predicts general partners’ appetite for AIM targets to grow, particularly small-cap pharma and high-growth technology for growth investors.
AIM is a sub-market of the London Stock Exchange for smaller growing companies, from early-stage venture-capital-backed firms to more established companies. The market has become home to larger and more profitable companies in recent years, with governance and reputation also growing.
The number of PE-backed deals for AIM companies have trebled in the past year. PE funds bought and took 12 companies private in 2019/20, compared to just four deals in the previous year ended 31 March.
As the economic consequences of the pandemic start to be realised, AIM companies will likely face greater liquidity and in some cases solvency stress. That, coincided with a paring down of government support, will mean their access to the investment grade liquid credit markets remain limited, Mondesir says.
“This dynamic could lead to more sponsors stepping in to acquire these assets from the public markets,” he adds.
However, Stead warns that while take-private transactions may look attractive because of depressed valuations “there is a gamble to be considered around where valuations will be in a few months.”
Many of the bigger firms, like KKR, may consider the leap of faith to be worth it in the face of further waves of the pandemic.
Pipe deals offer an alternative for cautious investors
Zoom has come to characterise much of the City’s coronavirus lockdown experience, but it has posed difficulties for due diligence within the private equity industry.
Michael Mowlem, head of private equity at family office Sandaire, says: “There is a lot of value in walking round an office or a factory before buying a business and seeing how management teams interact with staff. You get a feel for the culture and organisation and it is impossible to quantify what that is otherwise.”
With that in mind, private equity firms may instead look to so-called pipe deals over take-privates, which offers a middle ground.
A pipe deal is a private investment in public equity, which involves the selling of shares to private investors. They are more commonplace in the US than in the UK, with figures from PrivateRaise showing more than 1,100 pipe transactions worth $74.3bn occurring this year alone.
A pipe deal in the UK has not occurred since Warburg Pincus took a stake in Mr Kipling cakes maker Premier Food in 2009. However, the coronavirus crisis has seen private equity firm Clayton, Dubilier & Rice invest up to £85m in construction supplier SIG. It was part of a wider equity raise proposed by the company at the end of May, worth approximately £150m.
Wood says: “In the past a lot of [UK] funds have said that while they may want to it’s not what they’ve been set up to do and therefore not what investors want.”
But while it is not where PE naturally sits, it remains true that amid the pandemic some companies simply need cash injections to survive.
Target boards and shareholders in industries suffering heavy losses due to the pandemic are unlikely to be receptive to seemingly exploitative offers.
But an equity stake may prove more palatable in the current environment, and it could work well as a long-term strategy for funds with a view to doing a full take-private later down the line.
“Shareholder approval [for a public to private deal] could be easier to win when the economy has stabilised somewhat,” adds Mondesir.
However, pipe deals do come with lengthy prospectus requirements and limits on the discounts that can be offered. These restrictions lessen somewhat on AIM-listed firms, making general partners further look beyond the main market.