Landscape of Fundraising
The current market environment allows for private equity funds to be raised in a short period of time. Consequently, fundraising is not among the great challenges of today. However, the panel members highlighted that the market for M&A transactions is more challenging. In order to fulfill the same or similar return expectations, it is no longer advisable to focus on financials, financial engineering and multiple arbitrage only. Instead, according to a participant of the M&A panel, it is now necessary to define the future strategy of the company more precisely and to focus on active value creation.
Sellers’ Market impacts Return Expectations
The M&A market continues to be a sellers’ market. The valuation multiples are increasing continuously, which consequently has a significant impact on return expectations. According to the prevailing opinion of the panel members, the M&A market in Germany as well as in the United Kingdom is heated but not overheated. However, there is an immense volume of equity and debt capital on the one side, and only a limited number of high quality assets on the other side. This phenomena causes an increase in prices and leverage levels. The panel members expect a cooling down of the economy in not so distant future which has to be factored into current investment strategies.
Strategic Investors vs. Private Equity in Auctions
The participants of the M&A panel coincided that a strategic investor cannot automatically be defeated by a PE investor in an auction. On the contrary, the strategic investor can always outplay a PE investor since the latter by nature will not have the synergistic potential of a strategic investor. Furthermore, if the strategic investor is listed on the stock market, capital is available to him more easily and he can benefit from current low return expectations. Private equity sponsors are also no longer at an advantage when it comes to management incentivisation through an exit: As one panelist explained, strategic investors have developed synthetic exit-option concepts, giving the management teams essentially the same economics as a PE investor.
In regards to auctions, auction processes, especially in the United Kingdom, are becoming shorter and shorter. As a consequence, investors need to be prepared even better in the near future. In the United Kingdom, but also in mainland Europe, long term investors (8-10 years) with a completely different return profile, such as family offices, wealth funds, pension funds and insurers, now directly compete in auctions. Initially, this so-called “patient capital” used to participate through funds or co-investments only.
More Investors from non-EU countries are investing in Europe
The members of the M&A panel consented that Asian investors, and in particular investors from China, have gained significant experience and are now competing very successfully in auction processes in Europe. It remains to be seen if foreign investment control restrictions will increase and thus limit non-European investors in their M&A aspirations.
Warranty & Indemnity Insurances
In the vast majority of M&A transactions the parties are using Warranty & Indemnity insurances to cover potential warranty claims and claims for tax indemnification. The market for Warranty & Indemnity insurances appears to be more sophisticated in the United Kingdom compared to the rest of Europe. Policy holders in the United Kingdom have the option to discard knowledge qualifiers and materiality qualifiers so that, for an extra premium, the warranty will be applied vis-a-vis the insurance company as if no such qualifiers exist. Whether this option will find its way into the German M&A market and, as a consequence, shift risks in M&A transactions significantly, remains to be seen.
See the video to this panel discussion here.