According to data from Refinitiv, the value of takeovers of British companies rose to a 14-year high in July as overseas trade buyers and, increasingly, private equity have pounced on the cheap relative valuations amid improving market dynamics. Many asset allocators and wealth managers, however, have been reducing their allocations to UK equities and taking a more global approach. So why is private equity, who have struck more deals so far this year than in the same period in any year on record, keen to invest when many other public actors are not?
Firstly, a combination of low interest rates, allowing for relatively cheap financing, has helped facilitate interest from private equity firms and institutional investors looking for higher yields and returns less correlated with conventional asset classes. Cheap financing has allowed the industry to build nearly $2trn of ‘dry powder’, committed capital that is yet to be invested, which needs to find a home and start generating returns.
Secondly, as we have noted previously a number of times, the UK market has derated significantly since the Brexit vote in 2016 and now sits at its lowest relative valuation (on a price/earnings basis) versus its global peers for over 30 years, even after excluding the more cyclical banking and energy sectors which make up a large weight in the market. Meanwhile, having seen many companies restore dividends following the Covid-19 pandemic and in many cases start paying special dividends, the UK market offers a historic dividend yield of over 3% compared to 2.2% and 1.3% respectively for Europe and the US. Dividends paid by UK companies were up 51% in Q2 2021 versus the corresponding period last year as companies paid out £25.7bn.
Figure 1: UK relative to World 12 month forward Price/Earnings ratio
What appears to be different now is that alongside an attractive starting valuation, Brexit uncertainty has moderated somewhat and the UK economy has rebounded from the Covid-19 crisis in a far stronger position than many other developed countries. Additionally, despite some recent strength, sterling is only back to levels seen in 2016 against the US dollar and euro, making deals attractive for non-sterling overseas investors. Private equity buyers have also highlighted the open business environment and liberal attitude towards M&A activity as reasons behind the significant increase in takeover activity, while historically high levels of governance and the rule of UK law are certainly high on the agenda as ESG becomes even more important when analysing potential companies.
Hence, US private equity firms such as KKR, Blackstone and Carlyle have been beefing up their UK operations and investing in staff to search for undervalued UK companies. KKR’s European Head Mattia Caprioli commented in July that there was “more value at a high level in the UK than there is in other markets.” Whilst the UK’s Bridgepoint, owner of Wiggle, Hobbycraft and Burger King (UK), has seen its share price rise more than 50% following its recent listing, raising more than £300m to target mid size UK and European businesses.
However, it is not just private equity who have war chests to spend on acquisitions. Corporates in the UK, who have seen net cash balances rise significantly over the past year (£109bn as of May 2021 and up from £20bn in March 2020), are increasingly rivalling private buyers, while overseas trade buyers are also targeting ever larger deals. So far this year, while M&A activity has been spread across a range of sectors – defence, property, software, financials, pharmaceuticals amongst others – it has largely been focused on mid, small and AIM-listed companies with only one deal in the large cap index.
Given the value apparent in the UK market and the magnitude of money looking to be spent, we would not be surprised to see a mega cap deal this year. However, regardless of size, the message is clear – if investors don’t take advantage of bargain prices, then private equity, trade buyers, activist investors and sovereign wealth funds will.
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