As Europe continues to wait for economic stability to return, Milan Panchmatia considers how the UK’s vote to leave might affect equity markets.
While the exact impact of leaving the European Union is still unknown, it is clear that Brexit will affect British and European businesses in a number of ways. Initially, currency fluctuations and volatile conditions are likely to slow economic growth. Companies which rely on businesses on the other side of the channel will need to find ways to mitigate the effect of the break. The ensuing uncertainty means many will avoid making deals. But not all.
Private equity firms and volatile markets are a match made in heaven. Whereas corporations lack the agility and long-term planning to invest, private equity has the cash and the mindset needed to take advantage of changing conditions. This type of investment also enables businesses to benefit from private equity specialities: better operational efficiency, access to funding and growth. All key elements to emerging from a period of uncertainty in better shape.
The first nine months of 2016 saw the value of private equity deals in Europe drop by close to a quarter compared to the previous year, according to data provider PitchBook. Since the vote to leave on June 23, the value of deals in the UK and Ireland fell by 34%. While part of the drop in value is down to currency fluctuations, there is little doubt that dealmakers have been playing it safe.
On the other hand, analysts at PitchBook suggest that the repricing of businesses due a weakened pound could see a rise in interest in British firms. This is particularly enticing for private equity firms, which are not subject to the same short-term investment timeframes as other companies. This would allow them to take advantage of opportunities whilst weathering short-term instability.
In addition, while data suggests a slowdown in large deals for 2016 – only two for the first three quarters of the year vs. 19 over the same period in 2015 – investors continue to view private equity as a value proposition. A total of 41bn Euros were invested in 63 vehicles during the same period – a figure in line with what was invested last year. A sure sign that deals will be made.
Entering a period of greater certainty
The full impact of Brexit will take time to quantify, particularly in private equity markets as they deal with long-term, illiquid assets. What is clear is that private equity firms are in no position to sit back and wait years for stability to return. In fact, a recent report by Boston Consulting Group identified sectors such as industrial distribution, private medical clinics, aerospace manufacturing and recruitment as areas with potential post-Brexit opportunities.
In conclusion, a ‘wait and see’ approach was justified in the run up to the referendum. However, now that a path has been set, and we have some additional clarity from the UK Government on the type of Brexit they are going to run, private equity firms must work towards uncovering the right businesses to invest in. These firms are accustomed to balancing risks and a slowdown in corporate deals could well work in their favour as they seek to drive value in the midst of an economic storm.