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PE houses look to invest in UK financial services sector

More than two thirds (68%) of Private Equity houses plan to invest in the UK Financial Services (FS) market in the coming year, according to a Grant Thornton report called "Where is the Smart Money Going in Financial Services?" However, in the survey of the 40 leading private equity investors, forthcoming regulation has been cited as a major hindrance to investment.

"Our survey indicates that there is a renewed interest in PE houses investing in FS firms with 90% of respondents predicting increased private equity activity in this sector. This has been a long time coming since the banking crisis of 2008. While it is good news that there is this renewed interest in the FS sector, the appetite to invest is significantly lower than that shown in other sectors including media and support services," says Peter Allen, Partner and Head of Financial Services at Grant Thornton.

Regulation is one of the main concerns for PE houses investing in the financial services industry. This includes the major new global banking standard Basel III and the new EU insurance measure Solvency II. 58% of respondents rate regulation as a primary challenge, while 93% say this will be important in shaping private equity buyers’ appetite for FS businesses.

"While some PE houses see regulation as a deal breaker, regulation can be seen as providing some attractive buyout opportunities. And indeed while regulation increases the cost of running a business, those businesses that do survive are stronger for it," says Allen.

The UK’s strong base of niche financial services companies is at the heart of PE’s attraction to the sector. 62% of survey respondents cited it as the primary point of interest to invest in the FS sector. Attractive niche companies include financial technical services that deliver specialised offerings such as payment software and desktop trading systems.

"Niche companies within the FS sector are the right size and are mainly priced in the range of tens of millions of pounds rather than hundreds. This means that the average private equity fund will be able to afford one as part of a mixed portfolio. Going forward I think these will become very attractive services to be acquired," says Allen.

Due to new capital adequacy requirements and, in the case of state intervention in the banks, insurance houses and banks are actively selling off some of their non-core assets. This has created some high value deals in the PE market including the sale of RBS Global Merchant Services and HSBC’s GBP2.1bn sale of the Eversholt Rail leasing operation. 90% of respondents now believe that similar spin offs will be a continuing trend in future deals.

Another significant factor which has made PE houses reluctant to invest in financial services businesses is the premise that the value of a business is reliant on a few key people. This is regarded as a deterrent to invest in this sector with 35% stating this. The sector is also seen as "baffling" with 30% of our respondents citing the difficulty in understanding the sector as a major deterrent to investment.

Therefore it is not surprising that 60% of survey participants consider "excellent sector knowledge" the most important requirement when selecting a financial adviser, with a further 25% considering it very or somewhat important.

"This study shows a renewed interest in the FS sector yet we will have to wait and see whether the forthcoming regulation will indeed act as a hurdle to investment or indeed make the FS sector far more robust and profitable," says Allen.

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