Regardless of the final outcome of Brext negotiations, the continued uncertainty and political volatility caused by Brexit is having a significant impact on UK markets. Whilst the UK avoided a cliff edge ‘no-deal’ last month, the extension of the Brexit deadline to 31 October has not changed market sentiment. Grant Thornton business advisers are continuing to see subdued trading and investment for the UK’s mid-market businesses. But there remain opportunities amidst this uncertainty.
The last month has seen ongoing postponement of investments alongside signs of financial distress in some sectors. Nonetheless, high levels of liquidity mean finance is available for strong propositions in debt and equity markets. There are opportunities for propositions able to demonstrate they are insulated from or mitigating current uncertainty and future political risk.
Financial distress in some sectors
In the mid-market, we are seeing some sector specific distress continuing in retail, construction and related trades (eg plant hire) and Further Education.
Across all sectors, there is a sense that business profits are increasingly coming under pressure. Relatively few businesses are outperforming their plans.
The work out departments of banks, which deal with customers facing financial difficulties and struggling to repay loans, are telling us they expect to be busier, but they are not yet. More generally the wider restructuring market is patchy, with no clear trends yet.
Investment decisions on hold; restructuring more widespread.
Uncertainty continues to affect business investment and M&A activity. In March we saw a noticeable dip in decision making on new deals, as the ‘false’ 31 March Brexit deadline loomed. Extending the date of Brexit to 31 October 2019 has freed things up a little, removing a short-term blockage as sitting on your hands for another six months is really not a viable strategy. The mid market, with a lower risk profile, is proving better insulated than the larger deal market. But the lack of clarity is adversely impacting investment decisions more broadly of which M&A is a key part and there is a real risk that deals freeze up even more in run up to 31 October if we have no greater clarity by then.
As noted above, business profits are under pressure; this also means greater execution risk in investment deals.
There is more restructuring activity in the market, with businesses looking at how best to optimise and grow their existing assets. Private equity is also leading more restructuring as covenants tighten against lower growth to original plans.
Overseas investors are looking for more certainty
We have seen some evidence of overseas trade buyers not feeling confident enough to invest in the UK right now until there is greater clarity. It should be emphasised that this not across the board and the number of deals affected remains relatively limited, but it is certainly a factor in the market. Some industries are being more adversely impacted from a deal perspective than others, eg food and beverage and the wider consumer sector.
Wider concerns about UK political risk amongst private equity and funds
Concerns over future political change – and the risk of adverse policy decisions around capital taxes for business owners – are probably outweighing the short-term Brexit uncertainty risk in the minds of private business owners. There is greater focus on de-risking and partial liquidity events rather than full sales as a hedge to this.
Consumer deals are almost non-existent in private equity but there are still good quality deals taking place in businesses and sectors with lower Brexit risk. Tech is still seeing some deal flow. We are also seeing more dividend recapitalisation rather than sales as PE houses wait for some certainty.
Amongst funds, those that can are noticeably focusing more on European and broader international opportunities rather than UK specific ones.
Funds attracted to buy-and-build rather than start-ups
In the tech sector, funds are focussing hard on deploying more capital behind existing platforms and teams. Buy-and-builds are the order of the day: compared to new platform deals they provide a route that is lower risk and easier to deploy new capital, especially debt.
Capital markets remain quiet
Broker results show the impact this is having. It remains to be seen whether the rush of large tech unicorns to the markets in the US (Uber, Lyft etc) will have an impact on UK equity markets; there are signs of life in public markets, but London activity remains quiet. The Q1 rally in pricing hasn’t reopened IPO pipelines as yet.
Strong liquidity means finance is available
Liquidity remains strong in debt and equity markets, but genuinely new deal flow with the right characteristics for PE in particular remains thin. We continue to see lots and lots of liquidity from the debt funds in the mid-market but very few deals. High quality credits and very good asset coverage situations continue to attract good offers of funding, irrespective of sector.
Debt finance: active lending but some tightening of credit
Banks are still actively lending in the mid-market although we have seen a very slight tightening of credit conditions in the last two months. Debt funding remains difficult in construction, retail (and anything consumer facing with a retail front) and automotive dealerships and supply chain. More widely, banks very much remain open for business and keen to do deals. Borrowers looking at refinancing or cash-outs continue to find a strong appetite from the lender community.
Despite the uncertainty there remain opportunities….
Whilst the UK avoided a cliff edge ‘no-deal’ last month, the extension of the Brexit deadline to 31 October has not changed market sentiment. Grant Thornton business advisers are continuing to see subdued trading and investment for the UK’s mid-market businesses. But there remain opportunities amidst this uncertainty.