Ian Larkin, managing director at Lloyds TSB Commercial Finance, explores how management teams and private equity sponsors are increasingly leveraging their fixed and intangible assets to fund corporate transactions.
Many would argue that the health of UK deals remains volatile, in line with broader economic conditions. However, some parts of the M&A market are proving resilient against the low growth backdrop.
While the latest research from Experian Corpfin notes a 13 per cent fall in volumes in the UK for the year to May 2012 compared to the same period last year, a handful of large transactions boosted the total aggregate value by over 60 per cent.
The growth in deal size is encouraging, while the fall in volume could be viewed as modest given that the UK re-entered recession in the first quarter of 2012.
Despite a few large transactions boosting overall value, activity in the lower mid-market, in particular, has remained relatively robust and has largely held up the wider UK deals market in recent years.
The £10 to £100 million value bracket contains a number of high quality investment opportunities for private equity and corporate acquirers alike, and many industries remain ripe for consolidation, presenting significant opportunities for management teams with buy-out ambitions or targeted buy and build strategies.
Vendor and acquirers’ pricing expectations, too, are slowly re-aligning in this space, as companies have better visibility over profitability having had time to adjust to recessionary conditions.
As such, management teams are increasingly turning to the asset-based finance (ABF) product set, which includes asset based lending and invoice finance, to fund growth ambitions.
ABF allows businesses to leverage both their current and fixed assets, including receivables, stock, plant and machinery, and property, to release funds to support M&A deals.
This makes it attractive to businesses which are unable or reluctant to use funding from cash reserves alone and would prefer not to relinquish equity or take on additional senior debt.
It commonly incorporates fewer covenants than traditional leveraged debt and is often quicker to arrange so, as a result, is useful in a market where deal processes are taking longer to complete.
The lending process is naturally suited to firms with significant tangible asset bases, and finance providers of scale can commonly fund complex cross-border transactions, leveraging assets across varying geographies.
Invoice finance, which leverages the value of issued invoices, is typically used by younger firms with lesser growth track records to fund acquisitions.
Funding the future
One such business to successfully use this kind of finance to support a buy-out and position itself for growth is Encon Group, a £194 million turnover distributor of insulation protection products.
Established in 1981, the company is a supplier of insulation and fire protection products, dry lining, suspended ceilings and partitioning to all sectors of the construction industry from major contractors and house builders to specialist sub-contractors.
In November 2011, Lloyds TSB Commercial Finance provided a £35 million facility to fund the management buy-out of the company from its listed parent. Led by Managing Director Stuart Moore, who has been with the company for 23 years, the transaction secured the future of 500 employees.
We provided a package suited to the cyclical sector in which Encon operates, working with Lloyds Bank Wholesale Banking & Markets. By leveraging the value of the business’ sales ledger, the ABF facility provides an important source of flexible financial headroom to support future growth.
The company’s expansion strategy will concentrate on organic growth, executing plans to open new sites and increase its geographical reach, as well as expanding its partitioning and roofing product lines. It also plans to develop a range of sector-specific solutions to target selected customer segments. Take up of asset-based finance amongst private equity firms has also been steady in recent years.
These investors, by their nature, maximise the amount of sustainable debt in businesses and asset-based lending achieves this to the highest level by monetising core assets, making it attractive.
While the mid-market is currently holding up reasonably well, the medium-term outlook for the UK M&A recovery is uncertain. However, those deals that are completing are better quality and carefully considered, while the funding climate has adapted accordingly to low growth.