By John Malpas
The final quarter of 1998 was not a good one for management buy-out (MBO) lawyers. John Penson, a buy-out specialist at Lovell White Durrant remembers one week when three deals he was working on collapsed – including the US venture capital house Kohlberg Kravis Roberts' (KKR) £1bn acquisition of paint supplier Herberts from German chemicals giant Hoechst.
Recent figures show that 1998 was a record year for the UK buy-out market. But there was a dramatic slump in the final quarter. Only 27 £10m-plus deals were struck during that period with a total value of £1.4bn, compared to 40 worth a total of £3.4bn during the preceding quarter.
"Turmoil in financial markets and mounting fears of recession killed off the appetite of all but a handful of banks for backing these transactions," says Mike Stevens, UK head of MBO services at KPMG Corporate Finance.
But things have started to change for the better in a remarkably short time. With the markets relatively settled after the round of US interest rate cuts and the successful launch of the euro, analysts are predicting renewed buy-out activity, especially on the Continent.
Earlier this month KKR confirmed plans to raise a multibillion dollar fund to target Europe. And this week it has emerged that 3iGroup, the UK's largest venture capital house, is negotiating the takeover of its main rival, Electra Investment Trust.
Both moves reflect the growing competition among US and UK equity houses to tap the European market – part of the rationale for the 3i move is Electra's strength on the Continent. Penson currently has 10 MBO deals on his books, which, he says, is pretty comparable to this time last year. He predicts the multimillion pound cross-border European deals that were a feature of the first half of 1998 will resurface this year.
Allen & Overy partner Susan Howard agrees. "The feeling is that the UK market is fairly mature and companies have gone down to their core businesses, whereas Europe is a few years behind the cycle and there is a lot of room for consolidation."
Hoechst is a case in point. At the same time as it unsuccessfully attempted to dispose of Herberts, it succeeded in selling its synthetic resins division Vianova Resins in a £250m deal.
Leading UK firms are well positioned to tap into this market – not just because they have been investing furiously in Europe, but also because the larger European buy-outs tend to be auctioned off in the City. But it is not all happening on the Continent. The UK market is also expected to recover reasonably quickly. As KPMG's Stevens points out, the large private equity houses have plenty of money to invest. And while that cash is stuck on deposit they are earning "ever declining rates of interest".
This predicament is persuading them to look more seriously at public-to-private transactions. In the past two years, public-to-private deals – where smaller quoted companies return to the private sector – have emerged as a new trend. So far there has been only a modest flow of such deals, but buy-out lawyers expect their number to increase as the market becomes more comfortable with them.
Chris Hale, at Travers Smith Braithwaite, has acted on several public-to-private transactions. He says the trend has been fuelled by a shift in the financial markets' structure which has led to investment being channelled into the larger listed companies at the expense of the smaller ones.
"The smaller companies are being neglected, making it more difficult for them to go to the market to raise capital, which is why they went public in the first place." Although public-to-privates are inherently more risky than standard management buy-outs, Hale expects a steady stream this year.
Ashurst Morris Crisp's Charlie Geffen agrees public-to-privates have a future "if they are structured in the right way". Like his competitors, he says it is pretty much business as usual at Ashursts' buy-out department. "Operations on the Continent and public-to-privates will continue," he reports. If the markets remain stable, and that is a big if, buy-out lawyers look set to have another good year.