The majority of dealmakers made the cautious prediction that 2018 would see merger and acquisition (M&A) processes stalling in the latter half of the year as the Brexit deadline came into sharper focus.
Roll on to the present day and whilst this prediction wasn’t too far off the mark, actual deal volumes have remained steady (6% drop in Q3 2018 versus the prior year) and valuations for attractive assets are at a high since pre-recession. Deal momentum in the middle market appears strong, with a number of high profile corporate and private equity (PE) investments in the run up to Christmas.
So what were the key trends in 2018?
Our experience of the middle market suggests that three dynamics drove deal volumes in 2018: strong corporate reserves and liquidity; cheap sterling enticing overseas buyers and record amounts of funds raised amongst mid-market private equity firms.
Whilst capital markets liquidity fluctuated, the weak pound made the UK attractive for overseas buyers looking to enhance their returns. In recent months we’ve seen significant inbound appetite, particularly from the US. This has led to enhanced valuations and steady deal activity, which is perhaps surprising given the continuing uncertainty regarding Brexit and the implications on UK trade.
From our experience, investors are taking a longer-term view and recognising the longstanding relationship between the US and UK. In Q4 of 2018 we witnessed first-hand the prevalence of UK/US activity when concluding notable mid-market transactions, including the sale of LPW Technology to Nasdaq listed Carpenter Technology and the sale of Holchem to NYSE listed Ecolab.
Record levels of PE ‘dry powder’ increased competition, resulting in significant deal valuations in the mid-market. According to Invest Europe, investors channelled €45.6bn into private equity (PE) and venture capital (VC) in Europe in the first six months of 2018, with fundraising 40% higher than in the second half of 2017. There has also been a recent trend for US PE funds entering the UK market as sky-high valuations in the US are reducing returns across the Atlantic.
2019 – a year of turbulence?
Brexit is weighing heavily on some, and others are predicting a recession as early as Q4 2019. Will 2019 bring what has been a bumper few years for the mid-market M&A community to a shuddering halt?
Uncertainty is the enemy of business. There are many unknowns. Will we leave with a no deal? Will we have a second referendum? Or will we even see a labour government this year? And this is even before we get to the question of how the trade negotiations with the EU will evolve and the potential impact on exchanges rates.
Regardless of where the country stands on 29 March 2019, there will be a period of intense focus for exporters and businesses involved in international trade to ensure that they are up to speed with what is required. Therefore, it seems unavoidable that deal volumes will slow as corporates take an intake of breath as the country’s future is decided and their focus is drawn to internal matters.
Maintaining perspective during the turbulence is important. We need to be cautious about talking ourselves into a slow-down. This isn’t the same crisis we found ourselves in 2007/2008 with the global financial meltdown. There is every possibility that for a significant proportion of sectors in the UK, businesses will continue as normal which means making acquisitions.
So what about the PE market? A number of UK funds have stated that they are already taking a cautious approach, which will likely continue until we have clarity over exiting the EU. However, Brexit does not change the fact that these funds have record amounts of money and significant pressure from investors to get it deployed.
On a very simple basis, equity funds look at three things: the market, the company and the management team. The fundamentals won’t change. Brexit does not shift the strength of a management team and at the mid-market level there are a number of businesses that have minimal exposure to the European market both from an employment or trade basis.
Inflexion’s investment into UK Fast and ECI’s investment in Moneypenny are prime examples of this. The mid-market has shown that there are markets which funds will be able to get comfortable with, and there are certainly some exciting deals to be done. This is something which looks set to continue given Bowmark’s recent £600m raise.
So, to summarise as we approach Blue Monday, it is not all doom and gloom for the mid-market M&A community. While a slowdown seems inevitable; there will be plenty of deals to be done and opportunities to expand. It seems unlikely that 2019 will be the year where it all comes crashing down around us.