A continuing decline in buyout activity according to the UK Watch

15 July 2002

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This month we examine the updated statistics of the UK Watch â€“ Initiative Europeâ€™s 12-month rolling figures on UK EUR 10m+ buyouts. The last commentary on the Watch was presented in May, at which time a decline in the volume and value of completed buyouts was apparent in the rolling figures for the year to 1 May 2002 (20th May 2002, page 30). Since that point buyout activity has continued to decline. The figure for the total value of deals in the year up to 1 July 2002 is the lowest figure recorded since June 1999, while the volume of deals has dropped to levels not yet seen on the Watch charts. A significant part of this decline can be attributed to ongoing economic uncertainty, which has been exacerbated by a number of events in the last twelve months, including September 2001â€™s attacks in New York and a series of major accounting scandals in the US. Furthermore, any pick-up in deal activity in recent months may have been affected by the lengthening of the time required for deal processes to conclude, with the consequence that a significantly higher than typical number of deals have not yet completed. In terms of value, recent figures will not have been improved by the lack of EUR 1bn+ â€˜mega-dealsâ€™ completed since May 2002. The largest UK buyout in this period has been the EUR 575.8m Priory Healthcare deal by Doughty Hanson & Co; in contrast, the same period in 2001 produced two EUR 3bn+ deals: the EUR 3.8bn Meridien Hotels buyout and the EUR 3.6bn Yell Group transaction, both of which will now have dropped from the latest 12-month rolling value figures. Given these trends, it may be surprising to note that the overall p/e ratios recorded for buyout deals have actually risen since May. According to the statistics, p/e ratios have increased from 8.64 in May 2002 to 9.41 for the year up to July. One possible explanation for this rise may be the fact that increasingly selective equity providers have been willing to pay higher prices for companies that they believe will remain strong in the face of the current downturn. Alternatively it may indicate that while the earnings of target companies have dwindled, prices offered have so far remained constant. In contrast, and unsurprisingly in the wake of the major accounting scandals that have damaged a number of global corporations, there has been a decline in the p/e ratios seen on the public markets. On the FTSE All Share index p/e figures dropped from 22.45 in May to 20.42 in July 2002, while the p/e ratios seen on the FTSE Small Cap (not shown) have descended into negative figures. This decline (particularly for smaller companies) may provide good deal-pricing prospects for equity providers, as well as an increasing number of public-to-private opportunities. The chart highlighting the average contribution of debt and equity to EUR 10m+ buyouts without mezzanine suggests that in the last year there has actually been an increase in gearing levels, from 56.5% a year ago to 59.7% in the figures for July 2002. This is surprising given the expectation that in the current climate banks would pull back on their contributions to buyout deals. One possible explanation of this rise may be the fact that banks have been willing to provide relatively generous levels of debt on buyouts with real potential within a market that is otherwise depressed. This said, a 0.3% drop in the senior debt contribution on deal values was recorded in July in comparison to May, although it is too early to tell if this is indicative of a new negative trend. For EUR 10m+ deals utilising mezzanine it generally appears that, over the last year, the mezzanine contribution on deals has risen to fill the gap left by declining senior debt levels, as would be expected. This said, there has been a degree of volatility in the figures recorded, with an unusual peak in equity contributions at the beginning of 2002. Focusing on the period since May 2002, the most notable change has been an increase in the average contribution of mezzanine to deal values, rising from 15.2% for Mayâ€™s figures, to 16.5% for July. Notably, this increase has actually made up for a reduction in the equity contribution on deals, rather than debt shortages, with the equity component dropping from 34.8% of the total deal value in May, to 33.3% in July.