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Private equity cools on mid-market

In the wake of the mega deals being routinely announced by private equity funds, typified by this week’s US$45bn offer for TXU, perhaps it is no surprise that financial buyers are withdrawing from the mid-market.

Yet this is the finding of a survey of 270 European mid-market corporate and private equity funds conducted by KPMG recently. When asked about the outlook for the next six months, private equity buyers were less enthusiastic than corporate purchasers.

That said, just over half of private equity firms, 58%, still expect M&A activity to increase in their country during this period. But corporate acquirers are more positive, with two-thirds, 67%, believing an increase in activity will take place.

Steve Halbert, head of mid-markets in KPMG’s corporate finance practice, put this down to a number of factors. “We have seen interest rates rising, an increased threat from infrastructure funds and growing concern about over-leveraging,” he said.

Looking at trade buyers, Halbert said: “So bullish is the corporate mood that 58% say they do not regard private equity – which has the edge in leveraging, motivating management and closing deals swiftly – as a threat.”

Nevertheless, private equity firms are effectively forced buyers in this market, regardless of whether they think the time is right to make purchases. Because of their partnership structure, they agree to invest specific amounts over a certain period.

This might explain that while their confidence is declining, more than half of private equity firms still expect activity to increase. Both groups say valuations have increased over the past year but only a majority of corporates think they will increase in the months ahead. That may be wishful thinking on the financial buyers’ part.

Halbert said: “Private equity houses are now factoring in lower exit multiples for acquisition targets – a sign that the private equity community is concerned about pricing levels. That said, while strong appetite remains, the pressure cooker of competitive situations should not be underestimated.”

Both parties agree that targets are now over-leveraged but only a handful think this a problem as they believe any defaults will be isolated.

Turning to specific sectors, private equity firms are most keen on industrial deals in the Netherlands, Germany and France. Healthcare in particular is singled out as a busy sector in the UK and consumer and business services are expected to be active across Europe.