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British private equity braces for post-Brexit uncertainty

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The British private equity market is anticipating a drop in both dealflow and fundraising as investors take stock of the country’s vote to leave the European Union. Kenny Wastell reports

In the days following 23 June – when the UK electorate voted to push the eject button on its EU status – both the country's currency and its political stability plunged into freefall. The pound has steadied somewhat at the time of writing, trading at around €1.19 and $1.31; a decrease of 9% and 11% respectively compared to 22 June.

The political situation, however, has continued its descent into chaos. The figureheads of the campaign for leaving the EU have all either been absolved or absolved themselves of the responsibility for plotting Britain's course ahead; the prime ministerial baton has been passed from David Cameron to Theresa May; and Labour leader Jeremy Corbyn faces a coup from his party's MPs. Meanwhile, the Liberal Democrats and Labour Party have already started calling for a general election citing the undemocratic "coronation" of May.

Commercial terms from debt providers have become a bit tougher, though the suppliers do still appear to be willing to provide debt" – Tim Hewens, Squire Patton Boggs

While the medium-to-long-term implications remain very much unknown, it is becoming clear the uncertainty of the months ahead will lead to somewhat of a slowdown in dealflow within the country. "I believe people are going to pause, at least over the summer to take stock," says Tim Hewens, corporate partner and head of UK private equity at law firm Squire Patton Boggs. He argues there will be some who will want to analyse the fallout in the months ahead before making investment decisions. The view is echoed by Alexandre Neiss, part of the corporate and acquisition finance team at Investec. However, Neiss also highlights an accurate picture may not develop until Q4, given the usual summer slowdown in activity.

One immediate implication of the vote, explains Squire Patton Boggs' Hewens, is some lenders beginning to impose tougher covenants on debt. "Commercial terms from debt providers have become a bit tougher, though the suppliers do still appear to be willing to provide debt," he says.

Yet, while European investors are likely to proceed with more caution until the full implications of the referendum become clear, there may be an opportunity for US-based managers of dollar-denominated funds to take advantage of Britain's sliding currency. The weakness of the pound and relatively low multiples for European and UK assets will certainly render some British companies alluring - in particular those that are relatively sheltered through extensive operations outside the EU. As YFM Equity Partners' managing director David Hall points out, "with volatility also comes great opportunity".

Just yesterday, Terra Firma agreed to sell Odeon & UCI Cinemas Group to listed US trade buyer AMC Theatres, in a deal valuing the business at £921m. The acquirer stated the "three-decade low" of sterling versus the dollar made the valuation "highly favourable", despite "some uncertainties related to Brexit".

A scenario where you have no access at all [to the single market], with national private placement regimes completely closed down and UK managers unable to raise capital in Europe - that would be the least favourable outcome" – Erik Jamieson, Hogan Lovells

Gambling on currency
On the fundraising front, however, the fallout from Brexit could be both more profound and longer-term. While the devaluation of sterling could present potential investment opportunities in terms of individual deals, currency volatility presents risks for international LPs. With such levels of political uncertainty, there remains a possibility the pound could strengthen – as might happen in the event of a consensus on the UK joining the European Economic Area. In such circumstances, a drawdown by a sterling-denominated fund would become more expensive for a US LP than it might have been when it made its original commitment prior to any such agreement.

"In the short term, investors will hold off before committing capital to UK funds," says Erik Jamieson, partner and head of the listed funds practice at Hogan Lovells. "We've already seen some transactions fall away or be put on hold as a result of the market uncertainty."

Of longer-term interest will be the implications of Brexit on GPs' abilities to market funds in Europe. As Jamieson explains, UK private equity houses raising EU commitments through private placements or reverse solicitation should see little difference. In the case of larger buyout funds, he says, "marketing on a pan-European basis with the AIFMD passport, the degree of change will depend on whether or not we retain access to the single market." However, he also points out the potential for the introduction of a passport for third-country managers.

The only current certainty for the UK's economic outlook is uncertainty. In order to attract continuing interest from international GPs and LPs, it is essential the country retains access to the single market. As Jamieson argues: "A scenario where you have no access at all [to the single market], with national private placement regimes completely closed down and UK managers unable to raise capital in Europe – that would be the least favourable outcome."