Turnaround investors find new opportunities in healthy economy

Consumer spending is on the up and is leading the UK economy's revival, with a 0.8% increase in Q1 of this year compared with the previous quarter, according to the UK government's Office of National Statistics. This is equivalent to a £2bn rise.

This means the wealth of retail businesses that survived the tough post-recession period, or those that have emerged since, now have the potential to flourish as confidence in the economy is bolstered.

However, it also means the focus of UK businesses must now shift from simply surviving to maintaining a healthy balance sheet for endurance. This is where a market for turnaround investors is opening up.

Adapt to survive
"The turnaround market is shifting into different sectors," says RCapital CEO and co-founder Jamie Constable. "At the start of the recession there were a lot of bank restructurings, debt-for-equity swaps; the second phase was banks selling their assets through portfolio sales. We are, in the main, past that, and in a period of lots of SME and mid-market companies with balance sheets that are still carrying too much debt and are still in need of restructuring."

While there may be a glut of businesses in the UK with unevenly weighted balance sheets, Constable notes that the cull brought on by the recession has left a handful of healthier companies that stand the chance of building or rebuilding to pre-crisis levels. "Now that there's growth in the economy, we're seeing more quality businesses with fundamental issues," he says.

To ensure they survive this crucial period as the economy finds its feet again, these businesses will need to strengthen their balance sheets. "If trading gets stronger, these companies will need working capital," says Rutland Partners managing partner Paul Cartwright, "and at the moment they have quite thin balance sheets. There are an awful lot of debt funds around now, so there's a much wider source of debt."

"But there's still a shortage of good opportunities," Cartwright says. "There have been several trades of blocks of debt, most recently coming out of Ireland, but overall it's very much been a trickle at best in terms of single-asset deals."

However, RCapital's Constable believes that the last 18-24 months have been "lucrative" for the turnaround industry. Indeed, Constable's firm has completed eight deals since the start of 2013, while Rutland has carried out high-profile deals such as its £85m buyout of Maplin from Montagu Private Equity in June.

Survival of the fittest
OpCapita managing partner and CEO Henry Jackson shares Constable's sentiment: "The market has become more active, but with targets that have survived the worst of the recession. These are businesses that have not had proper investment because they were non-core, but now require focus and capital."

However, recent developments regarding sunken high street electronics retailer Comet, which was acquired and subsequently liquidated by the OpCapita-advised special purpose vehicle Hailey Acquisitions Limited (HAL), run the risk of reopening old wounds that could do harm to the turnaround industry.

At the end of July, UK business secretary Vince Cable announced that the government's Insolvency Service had referred the three Deloitte insolvency practitioners who acted as administrators of Comet to their regulatory body, the Institute of Chartered Accountants in England and Wales (ICAEW).

According to the Department for Business, Innovation and Skills, the acceptance of the position of administrators by Deloitte's Christopher Farrington, Nicholas Edwards and Neville Kahn in 2012 may have been a potential conflict of interest. This is because the firm had previously advised the company prior to its insolvency.

OpCapita acquired Comet for a symbolic £2 in 2011, and also received a £50m working capital dowry from vendor Kesa Electricals. A month after the business collapsed in November 2012, Cable launched an investigation into the acquisition and handling of the business.

Despite the issues surrounding the Comet insolvency, recent months have seen a string of successes from turnaround deals. At odds with the outcome of Comet, OpCapita's Game Digital, which the firm acquired for just £1 in April 2012 after the company fell into administration, achieved a £340m market cap through its IPO in June.

Despite a few dips in price, shares in Game have been on a steady incline since its flotation. The contrast in OpCapita's portfolio successes is a prime example of the risks involved in the turnaround space.

Pricing predicament
OpCapita caught the tail-end of the hot public market with its listing of Game. Confidence has been returned to the UK's retail sector, meaning both investors and the public are spending more than they were this time last year.

But while allowing for larger-than-expected exits, the rise in consumer confidence has also pushed up prices of potential turnaround assets. "Price expectations from sellers are higher than before, but in many cases there has been no underlying improvement to justify those higher expectations," says OpCapita's Jackson.

This sentiment has been reflected in the wealth of retail businesses that have floated this year, many of which achieved bumper market caps due to investors pricing in future European recovery.

However, a large group of these businesses have experienced decreasing share prices following their IPOs. "Nothing has fundamentally changed in our economy," notes Constable. "Confidence has been built but nothing has been fixed."

And with banks lending again and consumer spending on the up, the chance of the cycle repeating itself is ever-growing. "Markets have surprisingly short memories," says Jackson. "The banks will inevitably lend too much before the next downturn, but that will lead to more restructuring opportunities in the next down cycle. One of the jobs of investors is to bring the historical perspective that markets lose sight of."

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• Topics
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• Turnaround/Special Situations
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• RCapital
• Rutland Partners
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