It may be that it is a little early to be calling the beginning of the end, for a number of reasons.
Firstly, it has become apparent that the better connected private equity houses are managing to negotiate rates which are below base. This extraordinary revelation is hardly the sign of lenders losing their appetite. Naturally, any marginally higher rates will eat into the gap between the lending rate and the rate of return on capital, but in the majority of cases where the takeover has proved successful, there is more than adequate scope to shave a little from the end profit.
Furthermore, there have been a couple of spin offs from the hyper-activity of the private equity firms which have not had much publicity. To begin with, these firms are starting to rake in some serious profits as the deals going back three to five years culminate (usually) in a relisting of the stock in question.
The profit capital which is thus raised can be reinvested into future deals. At the same time, the likes of KKR and Blackstone in the US have gone a stage further by listing themselves. This also brings fresh capital and very much lessens their reliance on borrowing from the banks as being crucial to their next project.
Admittedly, the listing route may be one for which the market has a finite appetite, but on the basis that nothing has hit the UK as yet, and assuming that the US model is followed here as is so often the case (with the exception of 3I, who have been quoted for some considerable time), there will be some room for manoeuvre.
Of course, M&A activity is not the sole province of the private equity houses.
A number of cash rich European corporates have for some time been casting their eyes over the cream of UK companies, which have been buoyed by strong earnings growth and which find themselves in an open market which does not suffer from the protectionism seen elsewhere. Often these European companies have seen that their home markets are saturated (such as the German utility companies) and therefore have had to look further afield for acquisitions. As a side issue, and in the case of the German utilities, some of them have also had previous experience of acquiring UK utility firms and therefore the comfort factor is that much higher. In more recent times, this European source of predators has seen the likes of Abbey, O2, BAA and BOC falling into foreign ownership.
There is also the possibility that this foreign invasion may yet take another turn. It has been suggested that diversification among “sovereign wealth funds” could well prove to be another driver supporting M&A or, at the very least, buying pressure into equities.
It appears that these cash rich countries are looking to invest some of their wealth into stable, sizeable businesses which are fairly valued and for which the outlook remains promising.
Quite apart from the recent example of stakebuilding in Sainsbury shares by Dubai International Capital, this body also has a substantial holding in HSBC and, along with its counterparts, it does not appear that they have even begun their spending spree in earnest. And, given the criteria which the sovereign wealth funds have set themselves, UK stocks are currently ticking all the right boxes.
There is little question that, in the event of a major private equity default, the knock-on effects to market perception would be very noticeable. It is also fair to say that as time goes on, more and more of these deals are taking on a level of leverage which some find uncomfortable.
Nonetheless, the worst case scenario of unsustainable debts following on from historically high interest rates is not on the radar and so surely, at least for the time being, the drivers remain in place for continued M&A speculation and activity.
If you’d like to read more free research, comment and analysis from me and the rest of my colleagues at Hargreaves Lansdown please visit our website at www.H-L.co.uk
Richard J Hunter
Head of UK Equities
Hargreaves Lansdown
www.hargreaveslansdown.co.uk