Trends Driving Deal Flow in Business Services

On today's podcast, we’re joined by two guests from Clearwater International. Marcus Archer, managing partner and head of private equity, provides insights into valuation trends in European private equity, and Rob Burden, a partner at Clearwater International, who discusses recent activity in the Business Services space across Europe. Dealcast is presented by Mergermarket and SS&C Intralinks.

In this episode, you’ll learn about:

• Trends driving deal flow in Business Services in Europe
• Buy-side strategies and the most sought-after niches
• Challenges with funding transactions
• Why firms that provide mission-critical services are the most attractive opportunities
• The most promising markets in Europe
• Outlook for Business Services in the next 12 months

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Transcript

[MUSIC PLAYING] JULIE-ANNA NEEDHAM: Welcome to Dealcast, the weekly M&A podcast presented to you by Mergermarket and SS&C Intralinks. This special episode is in partnership with Clearwater International. I'm Julie-Anna Needham, a journalist who's been covering M&A for a decade. In this episode, we're looking at valuation trends in European private equity and then focusing on one sector, business services.

We'll explore the findings of a multiples heatmap produced by Clearwater International and Unquote. I'm joined by Marcus Archer, who is the managing partner for the UK and head of private equity, and by Rob Burden, who's a partner and European head of business services, both at Clearwater International.

Hi, Marcus. Hi, Rob. Thanks very much for joining me today.

MARCUS ARCHER: Morning.

ROB BURDEN: Morning.

JULIE-ANNA NEEDHAM: So to begin with, Marcus, can I ask you to just explain a bit more about the multiples heat map, please?

MARCUS ARCHER: Yeah, sure. So with Clearwater national in collaboration with Unquote produced the multiples heat map, which identifies major themes, driving EV to EBITDA multiples in Europe private equity deals. The objective is to help private equity understand themes and trends across regions and sectors, and the intention is to help private equity companies in Europe make better investment decisions based on the data that we produce.

JULIE-ANNA NEEDHAM: And staying with you, Marcus, can we look at deal volume across Europe in 2022 so far? It looks like deal volume performance in the first half was strong by any normal standards, and far above the average of recent years. Can you tell us more about the very challenging dealmaking environment for the first half of this year, please?

MARCUS ARCHER: Absolutely. Yeah, the data does show deal volumes for all of 2021 and the first half of 2022 have been at high levels and seem to be maintained despite some of the turbulent waters which are starting to appear. A few themes are coming through for private equity in these more challenging times.

The first one is we're clearly seeing a flight to quality and a flight towards attractive and robust end markets. And a lot of the private equity funds have become very clear in the markets in which they want to invest and running very hard assets to give them exposure to those markets.

Themes around ESG and tech enablement are prevailing across all sectors. And any business which has got those characteristics is very sought after by most of the mid-market and large cap funds. The key new due diligence themes appeared in the last quarter is all around resilience.

And private equity funds are spending an awful lot more time looking at business plans, looking at numbers, looking at growth plans, running scenarios to try and do the best they can to see how resilient businesses may be and what may come over the next 12 to 24, 36 months. And the reality is nobody really knows what's going to come, and what's going to come is going to be different to last economic cycles, but that resilience, due diligence is meaning deals are taking longer.

The final point which has come through in the first half is availability of debt. And what we found is, traditionally, running stable debt process to underpin sale mandates was something that market's been doing for a number of years now. And what we found more recently is that's become harder and harder to do, and the banks and debt funds have become much more sponsor specific in terms of the debt packages they're putting forward.

So our debt team are working very closely with specific sponsors at the right time in a deal to raise debt packages rather than raising more generic packages which can port across to multiple funds. So there's a few things that people are using to adapt to the changing climate.

JULIE-ANNA NEEDHAM: And do those debt packages very much depend on the resilience of the business in question?

MARCUS ARCHER: Yeah. I think there's two factors. One will be the resilience of the business itself, which goes into the markets and the strength of the management team, their track record. The other bit will be more sponsor specific in the specific private equity fund track record and relationship with particular banks.

So I think banks are looking at both things to give them confidence that they're making a good lending decision.

JULIE-ANNA NEEDHAM: Great. Thank you. And Rob, coming to you, what are the major trends driving deal flow in the business services space, and how is that deal flow evolved so far in 2022?

ROB BURDEN: Sure. Well, it's been quite an interesting period, actually. As Marcus says, across the piece and certainly within business services, deal volumes have been maintained. And it's been an interesting start to the year despite some challenges.

So I think there's some overarching themes that drive an activity within business services, whether that's the war on talent, which has been a feature for many years, partly long-term skill shortages within the UK and within certain geographies, probably accelerated by Brexit and migration of labor and what that means for certainly the UK economy.

JULIE-ANNA NEEDHAM: And could you just outline what those skills shortages are?

ROB BURDEN: Yeah, of course. Of course. Well, I guess the best example is what you might call jobs for the future, so it's investment in IT and digital skills, in coding, in the creative spaces, those types of industries where there's increasing demand within the UK labor force. But perhaps we haven't invested as early as we might have done in developing that talent in early years.

It's why you see a lot of private equity investment at the moment going into those sectors, whether that's apprenticeships, corporate training, e-learning, upskilling, which goes to address some of those challenges. I guess some of the other factors driving deal flow.

Obviously, we've got some large inflationary pressures rippling through Europe at the moment as a consequence of the Ukraine crisis, digital disruption, digital transformation, tech enablement themes that Marcus referred to earlier on, and, of course, ESG, which presents itself in a number of different ways, where that's kind of decarbonization.

So any businesses providing services to address those kind of megatrends and those themes are attractive in the eyes of investors and highly prized.

JULIE-ANNA NEEDHAM: Rob, staying with you, what are the main buy side strategies or motivations that you're seeing? And which are the particular niches or subsectors that are sought after?

ROB BURDEN: Yeah. I think there's a flight of quality, which is a little bit of a cliche, but certainly what we're seeing at the coalface in terms of interest from private equity. And then really focusing on quality of earnings, visibility of earnings, services that are providing mission-critical services to their clients, and really that sort of robust, resilient pockets of the market, whether that's compliance-driven regulation-driven services.

So in terms of specific niches and subsectors within business services where we're seeing activity, the tech space remains extremely active, whether that's fire and life safety, environmental services, building safety compliance, those types of assets. Lots of interest from investors in that part of the market.

Professional services, legal services, accountancy services. Again, presenting those compliance-driven services for their clients, repeat revenues, high quality of earnings. And then within human capital, that's the area that we're seeing most interest would be the upskilling training agenda, whether that's corporate training, the apprenticeship space adult learning, especially with some kind of digital wraparound delivery model through kind of an LMS or early learning platform, especially where they're focused on those sectors of interest.

The jobs for the future that I mentioned earlier, the digital skills, the IT skills which are going to be increasing demand. And there'd be maybe three subsectors that I'd see and expect plenty of activity in the 6 months and 12 months to come.

JULIE-ANNA NEEDHAM: Thank you. And can we look at some of the European geographies and which subsectors within those geographies or countries which are looking most promising and why-- you mentioned about the UK earlier-- but what about the wider European region?

ROB BURDEN: Yeah. I think the data shows that multiples of continue to hold up and perform strongly across the piece, probably call out-- two that are particularly hot right now being the Nordics and the UK as the data shows. And without sounding too much like a stuck record, I think subsector-wise, we'd expect a continuation of what I've just said.

So tech compliance services, professional services anything tech-enabled is where we really expect the activity to continue and that to be more of a driver of investment as opposed to a specific geography.

JULIE-ANNA NEEDHAM: And Rob, are you seeing any strategics in other sectors looking to acquire companies in the business services space, such as a major logistics firm wanting to buy in its digital training capacity?

ROB BURDEN: Yes. It's an interesting observation. It's not something that we're seeing right now in the space where people are looking to acquire expertise and deploy that in-house. Partly that's because those businesses are often servicing multiple clients, which include their competitors. There's clearly a bit of a channel conflict there.

Not to say it doesn't happen, but it's quite rare that it does. In our experience, organizations tend to want to work with third-party experts, getting that great service that delivers their needs and scaling accordingly rather than acquiring and bringing that house. Just a more efficient use of capital.

JULIE-ANNA NEEDHAM: Great. Thank you. And Marcus, bringing you back in here. How are private equity acquirers responding to this much tighter and uncertain economic climate? We spoke a bit earlier about debt funding, but do you anticipate seeing any issues with funding transactions and any potentially not going ahead because of funding issues?

MARCUS ARCHER: Well, there's two sides to the funding. I think just out by one being the equity side of it and one being the debt side of it. If we look across the mid-market and indeed the whole of the private equity spectrum, there's still an awful lot of dry powder sitting in those funds which needs to be deployed.

What is happening is linked to what Rob said and I said earlier on, flight to quality. And there's definitely thematic investing around particular markets where the macros are strong and they look like robust and growth markets for the future. So I think private equity funds are reacting to the tighter climb up by being more specific and more focused in the areas they do and don't want to invest, which is making the market pretty polarized.

So anything around tech, tech-enabled services, pharma life sciences, renewables, et cetera, are pretty resilient markets. They're are here to stay. And a lot of them got government backing and infrastructure fund backing to execute on the strategies. The debt markets is where the squeeze might start to hit funds a little bit more.

So we're seeing funds over equity funding deals to protect the balance sheet of the company post-investment if there are some tougher times on trading. And as I said a bit earlier on, the funds are being a lot more specific about sponsors they're prepared to lend to or not and being very fussy about lending to some sectors over others.

So we've particularly seen raising debt, for example, in recruitment companies has got pretty difficult because they're known to be very cyclical markets in economic cycles. Raising debt for anything consumer focused is inevitably pretty challenging as consumer spending power and the squeeze starts to hit people's back pockets. So lending to B2C businesses becomes harder.

But generally, B2B businesses, tech-enabled service businesses, those resilient markets, the appetite for lenders to support private equity transactions where the sponsors have got a good and proven track record and relationship with the funds-- that money is available, but that's I think where the squeeze that will follow is the availability of debt to raise funds rather than the availability of equity.

JULIE-ANNA NEEDHAM: And Rob, what's the outlook for business services? Do you think that assets are overvalued or do you think they could go higher still?

ROB BURDEN: I think it's very possible that valuations could continue to increase. I think that's partly driven by the flight's quality that we've talked about throughout this podcast. I think there'll be lots of competition, lots of interest from private equity for those businesses, those platforms that are capable of consolidating their own sectors in those resilient pockets of the market where there are good quality of earnings, good visibility of revenues, and top compliance drivers to those services.

I don't think by any stretch we're going to see volumes of deals disappear completely. I don't think we're going to see an acceleration of volumes. I think it will largely continue in terms of a lot of volumes that we've seen in recent years, partly driven by the abundance of private equity capital available to invest in the sector, which is driving activity in and of itself, partly due to the fragmented nature of the end markets within business services.

JULIE-ANNA NEEDHAM: So Marcus, just bringing you back in for a final question. What are you hearing from your clients? There are so many different macroeconomic and geopolitical factors at play in 2022. What do you anticipate seeing in the private equity space for the remainder of the year?

MARCUS ARCHER: Two sets of clients that we would have, one being owner managed and one being private equity funds. The owner-managed clients that we have in the main across resilient sectors continue to see strong trading, and the KPIs are still pointing in the right direction for the remainder of this year.

Some of our clients are quite surprised they're seeing such strong trading when there is this uncertainty around. And it's such a complex situation at the moment. I don't think anybody really knows what the answer's going to be and how to navigate it. And then from our private equity client's perspective, they do have dry powder to deploy.

They are already deciding which sectors they want to invest in next year, and they're already identifying the businesses that are going to come up in those sectors that they want to invest in. So conviction investing is a phrase we've used a few times on these podcasts, and that does continue where people are spending time ahead of a process to get themselves into a good position.

The question for a lot of people on the exit side will be, is now the right time to bring a business to market? Nobody wants a failed sale process. So part of our job as advisors is to work with our clients to think about a particular business, a particular market, a particular business model, think ahead of time around the resilience of the business and what the business plan might look like for the next 12 to 24 months.

Because we know that buyers, particularly private equity funds, are doing a bit of flow work, more work around that resilience and scenario planning for what they might need to do with the business to help navigate what lies ahead over the next period of time.

JULIE-ANNA NEEDHAM: Great. Thank you. And that brings us back nicely to the two themes we've heard all the way through, which is a focus on quality and resilience. Rob and Marcus, thanks very much.

[MUSIC PLAYING]

That was Marcus Archer, managing partner and head of private equity for the U.K., and Rob Burden, who's a partner and European head of business services, both at Clearwater International. Thanks for listening to this week's episode of Dealcast presented by Mergermarket and SS&C Intralinks. This special episode is in partnership with Clearwater International.

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