This was a record breaking year for deals, but it seems unlikely that next year will be. Ian Fraser reports.
IN SPRING 2007, Scottish dealmaking was riding the crest of a wave. Credit remained cheap, optimism was running high, valuations were elevated and the economic fundamentals seemed sound. Banks were falling over themselves to lend and some big private equity firms had become so cocky they even started dictating which firms of lawyers their lenders should use on deals.
This made for some extraordinary deals, including the £11.1 billion buyout of Alliance Boots by New York-based private equity firm Kohlberg Kravis Roberts, the first time a private equity firm had bought a FTSE-100 company.
Now that breaker has smashed into the shore. The credit crunch has intervened to bring the deals party to a halt and even though banks are still prepared to lend towards good deals and particularly to existing clients they know and trust, they have generally become much choosier about how they allocate their capital.
Anything with ‘questionable’ characteristics such as, say, a speculative office development or businesses that hamstrung by unattractive long-term distribution contracts will now struggle to secure funding.
David Cockburn, head of corporate finance at Grant Thornton, says: “Banks are being more cautious and they’re applying their capital in a different way. They are prioritising where they place their money and prioritising their existing corporate customers.”
Henderson Loggie corporate finance partner Bob Steel says: “Banks are not giving away anything on arrangement fees, they’re looking to increase other fees, and they’re being far more aggressive in their pricing. They know full well they can get away with it.”
Craig Campbell, corporate finance director at Deloitte, says: “In broad terms banks which were prepared to lend at a multiple of five times Ebitda, are now reducing that to four times ebitda. However some sectors are still attracting higher multiples, including oil and gas and fast-growing sectors of financial services such as insurance.”
Bruce Walker, director of corporate finance at KPMG, says: “This is the toughest market in which to find credit in the last 10 years. Banks are putting their existing customers through a much more thorough credit process before they lend.”
However, it’s fair to say the tide of credit continued to flow for much longer in Scotland than it did south of the border. This is largely because average deal sizes are lower, and debt funding for such deals can normally obtained from a single bank rather than a syndicated or structured approach.
This probably explains why the year to March 2008 was, in fact, a record time for dealmaking in Scotland. The total number of Caledonian deals surged to 502, up by 25% from 405 the previous year. Propelled by the sale of ScottishPower to Iberdrola and RBS’s astonishing takeover of ABN Amro, the overall value of Scottish deals soared by 106% from £17bn to £35bn.
And every single category of Scottish deal was up compared to the previous year, except for flotations (which halved in number from six to three) and reconstructions and specialist banking (marginally down from 36 to 31).
However, the number of deals advised upon by Scottish-based advisers featuring clients based off home turf fell by 6%, from 255 to 239 and the value of such deals fell by 24% to £16.7bn. This is worrying for two reasons. First it is probably a sign of is in store for Scotland and secondly it is clearly bad news for Scottish-based advisers seeking to carve a niche in the London market.
Jack Ogston, head of specialist and acquisition finance at Clydesdale Bank, believes that one reason the downturn has been lesser in Scotland than in England is because businesses are not so highly geared. “In small and mid-market deals, we’re not seeing private equity players pull back from the market,” says Ogston.
“Locally-based players including Lloyds Development Capital, Dunedin, Penta and Aberdeen are all still actively looking at deals.” He adds that Clydesdale parent National Australia Bank has no sub-prime lending and is therefore “very much open for business.”
The Royal Bank of Scotland is equally adamant that the credit crunch is not preventing Scottish-based companies from doing deals. In the first quarter of 2008, RBS Corporate ploughted £400m into deals for Scottish-based customers and the bank expects 2008 to be a busier time for financial services companies and listed companies than last year.
Kenny Stewart, RBS’s managing director of corporate and structured finance, says that, even though the credit crunch has created problems for some sectors, it has thrown up opportunities in others. “We’re not turning down deals. If a company ticks the boxes of having a strong business model and management team and the acquisition makes sense, then we’ll support it.”
However, by May, some corporate finance professionals were quietly admitting that, outside of the huge oasis of the oil and gas sector, Scotland’s M&A market had “stalled”.
Optimists believe that the downturn in deals seen in the second quarter of 2008 was largely because the glut of deals that were rushed through in March and early April to ensure they were completed by April 5. Chancellor Alistair Darling’s decision to axe capital gains tax taper relief from that date created an artificial spate of dealmaking activity which clearly helped inflate overall deal volumes and values for the year to March 2008.
In effect the deadline galvanized many owner/managers who were previously only vaguely considering a sale of their businesses to push ahead with a sale. Deals prompted, or at least hastened by the tax change, included the sales of Dobbies Garden Centres, Miller Group, Tulloch, Graham Technology, Black & Lizars, Sandyholm Garden Centres and the pharmacy chain Munro. There have been suggestions that Scotland’s SME base has been emasculated because of the tax change.
“That definitely caused a spike in completions in the run up to April 5th, many of which would have in any normal year have been allowed to run into the current tax year,” says Julian Voge, head of corporate at law firm Brodies.
Dundas & Wilson’s head of corporate finance Michael Polson says: “There were definitely deals that would not have been done had it not been for that driver. It was a drop dead date that people had to work towards.”
Another reason for the slowdown in dealmaking since April/May is that some business owners are in denial about the economic slowdown and still harbour unrealistic expectations as to what their businesses might be worth. Often these are based on artificially high prices fuelled by the credit bubble. Many currently believe they would rather not to sell than to offload their businesses for, say, 25% less than they believe them to be worth.
“The thing that is holding the market back is not the credit crunch.” says D&W’s Polson. “It’s vendor expectations. It’s wrong to blame the banks. Clearly the availability of liquidity is a factor. But the main issue is that many vendors still have unrealistic price expectations.”
He believes it will take another few months before vendors accept prices have fallen. “We’re several months from seeing the closure of that expectation gap.”
However Neil Patey, transaction support partner at Ernst & Young, does believe a shortage of credit is to blame. He says: “Since buyers can afford to pay less, we need vendor expectations to come down. But I would argue the real reason prices are coming down is because there is less debt available.”
This article was published in Scottish Business Insider’s Deals & Dealmakers Yearbook 2008, published in August 2008.