Ideological differences push political due diligence to the fore

Amy King
13 January 2015

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The due diligence offering available to the asset class has matured significantly. With the UK general election on the horizon, Amy King explores the rise of political due diligence

In five months' time, Britons will head to the polls in the UK general election. Since the political pendulum swung in favour of Margaret Thatcher in 1979, little has separated the nation's leaders; from John Major, Tony Blair and Gordon Brown through to David Cameron, UK prime ministers have differed in tribal, rather than ideological, terms. However, for the first time in decades that looks set to change.

December's Autumn Statement was widely seen as another marker of the widening ideological spectrum that separates the Conservative party from its Labour opposition. But the likelihood of a clear-cut winner in the upcoming election is small and a multitude of potential outcomes are on the cards.

Add to that the ongoing debate over the UK's membership of the EU, and the country's private equity practitioners find themselves sourcing, managing and divesting portfolio companies in an unpredictable political framework. As a result, they are increasingly turning to political due diligence providers that can summarise current or looming threats in policy or regulation that could affect the portfolio.

Investors are also waking up to the importance of political due diligence, and unquote" has noticed that it is an increasingly common feature of deals. "Political risk has become a more standard part of the due diligence stable over the past three years," says Marc Woolfson, director and head of policy risk analysis at political due diligence provider Westminster Advisers. "We've had a lot of feedback from investors, lenders, corporate finance advisers, lawyers and other due diligence providers, all of whom are increasingly aware that they need to understand how political change could impact their business case."

Wide reach
Portfolio companies across the board could be affected by political developments, particularly those that rely upon government or government departments for revenues – a group that is expected to increase in number given that most of the UK government's proposed spending cuts have yet to be made, making it more likely that the provision of some public services will increasingly be outsourced to the private sector. Knowledge of government budget projections for such services provides an invaluable insight into revenue streams for businesses in sectors such as healthcare, social care and education, where clients include government and regulation is tight.

Private equity has piled into such sectors in recent years. Taking healthcare as an example, unquote" data reveals that the number of buyouts of healthcare providers in the UK has risen since the 2009 nadir, reaching a peak in 2012 when nine were acquired. When considering buyouts in the healthcare segment as a whole, healthcare providers have taken 53% of dealflow by volume across a five-year sample. As the NHS continues its programme of outsourcing under the Tories, opportunities continue to present themselves to private equity.

But private providers of public services are not the only group to be affected by political change. Companies that are subject to an overarching regulatory framework are also at the mercy of government whims. In November, for example, due diligence provider GK Strategy assisted Graphite in the management buyout of Human Capital Investment Group, a recruitment company for specialist areas in public and private sectors.

ECI Partners-backed Citation can also be included in the category of businesses affected by regulatory frameworks; the firm advises companies on health and safety and employment law compliance. In January last year, the GP backed the £50m buyout of the business, with a debt package supplied by HSBC, according to unquote" data. "When we did that deal, it was very important to us that we understood whether there would be any major changes in the burdens facing businesses – changes to the regulatory environment could have an impact on demand for our services," explains Joe Garrood, investment manager at ECI, highlighting the role such due diligence providers play in forecasting future demand.

ECI also sought Westminster's opinion concerning its investment in Bargain Booze, the off-licence chain that kicked open the IPO window last year when it listed on the AIM with a market-cap of £66.7m. Prior to the oversubscribed sale, which rewarded the GP with a 4.5x return, the government had floated the idea of minimum unit pricing for alcohol. Clearly, such a move would have had an impact on the wider alcohol retail environment and could, arguably, have affected the GP's exit route. "That's one example where the business isn't B2B and it doesn't sell to government, but [where] government policy can have a fundamental impact. It can affect a wide range of sectors," says Garrood.

With less than 113 days to go until the general election, the asset class is no doubt keeping a close eye on the polls and tracking the chances of a return to power by Labour. "[What we've seen under Miliband] is a more obvious and active willingness to restrict market forces, or to intervene in markets the government perceives as failing, or as failing consumers," says Woolfson. "You see this clearly in its energy, transport and healthcare policies," he adds.

With such an ideological fork in the road lying ahead, it seems GPs will increasingly have to plot a multitude of potential political outcomes before making a business case or embarking upon growth strategies.