Iain Campbell is a partner of FC Corporate Finance, a mergers and acquisitions boutique serving the mid-market in the UK, Europe and MENA region, operating across all verticals but with particular experience in technology, the IT channel and passenger transport.
I have published two articles this year about the state of the mid-market for mergers and acquisitions in 2023, noting that, global deal volumes fell 39% in the first half of 2023 compared to the peak market in the first half of 2021, then fell a further approximately 18% in quarter 3 of 2023. In the UK, I previously reported deal volumes down 20% in the first half of 2023 compared to the first half of 2021. Recent ONS data shows deal volumes involving UK companies down a further 23% in Q3 2023, whilst BDO’s Private Company Price Index data (for a more limited data set) showed deal volume down a further 15% in Q3 2023 (but 18% for deals involving private equity).
As regards valuation multiples, globally these were down 20% in mid-2023 from the peak market in mid-2021, and in the UK over the same period valuation multiples were down approximately 11%. In Q3 2023, Pitchbook reported global valuation multiples slightly up in Q3 2023 from the previous quarter, but that was likely distorted by a small number of mega-deals and the trend in some sectors was down. In the UK, EBITDA multiples in BDO’s PCPI were down a further 2.0% from Q2 to Q3 for trade buyer deals, and down about a further 4.5% for private equity deals.
My previous articles explored the extent to which the current high interest rate environment, something until recently unfamiliar for the past fifteen years in the UK (and twenty years in the US) have affected liquidity and pricing, particularly in private equity deals whose dynamics are profoundly affected by borrowing costs.
As we moved into December improving economic data have emerged. It will be interesting to see what happens to interest rates in the new year. The markets are certain that rates will come down, and in the US some Fed members are encouraging this view. In the UK, the Bank of England having previously signalled an expectation that interest rates may remain around the current level for several years, is still downplaying any expectation of an easing next year. Even if this is a potential worse-case scenario, there seems no prospect of very low interest rates returning in the near future.
I’m jumping around a bit but another factor currently affecting private equity will be the state of the market for IPO’s. Globally, according to figures published by EY, IPO’s in the first three quarters of 2023 were down 70% by number and 45% by value compared to the first three quarters in 2021, and in the UK between the same two comparison periods, IPO’s were down 70% by number and a whopping 93% by value.
All of this potentially creates perfect storm conditions for mid-market private equity:
- Despite record “dry powder” levels, pricing hasn’t dropped nearly enough so far to make deals work at lower leverage levels (as it needs to do to accommodate higher debt service costs);
- There is insufficient liquidity in the M&A market, at least at current market pricing, for PE funds to be able to maintain or increase exit activity. This is exacerbated by:
- The almost total disappearance of IPO as an exit route; and
- The likely unavailability, or scarce availability, of the private equity’s exit route of convenience, the secondary buyout.
- Two years or so into harder market conditions, and in the absence of improved exit conditions, there must surely be a wave of refinancings that will start to come through in 2024 as investments that were intended to be moved on have to be refinanced instead and/or to address issues arising from breach of debt service covenants.
The consequence of all of the above is that there must be plenty of mid-market private equity funds that are sitting on portfolios that, in current market conditions, are overvalued and exceptionally illiquid (at least within reasonable pricing parameters). It will be interesting to see what they do in 2024. Some of them may shift focus onto what they all say they do anyway, which is to catalyse value creation in their portfolio companies. By and large that is likely to be focussed on improving quality of earnings and scaling organically, though in a sort-of buyer’s market there may be some scope to add shareholder value in portfolio companies through good-fit, bolt-on acquisitions. Other than the straight financial engineering stuff around acquisitions, it will be interesting to see what skills and ideas private equity investors can bring to their portfolio companies to keep the returns growing and avoid the nightmare scenario of exits starting to be forced on disadvantageous, even at-a-loss terms. Whilst that isn’t something that typically happens – in bad times usually, just like the housing market, M&A liquidity goes down significantly but pricing holds up reasonably well – these challenging interest rate conditions (and other economic issues) might just go on long enough that pricing will start to drop substantially.
If you are a seller, whether private equity or not, you should perhaps be thinking about ways to stimulate a sale or partial realisation and bridge the gap between the price you want and the price a buyer can fund. I’m never a fan of deferred consideration and earnouts but we are seeing more of them in deals that ever before and I predict it will only increase.
2024 is surely going to be an interesting one.
FC Corporate Finance is a UK-based advisory firm. The areas we specialise in include, amongst other things, private company mergers and acquisitions (both in the UK and internationally) in the mid-market and SME space. We have very extensive experience in both “buy-side” and “sell-side” and are intensive and hands-on advisers and process managers through the whole cycle – acquisition strategy, origination, target evaluation, target valuation, deal structuring and negotiation, implementation, due diligence (if required), and detailed contract negotiation through to completion.
In recent years we have been particularly active on buy side, including in the IT distribution and IT reseller space, staffing agency, cleaning, security and other personnel-orientated businesses. We also have internationally-recognised capability and experience in deals in the passenger ground transport industry.
E-mail: ic@fccorporatefinance.com
Mobile: +44 7964 893739
LinkedIn: https://www.linkedin.com/in/iain-campbell-a7a9a126/
FC Corporate Finance Limited is not authorised under the Financial Services and Markets Act 2000 but we are able in certain circumstances to offer a limited range of investment services to clients because we are members of the Institute of Chartered Accountants of Scotland. We can provide these investment services if they are an incidental part of the professional services we have been engaged to provide. FC Corporate Finance Limited has a policy of professional indemnity insurance with Arch Insurance Company (Europe) Limited of 60 Great Tower Street, London EC3R 5AZ. This policy has worldwide application except in relation to professional business carried on by the insured from its own offices in the USA or Canada.