The decade of uncertainty
What a tumultuous decade the first 10 years of the 21st century has been for financial markets, with the boom years of 2003 to 2007 followed by one of the biggest market crashes in history. For investors and traders alike, however, the pressing issue is how the trends of the past 10 years will compare to those in the next decade.
By Andrew Cave
Will we see again the megabuy- outs, large-scale public to private deals and dominance of private equity that characterised the “noughties”? Or will investments be different in nature, shape, size and structure in the more risk-averse and more heavily regulated financial environment following the downturn? Like any future projections, analysis must start with understanding recent history, when capital markets reached new peaks and there was an explosion of deals, many of which were fuelled by private equity.
In terms of smaller companies, the most noticeable trend was a boom on AIM, with a stream of international companies choosing to float on the market, attracted by its lighter regulatory requirements, compared with New York and other major Western markets. The volumes of companies listing on the market transformed its credibility, and institutional investors began participating much more fully. Only a handful of institutional investors regularly invested in AIM companies when it launched in 1995, but by 2005, nearly all the major institutions were investing in the market.
When it came to the recent downturn, however, AIM was no hiding place. The number of companies on AIM fell from a peak of almost 1,700 in 2007 to just over 1,300 at the end of October 2009.
Almost 500 companies have delisted since the beginning of 2008 for various reasons (and not all bad ones) but more significant has been a distinct lack of initial public offerings (IPOs). In the 10 months to October 2009, there were only 22 admissions to AIM. Of these, seven admissions were IPOs, with the rest being through introductions. However, the £4.2 billion funds raised on AIM in this period are almost at the level raised for the whole of 2008 (£4.3 billion), which has been underpinned by £3.6 billion raised for existing AIM companies.
Figures from the Centre of Management Buy-out Research show that only 31 private equity buy-outs were completed in the third quarter of last year – the lowest volume for 25 years. The number of businesses acquired from family and private owners fell by 73% from the previous year, while public to private transactions declined by 67%. The number of investments realised in the first nine months of 2009, excluding receiverships, dropped to less than a third of their 2008 level.
David Giampaolo, founder of private equity group Pi Capital, says: “We will not see 2005-2007 levels of activity for a considerable time, if ever again. Patience and caution will remain key themes for a considerable period.”
The downshift has also seen new funds raised for new venture capital trusts fall from £800 million in 2005/06 to less than £150 million in 2008/09. Whether these figures represent little more than an extreme point of a particularly vicious cycle or something more sustained is the subject of much conjecture.
Completion speaks to three experts – in capital markets, M&A and private equity – for their perspectives.
Capital Markets
Chilton Taylor
Head of Capital Markets, Baker Tilly
“The boom years were fuelled by an abundance of funds to invest in businesses but as belts were tightened in 2008, AIM, in common with all small cap markets across the world, suffered more than the major markets. But there now seems to be grounds for cautious optimism. By October 2009, the AIM All-Share Index had rebounded by 65% since 1 January 2009 (albeit from a low base) compared with the FTSE All Share of 16%.
Between January 2008 and the end of October 2009, nearly 500 companies had left the market, leaving just 1,335 companies – 20% less than the peak of almost 1,700 at the end of 2007. However, this is not all bad news; more than half the companies that delisted had a market cap of less than £3 million, leaving the market smaller but stronger, with an average market cap of £43 million compared to £28 million at 31 December 2008. There was also an increase in liquidity in the third quarter of 2009, and the number of departures from AIM appears to be slowing down.
In spite of this recovery, the AIM All-Share Index is still only just over half the value it was during its peaks in 2006/07. These relatively low valuations mean there’s tremendous potential for investors, but it’s important to recognise that AIM is a stockpicker’s market.
The IPO market has remained depressed with only seven IPOs on AIM and four on the Main Market at the time of writing, with investors clearly favouring further investment in existing listed companies rather than in unproved companies seeking an IPO. Indeed, secondary fundraisings for existing AIM companies are 25% higher than in the same period in 2008, and 86% of all funds raised to date.
When the IPO market returns fully, the emphasis will be on quality. There have been some concerns about a few overseas AIM companies, unable or unwilling to cope with the demands of the market. As a result, institutions are likely to focus on quality UK companies, with overseas firms having to work harder to show they have heeded these lessons.
It is always difficult to predict which sectors will attract investors, but the initial focus will remain on those which are currently proving resilient in the downturn, such as the extractive industries, clean technology and healthcare.
Government help will be required to stimulate the smaller end of the market because there is a real equity funding gap. Some £1 billion of assistance through various funding schemes would make a huge difference and, in particular, relaxation of the recently tightened VCT and EIS restrictions would go a long way to assisting the growth of SMEs, whether private or on AIM.
Clearly, there will be calls for increased regulation and companies will have to accept demands for a higher degree of corporate governance and transparency.
There will be potential competition to AIM from ‘standard’ listing on the Main Market, which is now open to UK as well as overseas companies, and other markets in the AIM mould are setting up across the world to serve local demand.
Companies seeking to IPO not only have to be suitable for listing but also be prepared, and as the markets are sure to return, now is the time to make those preparations.”
Private Equity
Simon Havers
Chief Executive of Baird Capital Partners Europe and Chairman of the British Private Equity and Venture Capital Association
"Private equity will carry on doing what it has done for the past 30 years, which is buying companies, investing in their improvement and selling them on at a profit.
At the end of the last cycle, the market became overheated and some of the large private equity deals were seen to be driving the market.
It is clear that the days of the multi-billion-pound deal seemingly every other week financed by easily available credit are over. Who knows when or whether they will return, but the private equity industry needs to return to refocus on what it is good at: using the benefits of having direct control of businesses and incentivising management to increase value.
Historically, this is something that the private equity industry has done extremely well, and it now needs to adapt itself again to the demands of operational improvement, particularly while the markets remain closed to mega-deals.
At Baird, we have 20 people in China who are there solely to help the US and European firms that we back to take advantage of opportunities in Asia. I can think of a number of underperforming companies whose performance we have helped improve in this manner, whether by procuring components more cheaply or by winning business in China itself.
Private equity firms will have to put more emphasis on this kind of operational improvement, although it would be a foolish person who said that a deal such as the takeover of Alliance Boots will never happen again. It may be a long time before we return to that, however, not least because of the reduced amounts of leverage we’re seeing at the moment.
Going forward, it’s inevitable that there will more focus in the private equity industry on sectors and geographies. The days of the generalist firm focused on a single country are probably numbered.
Longer term, however, I expect the market to recover. For the moment, it is the trade buyers who are starting to lead activity, but this is good news for private equity firms too because it will provide them with exits from some of their existing investments.
We may see some private equity firms take part in deals where they get only minority control. The industry also needs to continue to engage with the banks to ensure that they treat their portfolio companies properly and are prepared to come in alongside private equity partners in new investments.”
M&A
Rob Donaldson
Head of M&A and Private Equity, Baker Tilly
“It’s an interesting time because we’ve not seen such a severe downturn since the late 70s. We will have much more choosy investors, both private and public, than has been the case in the recent past.
The private equity market, in particular, will change. Over the five years up to 2007, there was a lot of financial engineering: businesses acquired using high leverage. Investors relied on a cocktail of cheap debt and rising prices to generate equity returns. Most of these transactions were buy-outs, as private equity players backed change of control deals.
You’ll still see plenty of buy-outs but an increasing proportion will be development and growth capital, with existing owners retaining businesses and using private capital to fund growth because they can no longer use bank finance or the public markets, and they are not prepared to sell out at today’s prices.
There will also be a reduction in the number of private equity investors. There are probably too many players in the middle market and some will not make it. As for the debt markets, the banks will remain only semi-open for business for a few years. And there will be fewer players. Debt availability will remain tight and cost will remain high.
The market dynamics will create opportunities for well-funded private equity players. Already we have seen a very high level of ‘all equity’ deals in the first six months of this year and this will continue. Another feature will be a renewed emphasis on M&A among business. Companies will be more prepared to do deals that consolidate market share because it may be more difficult to grow organically.
The role of governments will be important. There are many schemes aimed at guaranteeing bank assets, some of which offer value. These will continue to be reasonably successful, but they’re helping firms at a small level. Then there are other schemes aimed at helping the banks to provide working capital. These sorts of things will be helpful but they won’t replace the private equity market or AIM as a source of funds. All this does not necessarily mean that fee income for advisers such as Baker Tilly will shrink, but we will have to work harder and be more flexible.
I still have as many deals on as in 2007, but now some are distressed deals and some are people selling because they are scared about the future. The types and reasons for deals will change, but this does not necessarily mean there will be fewer deals done; just different.”