The rise of the mega-deal

With many major companies’ share prices eroded by a turbulent few years, the mega-funds are circling and recent deals suggest activity is increasing. But big isn’t always bad – and the rise in mega-deals may produce opportunities for other, smaller, players too

So many of the UK’s businesses are currently vulnerable to takeover that one former City minister has likened market conditions to a car boot sale. 

A look at the number of listed companies on the brink of being taken private, and with so many of them big names available at bargain prices, it’s hard to argue with the comparison.

In the past few months, retail giants Asda and Morrisons have joined the growing list of UK PLCs that have become targets for private equity buyouts. 

Morrisons found itself at the centre of an aggressive bidding war between rival private equity companies intent on snapping up a supermarket stalwart that was carrying a depressed share price following years of Brexit negotiations and the pandemic.

The UK is hot right now for private equity mega-funds intent on snapping up other household names similarly affected by Brexit and Covid.

Further evidence can be found in the fact that the number of listed companies in the UK has fallen by around 40% compared with 2008, according to a review of listings by Lord Jonathan Hill, the former EU financial services commissioner.

The UK government is now consulting on a series of recommendations put forward by Lord Hill’s UK Listing Review, which could further fuel PE activity. 

These include lowering the free float limit to 10%; reducing regulation around prospectus requirements; allowing dual-class share structures; and changing reverse takeover rules to encourage more SPAC listings. 

All of these measures are likely to encourage more PE-backed companies to tap the public markets.

Big isn’t necessarily bad

While the prospect of more mega-funds, and their mega-deals, might sound hostile, such behemoths need not necessarily be considered as a wholly bad development. 

There are straightforward reasons why mega-funds exist, not least their ability to give more access to a larger number of investors otherwise precluded from the private equity space.

David Crosland, Guernsey Investment Funds Partner at law firm Carey Olsen, points out: “Private equity and other alternative investments have been the preserve of institutional investors, but there is a push among private investors to get into the class.”

Add to this a desire from UK government to make it easier for the UK’s billions of pounds in defined contribution assets to be put into private equity and other illiquids, and there is a huge amount of dry powder waiting to be put to work – much of which looks set to find its way onto the books of the mega-funds.

Crosland says: “Private banks are putting together vehicles to allow investors to invest in private equity. They can’t sell [retail customers] a fund they’ve never heard of. Instead, they go to the big names – Blackstone, Apax – which attracts even more money for the mega-funds.”

Mega-funds are good news for limited partners (LPs), too. Robin de Gruchy-Wilson, Managing Director at Oakbridge Fund Services, says one of the most important benefits of investing in these enormous funds is the reduced number of general partner (GP) relationships needed by LPs. 

“For LPs particularly, the main attraction is the reduced number of GP relationships that they have,” he says. “If you are an investor into a number of funds across lots of assets, then it is time-consuming and costly to track everything.”

And for firms able to secure a contract to provide mega-funds with legal services or administration, they are effectively on a golden ticket.

Crosland adds: “If you are a service provider or administrator and you have one of these big guys as your clients, it’s fantastic. Some of the law firms are rising or falling depending on the fortunes of the clients they secured 30 years ago. 

“If they were the lead lawyers for Blackstone, for example, they will have built almost their entire business around that single client because they have been so successful.”

And success is indisputable, with mega-funds able to put their performance where their clout is.

According to private equity data provider Pitchbook, mega-fund internal rates of return (IRR) bounced back more quickly than smaller fund IRRs after Q2 2020. 

Importantly, the larger portfolio assets of mega-funds may have been more resilient to the effects of the pandemic and are more likely to be marked-to-market against public company comps, which means these funds shared in the stock markets’ rapid recovery.

Crosland says: “The guys raising lots of money are those with a long track record of producing good returns to investors. 

The bottom line is that no one will give you their money unless you have been shown to be successful.”

Success feeds success

This, of course, creates a virtuous circle where the mega-funds attract more investors because of strong performance. This in turn allows them to access deals outside the reach of those funds with less capital. And so the mega-fund gravy train continues.

All this dominance smacks of a world in which competition is stifled. Indeed, Crosland says, there is always room for more players that can generate opportunities among service providers that have not been lucky enough to get a contract with a mega-fund.

But this multibillion-dollar world is not for everyone. Clearly there are investors looking for smaller deals that the likes of KKR or Blackstone wouldn’t get out of bed for. 

Fortunately, says Crosland, there is evidence to suggest that the bright young things employed by the mega-funds harbour enough ambition to spin out their own smaller venture capital and private equity offerings catering to the smaller end of the market. 

“The good thing about the mega-funds is they are often full of entrepreneurial and ambitious people, so they are constantly spinning out individuals who want to [run funds] for themselves,” he says. 

“So, the big firms have teams starting their own thing and launching their own funds, which is good for the wider market.”

Mega-funds are not a new feature of the private equity world, but they are getting bigger all the time and their market dominance is growing, too. 

So far, the opportunities outweigh the negatives – but regulators need to keep a close eye on developments to ensure no-one is operating in the shadows cast by colossal fund juggernauts.