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“Take-private” deals take off

Despite choppier conditions in the global M&A market, public to private deals are proving remarkably buoyant and, this year, look set to exceed levels seen before the financial crisis.

With all the economic and political uncertainty hanging over the global M&A market, it is perhaps surprising to see one particular type of deal-making showing not just resilience but robust growth.

Public to private (P2P) transactions, or so-called take-private deals, are on the increase in many markets, but most noticeably in continental Europe and particularly in the UK.

It has been a consistent theme since the end of last year and one that shows no sign of abating, with PE houses, often with other longer-term funds and pools of private capital investing alongside them, showing an increasing willingness to bid for public companies, no matter the prevailing macro-economic turbulence or the size and complexity of the deal.

Indeed, in the UK, funds are proving to be a dominant force in deals valued in excess of GBP500 million with a number of important, big-ticket transactions of a greater size standing out in the year so far.

These include the USD3.4bn consortium acquisition of satellite operator, Immarsat, by APAX, Warburg Pincus and two Canadian pension funds in March and the GBP6bn acquisition of theme park operator, Merlin Entertainments, in June by Kirkbi, the investment vehicle of the Kristiansen family, owners of Lego, supported by Blackstone and another Canadian pension fund, CPPIB.

We’ve also seen the GBP4bn bid for Cobham, the defence group, by Advent, which awaits government clearance, while the brewer and owner of UK pubs, Greene King, is recommending a GBP2.7bn offer from CKA, the Hong Kong investment vehicle of Li Ka-Shing. Both of these deals have involved complex regulatory approval processes.

Commentators are now forecasting that 2019 will see P2P deals match or even exceed the levels seen in 2007 when PE activity in public markets reached its pre-financial crisis peak. One report forecasted that an all-time high of 212 P2P transactions would take place globally this year.

We’ve seen a similar – if not quite so dynamic – picture in key European markets this year. Germany, for example, has been one of the biggest markets for take-private deals, rivalling the UK with deals such as KKR’s acquisition of an interest in Axel Springer and the on-going Osram takeover causing a stir in the media.

By contrast, big corporate buyers, often executing highly strategic deals, continue to be the dominant force in the U.S. market, though there is P2P activity here too.

Familiarity breeds comfort

The return of PE funds to the UK’s public market follows a period when they fought shy of take-private deals. That was particularly the case in the aftermath of the Kraft/Cadbury takeover in 2010, when new rules on public deals were introduced requiring bidders to be identified at an early stage and bids to be announced within 28 days of any leak. An inability to secure break fees in target companies under these rules, or to win exclusive negotiating rights, also deterred PE bidders, as did the intense competition from corporate buyers willing to pay much higher premiums for sought-after synergies.

While those rules persist, it’s clear that sponsors have grown more comfortable with them and their confidence appears to be growing as more and more funds enter the fray.

Other more fundamental factors are driving activity. PE sponsors have accumulated record levels of cash in recent years – cash that needs to be deployed during the relatively constrained lifetime of newly created funds. Debt financing markets remain relatively benign and look likely to remain so in the immediate future. Low equity values, compared to other developed markets, and the steady devaluation of sterling also mean that UK asset prices are currently attractive.

In addition, we’ve seen the confidence of strategic buyers dip in recent months. In some cases they may be struggling to make investment decisions at a time of political and economic uncertainty, not least the turbulence caused by Brexit and the trade standoff between the U.S. and China. Some are holding back, except where there is a clear defensive opportunity to cut costs through a merger.

Hurdles

Despite all that, it would be wrong to conclude that sponsors are finding it plain sailing in the public takeover market. Transactions – especially the larger ones where PE bidders are particularly dominant – are invariably complex and can be highly competitive, as the auction battle for telecoms company KCOM demonstrates, with USS finally pipped to the post by Macquarie.

This also remains relatively unfamiliar territory in a number of important ways. For example, sponsors are typically used to higher levels of due diligence access than is typical in public deals. Instead, they have to make use of already public information issued by the target and deal with rules that insist that all bidders have equal access to information.

Yet careful diligence remains key, particularly around financial forecasts, as PE deals tend to be tightly financed and, in some cases, funds may have less flexibility than strategic buyers to get into a bidding war.

These strategies do still have the benefit of cost (and potentially revenue) synergies, which in some transactions might represent a significant advantage in the race to win an asset. On the flip side, depending on which way the antitrust/competition winds are blowing, the PE houses may have a distinct advantage on certainty of execution and speed to closing.

Another factor that sponsors must weigh up is management. Many will want to keep the current management in place. Incentives and rollover arrangements, therefore, tend to be a big focus of negotiation – but usually only when a price has been agreed.

Even if a share price has been in decline, target boards are tending to insist that valuations are based on an average view of the share price over a period and will be looking for a sizeable premium over that price. Having said that, boards know this is an expectation from shareholders to engage if such terms are offered.

In the case of the UK, a weak pound can obviously work in favour of overseas bidders, but they may need to carefully hedge themselves against any rebound in sterling that might come in the months ahead. Assessing political and economic risk is also a significant factor, but this has clearly become more nuanced in recent months. How a potential hard Brexit might impact a company will depend on its sector, markets and supply chain. There remains a high degree of caution, but some investors are betting that the current political difficulties will ease in the months ahead, and that the prospects for companies with a dependable home market will look much brighter.

Can the boom last?

All the signs point to this trend continuing, not least due to the amount of capital funds have accumulated and the need for them to deploy their dry powder. That is likely to remain the case for some time, provided that debt markets remain strong.

The growing willingness of funds to club together in consortia to execute deals also provides them with added firepower to take on bigger and more complex transactions. Increasingly that will be with the support of pension and sovereign wealth funds and family offices, although some longer-term funds prefer to support transactions later in the process, sensitive about being seen to be overexposed to any one market or sector.

For now, sponsors are active in looking at public company opportunities. Should targets or the relevant currency become more expensive, once there is greater certainty, deals will undoubtedly become harder to finance.

As and when confidence returns to corporate buyers, we may well see the balance swing back. However, that is unlikely to happen quickly and we see sponsors playing a dominant role in public takeovers for the short to medium term.