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UK mid-market keeps calm and carries on

There has been a marked shift in the UK away from larger buyouts into the mid-market. Despite an overall decline in private equity last year, deal activity here is showing resilience

This article first appeared in the April 2023 UK Insights Report

There has been a marked shift in the UK away from larger buyouts into the mid-market. Despite an overall decline in private equity last year, deal activity here is showing resilience

Driven by a fall in larger deals, the UK private equity market experienced a slight decline in deal volume and value last year, yet activity overall remains strong compared to pre-Covid levels.

Last year was characterised by a fast start, with over half of deals transacted in H1, while Q4 saw a slowdown in activity due to rising inflation, interest rates, and a tighter lending market, resulting in only 312 deals completed. According to a survey by Private Equity Wire in March, global interest in the UK private equity market remains flat going into 2023. As one of private equity’s largest and most stable markets, around half of all managers and investors surveyed said their level of interest in the UK has stayed the same over the past 12 months. Around a fifth showed decreased interest, but this was balanced by a quarter showing increased interest.

This interest is more targeted than before the pandemic, however. For managers investing in the UK, the mid-market provides the greatest deployment opportunity, according to over half of the Private Equity Wire survey. Venture capital and large public takeovers showed 28% and 12% respectively, but it is worth saying that both areas naturally attract a smaller pool of private equity funds, by size or specialism.

In the UK, there has been a marked shift from larger buyouts into the middle market in overall deal activity. Notably, only nine deals in the UK last year were valued at more than $1billion – the lowest level in five years – and they amounted to nearly three-fourths of the aggregate transaction value, according to S&P Global Market Intelligence data. Bolt-on acquisitions are surging as they typically require less debt and present a safer option when valuations and exits are challenged.

In 2022, bolt-ons accounted for 443 deals, representing just over 65% of deals, while minority deals – which give PE firms exposure to fast-growing businesses to diversify their overall portfolio holdings – accounted for 15% of all mid-market PE activity, with 102 deals, according to KPMG’s Mid-Market Review published in February. As sellers come to terms with the new valuation environment (as outlined in Private Equity Wire’s February Insight Report), there is optimism that a backlog of deals from 2022 will start to surface in the mid-market this year, says Simon Peet, partner at Livingbridge. “We’re seeing more bilateral or semi bilateral situations where sellers are exploring doing something slightly ahead of an auction process and more deal structuring and flexibility as a way to get around differences between buyer and seller invitations,” he says.

UK mid-market PE transactions are holding up based on historic levels. According to data from Mergermarket, 680 mid-market deals were completed in 2022, a 12.4% increase from 2019, with a total value of £46billion, up 13.1% from 2019. Moreover, performance across the year was more consistent in the mid-market than the overall PE market, says KPMG, with only 12 fewer deals in H2 than H1, and aggregate values increasing in H2, compared to the overall PE market, which saw a 122-deal decrease in H2 and a £10billion decline in values.

Given the performance of the UK’s mid-market, there is optimism for continued growth. UK-based managers are looking for investments with proven resilience, revenue stability and robust margins. Businesses that could meet these criteria and pass on price increases to customers and maintain good visibility of earnings continue to attract PE investment, even in a challenging market. Speaking on UK M&A in March, Steve Ivermee, UKI Strategy and Transactions Leader at EY said: “Looking ahead, we are likely to see smaller, more targeted [M&A] deals in sectors which play to the UK’s strengths including technology, energy and life sciences, with digital transformation, portfolio rebalancing and ESG issues the key deal drivers”.

Those businesses whose metrics were not quite as strong, or where the price expectations of vendors and sellers were too far apart, were more likely to see processes stall as confidence weakened towards the end of the year. As a result, Business Services and TMT are dominating mid-market deal volumes, accounting for 62% of all PE mid-market deals last year. Business Services includes Energy Services, which is itself seeing heightened activity levels, according to the KPMG Mid-Market report. Both sectors also tend to be quite fragmented, which lends itself to PE houses looking for lower risk bolt-on acquisitions to add to existing platforms. While UK healthcare and financial services deal activity held steady in 2022, a decline has taken place in consumer and retail, and industrials, which hold a reduced share overall of mid-market deal activity. This is no surprise as higher inflation, weak consumer spending, rising interest rates and supply chain uncertainty have started to impact companies in these sectors globally.

Looking ahead at 2023, international fund managers and investors are showing broad interest in the UK by sector, with around a third believing the UK’s technology sector to be the most attractive for investment, according to the latest Private Equity Wire Survey. Venture-capital backed businesses which are struggling to raise funding may be a part of this. “If these ‘stranded’ businesses slow down their growth rate and focus more on preserving cash, they in effect become less suitable for the high risk/high return profile of a VC portfolio and more appropriate for PE backers,” wrote Jasper Van Heesch, director, private equity coverage at RSM UK in a February analyst note.

Perhaps surprisingly, the industrial and manufacturing sector was deemed to be the second most attractive sector in the UK in the Private Equity Wire survey. There is of course a link to technology here too in the minds of private equity funds. And there are three main pathways they may use to access opportunities, according to KPMG’s report: technologies that improve factory efficiency and automation; the energy transition and decarbonisation; and the use of software to supplement traditional hardware and services. “Digital transformation in all sectors in the UK has been a driver of the investable scale being generated across the mid-market and this has presented a lot of interesting investment opportunities for private equity,” says Peet. “It’s a trend that is set to continue. In the UK, we’re probably around 3-5 years behind the US when it comes to the scale of the market which indicates that deal volumes in the mid-market will remain high.”

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