Private Equity & Leveraged Buyouts: The ‘Raid’ on Corporate Britain

Over the last decade, a clear winner from both the pandemic and the financial crisis has emerged; the private equity industry. Following the market dislocations caused by Covid-19, private equity firms have been seen to be participating in larger and more frequent acquisitions. This increase in deals has hugely benefitted commercial law firms and investment banks over the pandemic, with international law firms reporting record earnings. 

Crucially, data from Refinitiv has indicated that the number of UK buyouts from private equity firms in the first half of 2021 has increased by nearly 60% compared to the same time in 2019. Since the start of this year, private equity firms have approached over 13 companies listed in the UK; a large increase considering private equity firms have made no more than five approaches in the same period of any year for the last ten years.

The question is: why is this? 

With both Asda and Morrisons, historic brands and household names, being bought out recently, private equity is increasingly in the public eye. Even the Daily Mail has written articles campaigning against, what the tabloid terms, ‘pandemic plunderers’. This article will identify the fundamental causes of the increase in private equity deals within the UK.

Covid-19 as an ‘Accelerant’ – The Shift in Corporate Britain:

It can be said that Covid-19 has been an ‘accelerant’. For the vast majority of the past century, the British economy has been dominated by companies that were listed on public stock exchanges. This meant that their shares are available to investors to buy and, as a result, their managers faced a level of accountability for the company's performance. More recently, the British economy has shifted to an increase in ownership by private hands; namely, private equity firms. 

Crucially, private equity firms have been using their cash reserves to invest in long-term changes and trends, which Covid-19 has accelerated. We only have to look to the retail industry as an example; the decline of in-store retail has been happening over the last few years with the growth of e-commerce; the pandemic only accelerated this trend.

In essence, the strategy of many private equity firms has been less about predicting the time of the economic recovery but identifying the winners when the recovery inevitably occurs. The firms' investments do not require repayment according to a rigid schedule, but rather the aim is to sustain the companies until the recovery hits, hence allowing the firms to profit in the long-term.

The Environment – Low Interest Rates & Quantitative Easing:

Nevertheless, the pandemic has had a significant impact. The structural shift towards private equity in Britain is currently being driven by the low interest rate environment created by the government’s approach to tackling the pandemic. Firstly, the low interest rates have made borrowing extremely cheap; this is an aspect central to the private equity model, as seen through their use of leveraged buyouts. Secondly, the low-interest rates increased the amount of money invested into buyout firms by institutional investors who are keen to bring in higher returns. 

Furthermore, following the government’s response to the coronavirus pandemic, there have been vital market distortions due to quantitative easing. The use of quantitative easing to inject money into the economy to stimulate economic activity has complemented the low interest rates and has created an increased appetite for acquisitions. In essence, the market distortions created by both low interest rates and quantitative easing have furthered the long-term transition from public equity to private equity, which utilises leverage in order to generate higher returns.

Brexit & Capital Markets

In particular, the increase in private equity deals within the UK is being driven by the Brexit-related sterling volatility and the relative cheapness of equities compared with other international markets. According to research by JPMorgan, on a price to earnings basis, the gap between the UK stock market and other leading economies (such as the US and Europe) is at its widest in the past twenty years. In particular, following the Brexit vote, investors have pulled more than £29bn from UK equity income funds. As a result, companies listed on the UK stock exchange are looking relatively inexpensive compared to other markets, thus becoming more attractive. UK equities are currently undervalued in comparison to overseas peers.

Other factors worth considering are the UK’s emphasis on business alongside the successful and rapid UK vaccine rollout, both of these factors have been sources of confidence going forwards.

What the Future Holds:

The Positives:

Despite the Daily Mail and other sources labelling these private equity takeovers as unfavourable, these deals aren’t necessarily a bad thing. In fact, private equity buying UK businesses means more foreign investment into Britain thus bolstering economic development.

The positives of private equity often rest on the intent of the firm acquiring the companies. If private equity firms target UK companies with the aim of working with the business by making a positive contribution to its strategic development and growth, then these deals will be very beneficial for the UK.

However, there have been concerns that this might not entirely be the case for some of these acquisitions.

The Negatives:

There have been worries about the real intent of some of these deals, in particular, that of Morrisons. The concern is regarding private equity firms that squeezes the margins of a company for a few years to make a profit before selling the business back into public markets. This concern largely addresses the short-term shareholder capitalism in the UK where short term profit and growth are excessively emphasised over long term investment. Most notably, the government’s largely indifferent approach to takeovers means that British businesses are sometimes being bought by private equity firms with short-term goals without the interests of the British economy, businesses, workers and customers as a focus of these investments.

In the case of Morrisons, UK ministers have been concerned that, after being acquired by Fortress, the private equity firm would proceed to make a quick financial return by selling their assets – especially Morrisons’ property portfolio. However, Fortress has written a letter to the government offering reassurances over its intentions for Morrisons. 

Additionally, there is a fear that the increase in debt levels that accompanies private equity deals could potentially lead to high-profile corporate failures later down the line. In particular, the collapse of Debenhams during the pandemic has shone a light on the negative impact of private equity as it was in private hands over a decade ago. During that time, Debenhams was burdened with major debt, paid large dividends to its owners and was sold and leased back its properties.

Therefore, there is much to watch out for with the development of private equity deals as the mixture of consequences presents a large challenge for policy design. 

By Bobby Zhu