Article by Dimitrios Galatas
Britain has been the heart of the world’s financial markets and global financial activity for centuries, providing essential lending and investment services alongside providing access to their prestigious exchanges and markets, which are foundational to the world of business that we know today. Recently however, a trend has emerged whereby institutional investors, usually PE firms or other investment groups, have been swooping in to acquire British companies, offering bid after bid for the London-listed businesses. This article will look to discuss the reasons behind such a trend, and discuss what this means for law firms in practice.
The Threefold Justification
Such an acquisition spree can be boiled down to three essential factors.
The first is Brexit. Brexit has had the effect of fluctuating the value of the pound sterling currency, often leading to large dips within its value. International investors understandably try to capitalise on these dips through taking advantage of the exchange rate, making for cheaper business within Britain when compared to their international peers.
The second is low interest rates. Due to the pandemic, various Central banks led by the Federal Reserve have tried to reform the economic climate by driving interest rates down to historic lows. This was done with the intention of reducing the likelihood of economic down turn and the general slowdown of economic activity, whilst also acting as a means of enabling hard-hit businesses to raise capital at a lower cost. A correlated consequence of this was PE firms taking on unprecedented levels of debt, and using it to further load companies they already own a stake in, or even making new strategic acquisitions.
The third is the emergence the COVID-19 pandemic (and the ensuing lockdown). Whilst the pandemic had catastrophic consequences for the global PE market in its infancy, due to the unpredictable and volatile nature of the market, and general life more widely, deal value and volume has since bounced back tremendously. However many economic sectors still remain under tremendous pressure as a result of COVID-19, this has created opportunities for PE forms to step in by helping to restructure their debt, assist the managers in leading their companies through these situations, and provide additional funding support to the distressed companies. On the other hand, such economic sectors also faced a large tumble in their share price, allowing for a cheaper deal value if PE firms so wished to make a bid on their company. Furthermore, the uncertainty caused by the pandemic further had the effect of leaving dealmakers and investors sitting on lots of dry powder, waiting to capitalise upon any future investment opportunities.
Case Study: The Bid for Morrisons
These three factors can be encapsulated and demonstrated well in the acquisition of Wm Morrison by three private investment groups led by SoftBank-owned Fortress. These are Fortress, CPPIB (a Canadian pension fund), and a unit of Koch Industries. This offer comes following a rejection by Morrissons of an offer from PE group Clayton, Dubilier & Rice. This deal is the largest of its kind since PE group KKR bought out pharmacy chain Boots in 2007, and it is owing to the fact that Brexit and the pandemic have taken a toll on the share price of Morrisons. Morrisons agreed to the deal following a bid from the groups for a total value of £9.5bn, consisting of the £6.3bn equity of Morrisons and an inclusion of £3.2bn net debt. This deal still remains subject to shareholder approval.
This deal, when cast alongside the wider context of corporate Britain, leaves British directors and management in a middle ground; stuck between the views of scathing traditional fund managers and these ‘bullish dealmakers’ seeking to blow their dry powder on the next investment. Furthermore, issues regarding valuation arise for the British company boards. This is due to the fundamentally negative impacts of Brexit and the pandemic upon the share prices of companies across multiple economic sectors (including Morrisons’ supermarket sector in the present case), making it difficult to come to a reflective valuation of such British companies. This could result in under-valuations by buyout groups which do not sufficiently reimburse shareholders for their stakes in the company, something that arguably goes against good corporate governance and stewardship practice. Within the present case, this shift from public to private ownership was met with concerns by fund managers as they worry that such a shift could affect the pensions and employment of the target companies’ employees, as well as the public services and general long-term wellbeing that the companies would achieve in public ownership.
The Future: For Better or for Worse
When looking to examine the future, generally we can look to the past when similar trends have occurred. Such an example could be the collapse of Debenhams earlier this year. Debenhams recently had a period of private equity ownership within which the company was levered up, paid large dividends to their owners (feeding into the short-termism of directorial control which has been pervasive in today’s management), and sold/leased out its land interests and properties. This trend of PE in retail is dangerous in the case of corporate collapse as it leaves a “pension fund deficit” as pointed out by Labour MP Darren Jones, leaving thousands of employees of the chains to foot the bill in the case of a failure.
Cast against a broader context however, another consequence is the increase in corporate debt during times of prospective rises in interest rate and inflation. This is particularly pertinent when considering that European PE deals tend to use debt of approximately six times a company’s earnings, something that is well above the standard for listed companies as stated by Refinitiv.
Alternatively, economist John Kay suggests that if PE funds practice “[T]he kind of private equity that’s willing to stick with a business for 15 years and make a positive contribution to its growth and strategic development” rather than focusing on short-termism and paying shareholders large dividends, then this will be conducive for growth, and healthy for the United Kingdom’s economy.