The takeover of supermarket chain Morrison's, the fourth-largest in the UK, has caused something of a stir.
The UK-based supermarket chain is the subject of a bidding war between US-based PE firm Clayton Dubilier & Rice (CD&R) and a consortium led by Fortress Investment Group. After weeks of competing bids, Morrison's' board agreed to a revised offer from CD&R, which gave the supermarket chain an enterprise value of US$14 billion. The transaction is subject to shareholder approval, with the possibility that the Fortress-led consortium could return with another offer.
The deal is among the largest public-to-private (P2P) transactions of 2021 so far. It's also symbolic of a strategy that is back in vogue for private equity investors following a quiet period last year amid pandemic-induced market volatility. Stock markets have become a prime source of deals for PE managers in recent years, driven in part by their unstoppable ability to raise capital.
Already in the first half of 2021, global take-private deal activity involving PE firms totaled US$113.5 billion. Not only was this more than double the total seen in the previous six months (US$50.7 billion), it also represents the strongest half-yearly value since H1 2007, which saw US$258.6 billion activity. Similarly, the 46 transactions recorded in deal volume in the first six months of this year represents the highest half-yearly total in ten years, matching the 46 deals recorded in H1 2011.
This level of activity has been fueled by PE firms’ access to capital. Dry powder currently sits somewhere in the region of US$2 trillion and competition for privately held assets has never been higher. Add special purpose acquisition companies (SPACs) into the mix, which have an estimated US$133 billion at their disposal not including leverage, and PE is being pushed to look further and wider for opportunities.
Value play
The rising competition for privately held companies in recent years has made some listed assets look comparatively inexpensive. Even in coveted sectors—such as technology—there are relative bargains to be found.
The largest P2P in the first half of 2021 saw Thoma Bravo take Proofpoint off the NASDAQ exchange for US$12.3 billion, or 11.7x the cybersecurity firm's 2020 revenues—and that includes a 34% purchase premium. For comparison, the median revenue multiple of the BVP Nasdaq Emerging Cloud Index at the time of the deal was 18.6x.
Proofpoint was loss-making in 2020, making an earnings multiple valuation impossible and also making it difficult to compare against similar private deals. However, private assets are in many cases changing hands for eye-watering multiples.
This is especially true for enterprise software and IT service businesses, an investment strategy backstopped by the change in working arrangements brought on by the pandemic. By one estimate, the median EV/EBITDA private equity deal multiple in the IT sector topped 20x in 2020, twice the price paid a decade prior. It is against this backdrop of rising multiples in the private domain that PE funds have sought to capitalize on public market arbitrage.
UK discounts
PE firms will continue to seek out value where they can find it. This is what makes the Morrison's deal, and the UK stock market more broadly, so attractive. A Brexit-weakened sterling has made assets attractive on a currency basis. Add to this the chilling effect that the UK's departure from the European Union has had on its equity market. Indeed, British stocks' discount to global peers is the widest it has been in over three decades.
The FTSE 100 continues to trade below pre-pandemic levels, while the STOXX Europe 600 is up around 9% and the S&P 500 more than 30%. This is not a simple function of divergent company performance either. The FTSE is trading at around 12.6x forward earnings compared with 21x and 16.3x respectively for the aforementioned US and European benchmarks.
These fundamentals have fueled a surge of activity in the first half of 2021 that has included KKR's acquisition of infrastructure investment firm John Laing Group for US$2.8 billion and CD&R's successful takeover of UDG Healthcare, a UK-listed healthcare advisory firm based in Ireland, for US$4.1 billion (including net debt).
Security concerns
Like the Morrison's P2P, Ultra Electronics' delisting has caused a stir. Critics claim that the deal has the potential to undermine national security, while the Morrison's acquisition is seen by some as undermining the country's food security at a time when supply chains have come under immense pressure due to Brexit and the pandemic.
At the onset of the health crisis, European countries, at the behest of the EU, highlighted the need to scrutinize foreign direct investment into strategic sectors seen as critical for national security purposes. It is a concern being felt in many markets. Germany, Canada and the UK have revealed new regimes to vet critical investments.
The UK government published its National Security and Investment bill in November, which introduces a new review system for takeovers potentially giving rise to national security concerns. It is anticipated that between 1,000 and 1,830 deal notifications will be triggered each year. That is a significant increase on the fewer than 100 deals the Competition and Markets Authority currently reviews.
The US is similarly watchful, despite prior expectations that the Biden administration may take a more lenient approach to inbound cross-border investments. Under former president Trump, the Committee on Foreign Investment in the US stepped up its deal screening efforts, especially where capital from China was concerned. Not only have rigorous screenings continued under the current administration, but bipartisan support for the Strategic Competition Act of 2021 signals continued consensus to oppose efforts by China to undermine America's national security.
From a pure private equity standpoint, heightened deal scrutiny is likely to affect markets outside of the US more than it does the US itself. This is because the majority of cross-border PE buyouts come from globally mandated funds based in the US, and these are the deep-pocketed sources of private capital equipped to make multi-billion dollar take-privates.
Given the value dynamics that are still in play and the dry powder reserves available to private equity funds, P2Ps are likely to remain a theme for the foreseeable future. But, depending on the sector in question, they could face greater regulatory headwinds than before.
