UK M&A volume continues to impress despite value crunch

This year should continue to deliver a steady pipeline of deals in what remains one of Europe’s most dynamic markets

The UK M&A market had a mixed start to the year, with deal activity showing strength but with values shifting to the smaller side. There were 483 transactions in Q1 2023, up 13% on the previous quarter and remaining well above pre-pandemic levels. Value, however, continued to slump, falling by 31% quarter-on-quarter to US$22.2 billion, a low not seen since Q2 2016.

Acquirers are treading carefully and it’s no surprise because growth is showing signs of slowing as consumers feel the pinch. The International Monetary Fund highlighted that high energy prices, rising mortgage costs and increased taxes, and persistent worker shortages are dragging on the UK economy. Notably, energy prices were more than 42% higher in the UK in 2022 than across the eurozone. High costs of living and interest rates are stretching household finances. The Office for National Statistics, a government body, estimated that 57% of fixed-rate mortgages in the UK that are due for renewal in 2023 were fixed at rates below 2%. Consequently, in 2023, the UK has a significant chance of flat growth, if not an economic contraction, making it a global laggard.

Corporate restructurings

Such headwinds to growth are not conducive to strong M&A markets. However, there are still likely to be pockets of dealmaking activity in 2023. For one, corporates are expected to streamline their operations and de-lever their balance sheets as their debt obligations mature, driving carve-out opportunities.

A majority of corporate and advisory professionals expect a rise in divestment activity in non-core European and UK businesses by corporates in 2023, according to a survey conducted by alternative investment firm Aurelius. Approximately 78% of respondents anticipated an increase in such divestment activity. Among the respondents, 84% believed that a need to refocus on core operations would be the key driver of such activity, while 45% of the respondents chose the need to reduce debt burdens and 43% saw the need to reorientate a business from a weak market position as key drivers.

This represents a sizable opportunity for private equity (PE) funds, either by acquiring new platforms or scaling up existing portfolio companies via bolt-ons. Earlier this year, Deloitte sold its UK pensions business to Isio, a wealth and investment advisory firm that itself was carved out of KPMG three years prior by Exponent Private Equity. Creative financial sponsors are uniquely positioned to benefit from this deal flow, given their experience in executing these complex transactions.

In addition, environmental, social and governance issues will continue to drive activity. In 2021, the UK government set in law the world’s most ambitious climate change target of cutting emissions by 78% by 2035 compared with 1990 levels. There have even been examples of investors carving related assets out from corporate balance sheets. For example, in February 2023, DIF Capital Partners and German construction company ib vogt fully acquired a 720MW solar and battery project portfolio in the UK from Enso Green Holdings, a joint venture of Cero Generation and Enso Energy.

Exit pipelines 

Sponsor exits will also be a source of forthcoming M&A activity in the UK as fund managers remain under pressure to return cash to investors following a quiet period for divestments. There were 38 exits and secondary buyouts in the UK in Q1 this year worth a total of US$5.1 billion, representing year-on-year declines of 43% and 75%, respectively.

According to Mergermarket's Likely to Exit (LTE) predictive algorithm, the UK's sponsor-backed enterprise software companies are expected to play a significant role in driving the country's exit pipeline for the rest of 2023, providing a potential welcome boost to technology M&A activity.

Some notable enterprise software companies likely to enter the market for sale include Hg-backed IRIS Software with an LTE score of 67, Accel-KKR’s Kerridge Commercial Systems with a score of 65, and Horizon Capital-backed ERP provider Sapphire Systems with a score of 66. These companies have appointed advisors to explore strategic options, including possible sales.

Other potential exit candidates on Mergermarket’s list include Bain Capital's HR and payroll software business, Benefex, a subsidiary of Zellis; and QA, an IT education business backed by CVC Capital Partners. These companies are reportedly considering sale options, with potential launches throughout the year.

The year may have started off slow in UK M&A, measured by transacted value, but there is no denying that deal making continues at an impressive rate. This trend toward smaller deals is likely to persist for much of the remainder of 2023 as acquirers and vendors weigh their options amid a challenging macro outlook.

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