No way out

The divestment statistics for last year make for happy reading: 408 exits in the UK alone, with Continental Europe pitching it with a respectable 277, according to the Centre for Management Buyout Research (CMBOR).

The story for 2008 is not so rosy. CMBOR’s ‘Buyout Review’ for January to June shows there were 174 UK exits in the first half (H1) of 2008, a robust 43% of 2007’s full year total, but Continental Europe managed 89 H1 exits, only 32% of the 2007 total.

This latest analysis confirms that IPOs remain practically no-go for private equity while depressed stock market valuations make it impossible to get flotations away at acceptable prices.

“Secondary buy-outs have also slowed, which could present major problems as these have provided most of the largest exits in recent years,” said Rod Ball, research fellow at CMBOR. “In the short term, it’s unlikely trade buyers will fill this void.”


Mid-market GPs are more optimistic. “The climate for exits in the middle market is not easy, but they are possible,” says Christopher Marriott, director in the London offices of Barclays Private Equity. BPE’s four exits this year, and three after the liquidity crisis blew up in 2007, are points in case.

Marriott also cautions that whatever bulk statistics show, sale prospects and exit routes vary from case to case.

Retail is supposedly bombed-out for, example, yet when BPE offloaded designer shoe-seller Kurt Geiger to Graphite for €126m in February, the buyer knew it was backing a quality management team and a company with great international growth potential.

BPE’s sale of Dial-a-Phone to Phones 4U underlined the continuing interest that trade buyers have in making strategic acquisitions in consolidating markets such as mobile telephony.

Trade buyers are decidedly still in the market, says James Stewart, who is responsible for deal origination at ECI, a London and Manchester based mid-market house. “Corporate profitability in some areas has been relatively robust, so they have quite a lot of internal cash resources and internal banking lines to complete transactions.”

Secondaries this year show evidence of large PE firms’ anticipated move into the mid market. Charterhouse Capital’s first quarter purchase of Gresham Private Equity’s 41% stake in independent insurer Giles brought Charterhouse a buy-and-build vehicle to create a far larger entity in line with a big house’s usual transaction size. Similar plays are expected be a useful source of exits until large buyouts recover.

Good investments in good companies with good managers is the whole point of private equity, and such firms can do well even in ailing economies. “If they can demonstrate growth in the current environment, that gives banks a higher degree of comfort when they’re far more selective about the type of opportunities they’re looking for,” says Stewart.

For similar reasons, Marriott is among many who remain upbeat about returns.

“We’re not expecting to see lower returns purely because of economic problems. The returns that we’re expecting to make on our deals at the moment are the same as they would have been a year or two ago.”

Peaks and troughs

Nevertheless, pricing is clearly under pressure. Under ‘mark to market’ conventions, falling stockmarkets and hence lower price to earnings ratios are moving valuations downwards even for private companies with good underlying performances.

Also, with debt headed down from typically 80% to maybe 60% of transaction values, and more equity going in, prices will have to fall for private equity acquirers to get the returns they are looking for further down the line.

Some sellers balancing these considerations will just decide to sit it out: exit totals will thus reflect falling supply as well as demand.

John Gripton a managing director and head of investment management Europe at Capital Dynamics, an LP, sees it this way: “You should invest and exit when you believe it appropriate to do so, not on a regular basis. We naturally expect peaks and troughs in realisations just as in new investments.”

Yet holding assets until economic uncertainty clears and debt markets free up is an option only as long as greater multiples can be generated to avoid depressing IRRs.

Which is one reason why James Stewart is bullish about prospects for acquiring from both trade and private equity sellers in the next year or so. “As pricing will inevitably come off, particularly for the first half of 2009, there will be tremendous opportunities for private equity to pick up good assets at hopefully realistic valuations. I think it will be a vigorous year, but it will be selective, based on bank finance.”

The take-home messages are that secondaries and trade buyers will likely remain the principal exit routes in the short-term, albeit volume will fall and pricing will come under pressure.

There is of course one other type of exit, the one no-one talks about – receiverships. The stats are ominous in the UK – in the opening six months there were 65, the second most common form of divestment. For all the confidence shown by many GPs, there is no immunity from a crumbling economy.

The other route – the unmentionable but obvious elephant in the room – is receiverships, which CMBOR data show rising in the UK. This alone should concentrate minds wonderfully.