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Articles by Steve

Steve Russell

Fund Manager

17 September 2021

What can they see that we can’t? Private equity bids for UK companies are soaring, while at the same time the UK stock market languishes at valuations well below US peers.

Private equity bids for UK companies are soaring, while at the same time the UK stock market languishes at valuations well below US peers.

Over the last decade the UK stock market has underperformed the US by over 60%¹ and now trades on a forward price-to-earnings ratio (PE) of just 13x compared to 21x for the S&P 500.² Over the same period private equity interest in snapping up UK businesses has grown dramatically, hitting a record of almost $64 billion this year, with most of it stemming from the US.³

There are lots of reasons for the UK market to have underperformed the US over recent years – Brexit for one, plus our initially poor response to covid-19. Most importantly the UK lacks the tech giants and momentum stocks that have driven much of US outperformance. Our Ocados and Games Workshops don’t quite cut the mustard in global index terms.

But private equity isn’t bidding for the tech leviathans. They are seeking out value wherever they can find it and with interest rates so low, ‘value’ has almost been redefined. As retail and index funds chase the US tech giants to ever higher valuations the so-called ‘smart’ money of private equity is looking elsewhere.

Today this means in the UK, where takeover volumes are running at over double the level in the US or Europe.⁴ So far there have been bids for John Laing, Ultra Electronics, G4S, McCarthy & Stone and Aggreko amongst others, plus of course Morrisons. A supermarket business supposedly so dull hardly anyone was interested when the share price was 60% lower⁵ before private equity came snuffling around.

What do all these companies have in common? They were too cheap. Too cheap for the kind of reliable free cashflows they offer bidders with access to vast amounts of money at ultra-low interest rates.

Yes, the UK economy has its issues, but look around the world and who doesn’t? What the UK does have is decent companies trading at significant discounts to global peers. Many with cashflow yields significantly higher than the cost of debt.

Almost nothing in the UK market is too big for private equity interest. Maybe it is no coincidence the 34% valuation discount between the UK market and the rest of the world roughly matches the average 40% bid premium private equity has paid this year.⁶

With over $2 trillion⁷ of cash to invest, the money will be starting to burn a hole in private equity’s deep pockets. If Morrisons is bought for over £7 billion on a PE of 20x (12.5x pre bid), then why not Sainsbury’s (currently valued at less than Morrisons and on a PE of 13x)⁸ or even Tesco (current value £20 billion, but also on just 13x)⁹?

Today Ruffer holds half our global equity exposure in the UK, the highest percentage for over a decade. Some of this is in banks and energy, not the obvious candidates for private equity bids, but more than half is in medium and smaller companies. Of course, we don’t invest specifically for M&A activity, but it seems others are beginning to share our definition of value.

#growth, #value

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