Can PE ride UK’s race to the bottom?


This week the pound fell and the FTSE fell after the UK government last week revealed plans for a series of debt-funded tax cuts. The chaos is shaping up to be a chance for investors to pick up cheap British assets, but the wider economic fallout from the economic plan, which was unveiled by UK Finance Minister Kwasi Kwarteng on September 23, could have a sting in line to bargain hunters.

The brief, hastily compiled budget – which is called a “mini-budget” – is the first for newly appointed Prime Minister Liz Truss. It was received with almost universal derision. As of this writing, the pound has fallen against the dollar and the Bank of England has stepped in with a bond buying program to support the economy and protect savings. Even the IMF stepped in with a warning.

It is difficult to predict what the next few days and weeks will bring. Already, private equity investors are set to take advantage of the weak pound and falling public market valuations, as they did after Brexit. But higher interest rates, difficulty accessing debt and a general decline in confidence could dampen this trading outlook.

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For now at least, the British government is sticking to its guns. During the media rounds following the budget, Truss and Kwarteng remained unrepentant and said they believe their policies, which massively benefit the country’s top earners, will spur growth. Some have compared it to the “trickle down” economy made famous by US President Ronald Reagan and his British counterpart Margaret Thatcher (a political heroine of Truss) four decades ago.

The unpopular plan adds to any already volatile mix of economic headwinds that have dragged down the pound and the value of UK assets for several years. It’s fair to say that Britain’s current economic problems began with the Brexit vote and have been further aggravated by the pandemic and the war in Ukraine.

There are clearly aspects of the mini-budget that are meant to entice investors. Among them are the reversal of the corporate tax rate hike, the expansion of tax relief for early-stage vehicles such as venture capital trusts, tax incentives for technology investments and reforms that will allow more pension funds to invest in alternative assets, including private equity.

No doubt, there are also unintended benefits for private equity investors. With the pound now just above parity with the dollar, foreign investors will look to cheaper UK assets. This was already the case after Brexit. Last year, the total value of UK EP-backed equity investments topped €27 billion, a record high, and the sell-off is set to continue. Already, there are signs that this is happening.

This week alone we have seen UK waste management firm Biffa accept a reduced £1.3 billion bid from US firm Energy Capital Partners. A recent Bloomberg survey named a number of other plump UK-listed companies that could become targets for privatization. Among them are telecommunications group BT, gaming giant Entain and Darktrace, the software company recently targeted by Thoma Bravo, all of which have seen their stock prices drop significantly over the past month.

Securing financing for these transactions, however, can be a challenge. Private sockets are usually backed by leveraged finance and borrowing costs are rising. While a fall in the pound could lower the price of UK assets, when combined with a spike in interest rates, it will exacerbate existing borrowing costs for UK businesses.

Even before the announcement of the UK’s seismic budget, some deals struck during last year’s privatization spree have already shown signs of indigestion in the era of cheap money and interest rates. low or even negative interest. has ended. This includes the biggest deal of 2021: Clayton, Dubilier & Rice’s £10bn takeover of supermarket chain Morrisons, which the Financial Times said left underwriters Goldman Sachs struggling to transfer some £5bn pounds of debt.

The turmoil unleashed by Kwarteng’s filibuster tax policies will not only affect transactions, but fundraising could also be affected. Already the collapse of government bonds, which are backed by the Bank of England, has threatened to bankrupt the country’s pension funds. Meanwhile, there are reports of pension funds and insurers in Europe and elsewhere being deterred from investing in UK-focused private equity funds due to market turbulence.

One of the commitments contained in the economic plan is that it will make it easier for pension funds to invest in private equity. However, these policies are meaningless if the broader economic plan they entail threatens to completely deter investors from investing in the asset class.

Featured image of Kwasi Kwarteng by Carl Court/Getty Images


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