Brexit apprehension brings sharp drop in UK deal activity

Kenny Wastell
10 December 2018

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As Westminster prepares to vote on the UK's EU withdrawal agreement, the impact of Brexit-related uncertainty on the country's private equity activity throughout 2018 has become evident. Kenny Wastell reports

The UK and Ireland was the only region in Europe to have experienced an annual drop-off in both buyout volume and aggregate value in the first 11 months of the year. There were 206 buyouts worth a combined €29bn in the region between January and November, according to Unquote Data; down 9.7% and 14.6% respectively year-on-year. While no other European region experienced a drop in aggregate value, only the Benelux region and central and eastern Europe saw a sharper drop in volume, albeit from far smaller sample sizes.

Furthermore, volume and value in the UK and Ireland during the 11-month period were below that of France for the second year in three, having considerably outpaced it on both fronts in the four years prior to the Brexit referendum.

While the top-line figures paint a relatively grim picture, Baird Capital partner Andrew Ferguson argues that not all value ranges have been equally impacted by Brexit uncertainty. Indeed, UK buyout dealflow for transactions with enterprise values of up to £100m reached a post-Lehman quarterly peak in Q3, with aggregate value reaching the second highest total in the same time frame.

"From where we sit in the [lower] mid-market there has been no discernible impact on appetite to invest following the June 2016 referendum," says Ferguson. "Dealflow has held up well. The top graded assets continue to attract high prices in very competitive processes. There is perhaps some softening for assets below A-grade, but the weight of money in the system and desire to invest continues to push the envelope on valuations."

On the defensive
Ferguson says investors in the UK private equity space have either turned their attention to "defensible sectors", such as pharmaceuticals, healthcare, risk management and regulatory and compliance services, or towards "strong global secular themes". Indeed, the increased selectiveness of fund managers when targeting assets is a strategy adopted by Elysian Capital, as CEO Ken Terry explains. "From our point of view, we have been very careful recently to avoid investing in businesses with complicated cross-border supply chains," he says. "So we should be relatively well-positioned for all eventualities."

At the time of publication, the potential outcomes floated by opposing groups across the UK political spectrum include: the ratification of prime minister Theresa May's proposed trading relationship with the EU; a softer EEA-style relationship; a second referendum, potentially resulting in the cancellation of Brexit; or a no-deal scenario in which the UK would lose all of its current trading agreements with the EU (including its existing trade deals with non-EU countries).

"We have been very careful recently to avoid investing in businesses with complicated cross-border supply chains" – Ken Terry, Elysian Capital

Of the mooted solutions, a second referendum and a no-deal scenario would provide the most uncertainty. A recent BGF survey of 190 chairs and CEOs at its portfolio companies found that respondents were divided on the subject of a second referendum, with 50% in favour and 45% opposed. However, there was more consensus surrounding a potential no-deal outcome, with just 11% in favour and 75% preferring May's proposal when faced with a binary choice.

"The government should have prepared better for the possibility of a no-deal outcome," says Elysian's Terry. "Money should have been spent putting in place the relevant infrastructure earlier. But the scare stories about leaving without a deal are overblown. It would undoubtedly be disruptive, but it certainly wouldn't be catastrophic. The main issue would be uncertainty, which is what we are currently experiencing."

Says Baird's Ferguson: "The most significant concern must be the general impact on the UK economy of a hard Brexit and how quickly it can recover from the shock of leaving the EU. My personal view is that, should a hard Brexit occur, particularly a disorderly one, then there will be a significant fall in investment activity as buyers and sellers alike evaluate the impact on them and the markets they serve."

The UK's drop-off in deal activity was also reflected in fundraising, where the country recorded its sharpest decline since the turn of the century in the first nine months of 2018. However, with 2017 breaking 2016's records for both fundraising volume and value, it is likely that fund managers will face a growing challenge to deploy dry powder should the uncertainty persist or the UK crash out of the EU without a deal.