• Accelerating pace of M&A – There were 40 transactions of >£100m announced in 2023, with the pace increasing through the year.
• Smaller companies targeted – The activity was predominately in the smaller company space, with just three offers for FTSE 350 companies. This reflects the higher rate environment and reduced access to debt.
• Not refilling the hopper – There has been minimal IPO activity for the last two years. We believe this needs to be actively addressed.
Trends are clear – This note looks at the key trends during 2023, including sector activity, scale of premia and type of buyer. The key takeaway is that the pace of de-equitisation is relentless and will likely continue unless action is taken and impacts quickly. This is driven by the low UK valuations, which makes it an attractive hunting ground for acquirors and is a key factor behind the dearth of IPO activity.
• Smallcap focus – Of the 40 companies, there were none in the FTSE 100, three in the FTSE 250, 13 in the FTSE Smallcap, 20 on AIM, and four other.
• High premiums – The average premium was 50%, which reflects the depressed valuations of so many UK smaller companies. Six of the companies received a bump in the premium, which on average added an extra 12% to their offers.
• Increase in pace – There were three offers announced in 1Q, which was impacted by the surge in interest rates, combined with restriction of lending facilities. 4Q was the busiest quarter, with 18 announced offers.
• More financial buyers – Despite the change in rate environment, the majority (58%) of offers were from financial buyers, as well as the majority by value (71%). This reflects the ability to transact and attractive valuations. Corporate buyers were particularly active in 4Q, as the rate environment and economic outlook became clearer.
• Overseas appetite – There was greater activity from acquirors based outside the UK (55% by number and 64% by value).
• Tech in focus – Activity was spread across the sectors, with the Tech & Healthcare space seeing the highest level of interest (27% by number).
Reversing the trend:
Currently there are willing buyers (attracted by the valuations available and the probability of a successful conclusion) and willing sellers (due to fund outflows and scale of premia). In addition, the private markets are slower to adjust to tougher economic conditions, which means that acquisition multiples can be unrealistic.
The key driver behind this has been fund flows. There have been 30 consecutive months of outflows from UK funds, which inevitably drives selling pressure and impacts on valuation. There are many reasons for the fund outflows, including:
• The higher rate environment, resulting in changes to portfolio allocation.
• Pressure from the higher cost of living impacting ability to fund investments (eg SIPPs and ISAs) or encouraging withdrawals.
• Increase in tax on dividends and capital gains.
• Long-term withdrawal from equities by pensions and insurers.
• Internationalisation of portfolios.
• Limited interest from overseas investors.
The negative trend is self-fuelling, as the poor performance of UK equities makes them appear less attractive to fund managers and retail investors, the reduction in liquidity reduces appetite from overseas investors, and reduced capitalisation impacts on index weightings.
This all sounds very negative – but the reverse scenario can happen, and can happen quickly. It really needs a trigger to break the cycle. Increased fund flow would be the key driver, and this could come from:
• Increased appetite by retail investors (eg a British ISA, changes to CGT or dividend tax on UK shares).
• Allocation by pension funds and insurance companies, through government incentivisation and regulatory change to enable a greater focus on performance rather than risk.
• Increase in share buybacks, reflecting the low valuations and tax differential between capital gain and dividends.
• Appetite from overseas investors, if they perceived a material change in UK fund flows.
• Reduced cost of ownership and benefit of higher liquidity, through addressing the UK’s penal level of stamp duty vs other markets.
This could all be achieved without a change in the economic outlook, which would be the icing on the cake, with reducing inflation driving the prospect of lower rates and an improvement in economic activity. If we do see increased demand for UK equities, then valuations should improve materially, which would make an IPO a more attractive option. However, there are some deep-rooted issues in the UK regarding IPOs and the health of equity capital markets, which have material consequences for long-term economic growth. The fact that more UK companies of material size listed in the US rather than the UK in 2023 shows the extent of the issue.