By Ian Fraser
Published: Scottish Business Insider
Date: December 2007
Q3 deals round-up: While the world’s lenders felt the big chill of the credit crunch, Scotland’s deal makers claim to be better insulated. Ian Fraser finds, however, there is no room for complacency.
NOT many Brits can be unaware that the summer’s ‘credit crunch’ nearly brought the Tyneside-based lender Northern Rock to its knees. However, there are probably fewer who appreciate that it has also taken its toll on Scottish deal-making activity.
Sparked by the sub-prime crisis in the US and exacerbated by reckless lending and securitisation by the world’s major banks, the crunch effectively meant inter-bank lending froze up in July and August 2007. And the credit crunch has not yet lost its grip on aspects of the financial markets. Credit – in particular for big, highly leveraged deals with high loans to values – remains scarcer and more expensive than it was before July and ‘covenant-lite’ loans are now a thing of the past.
The Bank of England recently said the liquidity squeeze was far from over. “There have been signs of recovery in recent weeks, but some markets are still illiquid and the financial system remains vulnerable to further shocks,” said Sir John Gieve, the Bank of England’s deputy governor on 25 October.
Scottish deal-making has not been immune. Preliminary statistics show a sharp fall in the value of deals completed in the third quarter. Their aggregate value fell to £2.7bn, the lowest level since January 1999. There was also no single deal worth more than £1bn. The highest value deal was the Royal Bank of Scotland’s £669m purchase of a majority stake in Connecticut-based energy and commodities trading company Sempra Commodities.
The £2.75bn figure – which includes Scottish deals together with UK and overseas deals involving Scottish-based advisors and lenders – implies a 74 per cent slump on the £10.73bn of deals seen in the same quarter last year. The fall in the number of deals was less alarming: there were 118 in the third quarter, compared to 166 in the same period last year, implying a smaller average deal size.
There has been only one quarter in the past eight and half years with a lower number of deals and that was in Q2 2003, the nadir of the bear market. Yet even in that quarter, the 117 deals completed were worth £7.91bn – more than three times the total value of Q3 2007 deals.
The value of Scottish-only deals was lower than in any quarter of 2005. Their total value fell to £1.44bn, meaning it was 72 per cent down on the £5bn seen in Q3 2006, and 91 per cent down on the £15.4bn in Q2 of 2007, when any downturn was masked by Iberdrola’s £12bn acquisition of ScottishPower. The value of Scottish deals was 75 per cent down on the £5.55bn worth seen in the first quarter of this year.
Despite these figures, Scotland-based corporate finance professionals are adamant that the credit crunch has not cramped their style and that Scottish banks are not showing any reluctance to lend money for smaller deals. Alan Kelly, corporate partner in law firm MacRoberts, says: “While it’s clear there isn’t really any appetite for syndication, the midmarket is just as busy as ever. The banks and other players like business angel groups are definitely still prepared to fund deals in the £2m to £20m range. I don’t see the liquidity squeeze having too much of an impact. If it’s a good deal, the banks are still more than willing to lend.”
Ramsay Duff, principal in HM Corporate Solutions, says: “I was out with a group of private equity people the other evening and, while they acknowledge that the big London LBO market may well have been affected by the credit squeeze, there has really been no noticeable effect on the world we operate in.
“There’s no shortage of banks willing to support deals in our market, which is deals in the £2m to 5m range. If one bank is not interested, there are plenty of others that are.” Duff adds that Clydesdale Bank and certain Irish banks are “aggressively chasing deals at the moment”.
For his part, Jack Ogston, head of specialist and acquisition finance at Clydesdale Bank, is confident that “bread and butter” deals in the £1m to £75m range remain wholly unaffected.
He gives three reasons. “The fundamentals of the businesses that we’re lending to have not been affected by the credit crunch. Given that they are unaffected, why should we as a bank take a different approach than we did three months ago? The second thing is that, in the deals that we do, we are invariably the only bank providing the funding. There’s no second tier lenders or syndication or anything.
“And since Clydesdale is not caught up in any liquidity issues, our freedom of manoeuvre is not constrained. The third reason is that the deals we do in Scotland are leveraged at sensible levels.”
Bruce Walker, head of corporate finance for KPMG in the central belt, does not believe the credit squeeze is the reason behind the downturn in deals. “The third quarter’s figures may be lower than expected, but I wouldn’t point to the credit crunch as the reason,” he says.
“The vast majority of Scottish deals aren’t at the mega-deal end of the scale and in terms of the impact on M&A activity in Scotland’s mid-market, to date it appears fairly limited. Well-structured deals can still readily be financed on competitive terms. From our perspective, deal activity remains high and corporate confidence to look at deals is largely unaffected.”
Among smaller transactions, the biggest slowdown looks to be in property deals. There were only seven of these (six per cent of the total) in Q3, compared to 13 (11 per cent of the total) in Q3 2006. Given the uncertain future of the commercial property market, some commentators say funding for speculative developments is becoming virtually impossible to obtain at the moment.
In other sectors, however, plenty of smaller deals do appear to be taking place. Even in a quiet deal market there can, for example, be expected to be a steady flow of buyout activity, largely driven by succession planning. The introduction of a flat 18 per cent level of capital gains tax by Chancellor Alistair Darling, due to take effect in April 2008, is expected to accelerate this. Owner-managers of SMEs are already said to be queuing up to dispose of their businesses before the controversial new regime kicks in next spring – just so they can pay less tax on any capital gains.
The continuing strength of the smaller deals market is, to an extent, illustrated by the decision of law firm Harper MacLeod and its corporate finance arm HM Corporate Solutions to push ahead with the launch of their £29m Symphony Equity Investment Syndicate. In the quarter, this has raised £6m from wealthy business people and family owned, private equity firms, together with Clydesdale Bank chipping in around £23m of debt.
Symphony intends to target deals in the £1m to £5m range and expects to invest in about 12 such deals over the next three years. “I believe the economic outlook is likely to become noticeably tougher in the times ahead and this suggests that the timing of the launch of the Symphony syndicate is right and the strength of interest from investors backs this up,” says Duff.
With the exception of Royal Bank of Scotland, whose £669m investment in Sempra Commodities was the biggest deal in the quarter and whose takeover of ABN Amro will not feature until the fourth quarter, the most acquisitive Scottish company in the Q3 listing was Rosyth-based timber firm Scott Group.
The group’s £10.5m for Airdrie-based Marlaw Pallet Services was Scott’s 27th acquisition since 1998 and enabled it to grow its annual turnover from £95m to £123m and its workforce from 850 to 1150.
“Adding Marlaw enables us to continue to diversify the business and pursue strong growth in areas such as packaging and reconditioned pallets,” says John Scott, Scott Group’s managing director. Scott Group also bought Bristol-based packaging company Henry Sutcliffe for an undisclosed sum and shelled out £1.7m for Stirling-based engineering supply company Fasco.
This panoply of quick fire deals, on which Campbell Dallas advised, is quite an achievement for 27-year-old Scott, who took over his family’s loss-making sawmilling business on the sudden death of his father in 1998 – when he was only 18 years old – when its turnover was under £100,000.
Several sizeable bolt-on acquisitions were made by large Scottish companies in the period, which should inspire some confidence about the ambition of corporate Scotland. These included Forth Ports’ £46m acquisition of Tilbury-based waste management group Nordic. The acquired business, which has a turnover of £21m and specialises in port operations, materials recycling and document shredding, was bought from London-based private equity outfit Milestone Capital.
Forth Ports has taken on Nordic’s debt and also paid £28m in cash, £4m in unsecured loan notes and £1m by share issue. The Leith-based ports group, whose chief executive Charles Hammond believes there is scope to replicate Nordic’s “green” model at other ports owned by his group, was advised by law firm McGrigors, with Dundas & Wilson advising the private equity group. Other deals in this category included Quayle Munro’s £7.37m acquisition of New Boathouse Capital and Venture Production’s £14.2m acquisition of Guildford-based Wham Energy.
There was a greater number of deals in which Scottish companies were sold to UK or international groups. One such was Greene King’s £68m acquisition of Loch Fyne Restaurants. This was the Suffolk-based brewer’s second foray into Scotland in as many years, the other being its £254m acquisition of brewer Belhaven in 2005.
In a similar vein, the five-year-old Leith-based advertising agency Story UK was sold to London-based communications and advertising group The Mission Marketing. The deal is likely to be worth £13.5m to Story’s owners, Dave and Sue Mullen, once performance targets are achieved There were a couple of deals involving Scottish-based architecture practices. In July, Aberdeen-based Space Solutions bought itself out of the Chess Group, the latter retaining a 25 per cent stake. Space specialises in helping businesses maximise their use of property, for example, advising them how to adapt their premises to boost productivity. The architects were advised by Ritson Smith and Stronachs, while Chess was advised by Anderson Anderson & Brown and Brodies.
Another architect, Glasgow-based 3D, pulled off a merger with London-based Reid Architecture. The merged firm will employ 320 people and boasts initial turnover of more than £2m. 3D was advised by Craig Corporate and lawyers Semple Fraser. Reid, whose founder Geoff Reid retired from the business, was advised by Pinsent Masons and Macilvin Moore Reveres.
AIM flotations in the period included those of Livingston-based software developer Craneware and i-design, the Fife-based specialists of advertising on bank cash machines. Both used London-based nominated advisors – respectively KBC Peel Hunt and Arbuthnot Securities.
Aside from the credit crunch, a second potential dampener on deal-making activity came from the uncertainty over the future of the PPP (private public partnership) in Scotland. This stems from the SNP government’s very public mistrust of this funding method – and its failure to deliver anything concrete to replace it with. Commentators have suggested PPP is “effectively in limbo in Scotland at the moment”.
Nonetheless, several major PPP deals managed to reach financial close in the period, including the £134m East Dunbartonshire Schools project – a deal secured by the InspirED consortium, which includes Innisfree and John Laing Social Infrastructure – on which the majority of the funding has been provided by Barclays.
West Lothian Council also reached financial close on its £87.8m agreement with HDM Schools Solutions, a consortium made up of Essen-based builders Hochtief, Prestwick-based Dawn Construction and Strathaven Pacific Partners. This deal was funded by the Belgian bank Dexia.
Stephen Tobin, partner in McGrigors who advised HDM, says: “This is a landmark deal for the firm as this is the first Scottish schools PFI project to reach financial close under the new EU competitive dialogue procedure and McGrigors is delighted to have been involved.”
There were also several significant start-ups and early stage deals, notably in the oil and gas and technology sectors. Start-up business Fletcher Shipping, which provides platform supply vessels to the North Sea oil and gas industry, raised an impressive £13m. Dumbarton-based PWB Health – which is developing a device which enables women to check themselves for breast cancer – received £1.2m of equity funding from Edinburgh-based venture capitalists Longbow Capital and the Scottish Co-investment Fund. PWB is a spin-out of Wideblue, an MBO from the US group Polaroid.
Given the Bank of England’s 25 October warning that the availability of credit may tighten still further, there is no room for complacency.
Highly leveraged deals can be expected to remain extremely thin on the ground until well into 2008. And even if the smaller sub-£75m deals remain immune to the liquidity squeeze, Scotland’s deal making community will have to become accustomed to thinner gruel over the next couple of quarters.
This article was first published in Scottish Business Insider’s December 2007 issue. To view article on Insider’s website please click here.