UK turnarounds: Turning tide?

The tough economic environment might have been the subject of many conversations last year, but it apparently did not benefit that niche category of private equity investors who were rubbing their hands in anticipation - turnaround firms. Even for players rarely making the headlines - with their highly specialised focus, bottom end valuations and opportunistic dealflow - 2010 remained eerily quiet.

Not a bad time to be in trouble

Turnaround deals recorded by unquote" were relatively scarce last year, as Endless managing partner Garry Wilson confirms: "If you speak to any of the turnaround players in the market, they will tell you the 2009-2010 period hasn't been as busy as they expected it to be." Many factors might explain why 2010 wasn't such a bad time to be a struggling business after all.

The banks' attitude seems to have been of paramount importance here. "Banks have been more supportive to struggling businesses than I have ever seen in my career. There is a general willingness to try and find solutions rather than put businesses under, as was the case in previous recessions," believes Wilson. "Even when companies can't afford the debt structures, banks are prepared to be creative; that is why we've seen quite a few debt-for-equity swaps taking place."

As a result, defaults were few and far between - a phenomenon that wasn't limited to the UK alone. Oaktree Capital's distressed investment fund has recently returned $3bn of the $10bn it raised from investors, acknowledging it couldn't find enough distressed debt to feed upon. Cynics might call it "extend and pretend" - a term that kept making the rounds last year - but the banks' hands-on approach certainly resulted in fewer opportunities for turnaround investors.

In addition, the Bank of England deciding against a rise in interest rates meant that troubled businesses didn't have to face a sudden hike in the cost of debt repayments. And if that wasn't enough, HMRC's tax deferral scheme is believed to have been a substantial crutch for construction companies and retailers, helping them ease cashflow headaches while waiting for better days.

A changing environment

But while 2010 saw the UK economy slowly recover, Q4 served as a reminder that the coming months will remain tough for everybody. "The impact of the recession is finally starting to hit, as public sector cuts impact the economy, tax rates on individuals go up, and people are reigning in their spending at last" notes Wilson. And UK businesses might have to face this bumpy road to recovery with significantly less support than they enjoyed last year - a good omen for turnaround investors.

First of all, banks are warming up to the idea that they need to return to what they do best - not running companies, but lending money and getting it back in a timely fashion. As Wilson observes, "banks realise they may be holding on to too many equity stakes and don't want to take any more. This is pushing deals - that banks would have perhaps done on their own in previous years - back on the market."

Besides, a rise in interest rates by the Bank of England could be in the cards for the coming months. While it has kept rates at 0.5% for the 23rd month running, the institution is increasingly divided on the issue and could review its position soon. A hike, taken in conjunction with spending cuts and the VAT increase, could be bad news for struggling companies as Wilson points out: "It might be problematic for businesses that are close to the edge. An extra half a percent on some highly leveraged companies can equate to a few hundred thousand pounds of additional costs every year - if you are barely breaking even, it can mean the difference between survival and failure."

Increased dealflow for turnaround players?

The combination of a relatively flat economy and less traditional support for stressed businesses could open a window of opportunity for turnaround firms. The likes of Endless, Better Capital or HIG Capital have been busy in recent months: "We have definitely seen an uptick in dealflow," notes Wilson. "From being able to count turnaround deals on the fingers of one hand, we have seen them coming at a much steadier pace over the past few months."

Could the waiting game be finally over for turnaround investors? The false start of 2010 might serve as reminder not to get overly enthusiastic - the pipeline is looking strong, but the coming months should be crucial in knowing whether the tide is really turning.

 

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• Topics
• UK / Ireland
• Turnaround/Special Situations
• Endless