DC Advisory’s European Mid-Market Private Equity Round-Up

DC Advisory’s European Financial Sponsors team reviews the short-term impact of Covid-19 on the PE market.

This edition explores:

The impact of the virus on the European investment landscape
Emerging trends & sector by sector investment update
Existing short, medium & long-term views for lenders

European highlights: Impact of Covid-19 on the investment landscape

Buy-out activity is down 24% in Q1 2020 compared to 2019
Some countries are showing earlier declines in activity than others
Fundraising – at its final peak?
Emerging trends

Following a promising start in European buyout activity at the beginning of 2020, the sudden and severe global onset of Covid-19 proved to have a detrimental impact on European M&A.

When enforced lock-down across the continent became wide-spread, sponsors turned their focus to portfolio management and sought to conserve liquidity and identify the areas in which their portfolio companies needed support. The focused turn to portfolio prioritisation in Q1 2020 meant that many deals were either abandoned or put on hold indefinitely, particularly where deals were in their early stages. This, evidently, is the reason for Q1 2020 registering a 24% decrease in deal volume compared to that of Q1 2019 (see graph below).

Q1 buyout activity in the European Mid-Market (# of transactions)

Some countries are showing earlier declines in activity than others

The largest decline in actual transaction volumes were recorded in the DACH region and France. The two geographies were the largest contributors to the fall in European M&A, registering a combined 41 fewer deals in Q1 2020 than in Q1 2019. In percentage terms, deal volumes fell most notably in Spain by 53%. In comparison, deal activity in the UK fell by only 6% – perhaps an indication on the impact of Draconian lock-down measures being enforced more swiftly (see graph below).

Q1 buyout activity by geography

Total deals by geography and quarter

While deal volumes overall are beginning to decline, the initial impact of Covid-19 on each European region is also clear as the percentage share of deal flow has shifted since last quarter, with the UK and Benelux increasing slightly over average, and Spain and Italy’s share of deal volume slightly down in Q1 2020, versus 2014-2020 averages (see below).

Buyout volumes by region

Fundraising – at its final peak?

In tandem with the strong initial start to European buyout activity, private equity fundraising in the first quarter of 2020 recorded the second highest quarterly total since 2015. However, looking forward to Q2, Covid-19 is unsurprisingly expected to disrupt the positive trend as sponsors turn their attention to portfolio preservation and away from raising capital. In addition, LPs will need to consider fund allocation carefully to ensure they’re not too exposed to one asset class as valuations fall, thus making fundraising for sponsors more challenging.

In a similar vein, despite dry powder being at a near record high level in Europe at $192bn (see graph below), sponsors will likely wait until they have a greater perspective on valuations before deploying capital in 2020.

European financial dry powder ($bn)

Emerging trends

Increasing interest and activity in Related Fund Transactions – Related Fund Transactions (RFTs) offer an opportunity for GPs to deploy capital into well-understood, high quality assets whilst returning money to LPs. As the challenges imposed by Covid-19 on M&A continue, RFTs are expected to become more popular as sponsors look to provide support to their most valuable assets.

Financing at the portfolio and fund level – given current credit market conditions, sponsors are exploring financing options both at the portfolio level, for certain borrowers, and also at the fund level. Specifically, a number of sponsors are exploring the ability to incur debt at the fund level for a variety of reasons, including funding follow-on acquisitions or potential equity cures. On larger deals, sponsors are seeking to buy discounted debt in their own portfolio companies, often as a defensive measure ahead of a restructuring.

Increase in alternative M&A – Looking forward, we expect a number of near-term deals to require more creative and flexible deal structures to be completed. Consequently, it is likely that we will see a rise in the number of minority, structured equity and pure debt deals in the coming months. In addition to this, we expect that private companies will come to market sooner than private equity backed businesses, largely because of changes in the personal circumstances of owners and due to them not being encumbered by fund return requirements.

Distressed debt – given recent pricing, more funds are considering buying into secondary loan opportunities in response to current market dislocation. Although we have seen limited action here to date, we expect this to change in the coming weeks.

Sector by sector investment update

Despite the flurry of M&A activity that kicked off 2020 across most sectors, European deal-making ground to a halt in March, causing Q1 2020 buyout deals to fall against last year’s Q1 figures.

The sectors least impacted by the onset of Covid-19 were Business & Tech-Enabled Services and TMT. While both industries saw deal volumes decline by 7% and 17% respectively, they are widely viewed as pandemic-resilient and are expected to recover more quickly from the crisis than other sectors.

Whilst Healthcare buyout deals saw a larger decrease in deal activity (32% compared to Q1 of 2019) the sector will likely benefit from a surge in demand for healthcare-related goods and services.

M&A buyouts decreased by the second largest amount in Industrials (down 34% vs Q1 2019), largely driven by lock-down measures worldwide halting production, with a slow return to work now being seen in China.

Unsurprisingly, the Consumer, Leisure & Retail sector registered the greatest fall in deal activity – 38% against Q1 2019 levels. Where consumer behaviour shifts had been reducing sector investment for some time, Covid-19’s impact on spending and travel has dealt a fatal blow to the space. As a result of this, we are seeing a significant increase in restructuring activity as companies suffer material liquidity challenges.

Looking forward to Q2, the impact of Covid-19 on European M&A remains to be seen as buyout figures for Q1 2020 are only beginning to show the true impact of Coronavirus on deal activity.

Q1 buyout activity by sector (# of transactions)

Buyout volumes – 2014-2020

Buyout volumes – Q1 2020

Total deals by geography and sector

Debt & restructuring market

Following the heightened focus on portfolio management, it is apparent that borrowers have been taking the following actions:

Drawing existing liquidity facilities

Regardless of existing liquidity levels, borrowers have been drawing on underutilised liquidity facilities for their businesses. In addition, borrowers have been extending interest periods, deferring interest payments, holding non-critical cash outflows and using the flexibility on their various baskets to provide further headroom. In uncertain times such as these, having this readily available liquidity can be crucial.

Assessing additional funding needs

Borrowers have been assessing their near-term cash flows, taking into account mitigating actions, the financial support measures that have been made available by the government, and any other levers that can be pulled, to aid liquidity. The majority of these measures are temporary and will need to be unwound, adding to the risk of future liquidity issues. Additionally, many management teams have been running scenario analyses for the ‘unthinkable’ to stress test liquidity. These exercises are valuable in highlighting whether there are any upcoming liquidity pinch points and funding needs.

Pro-actively engaging lenders

Borrowers have been pro-actively engaging with their lenders to discuss how they are being impacted, what actions they are taking and if they require any lender support. Lenders remain pragmatic and willing to support viable businesses through interest and / or amortisation deferrals, covenant holidays, and by providing additional liquidity lines. With the heightened scrutiny on credit quality, these requests should be accompanied with clear and deliverable business plans, demonstrating the businesses viability over the long term.

Government aid

Alongside the pragmatic approach that is being taken by lenders, the UK government has launched a range of financing schemes that are designed to support UK businesses. These schemes include the CCFF (most relevant for investment grade businesses and large corporates), the CLBILS (for UK businesses with a turnover of over £45m) and the CBILS (for UK mid-market and SME businesses with turnover less than £45m). These support programmes are backed by the British Business Bank and can be accessed through participating commercial lenders. To be eligible, applicants must be UK-based, have an annual turnover relevant to the scheme being applied for, and must have a borrowing proposal which the lender would consider viable, were it not for the Covid-19 pandemic. At DC Advisory, we have spent significant time in assessing and analysing the support that is available to UK businesses and are keen to share our insights as the pandemic progresses.

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