All quiet on the Northern front?

Real Deals, 18 December 2003

The UK mid-market has been getting quieter, and the economy is making life difficult for smaller companies. But, armed with new funds, private equity funds are optimistic that things will pick up

It's often been said in London that they do things differently up North, but in terms of the buyout market there's little difference. On the topmost side of that imaginary line between the Mersey and the Wash, deal activity has seen the same slump as the South, and everywhere else for that matter.

In the twin business centres of Leeds and Manchester, some deal-doers are now claiming to see signs of recovery, though others remain phlegmatic. What is certain is that the North is increasingly confident of its own abilities to originate and handle deals of a size and sophistication that would once have been the preserve of the City.

The North's biggest homegrown deal of 2003 was the 142 million institutional buyout of the Isle of Man Steam Packet Company, led by the Manchester office of Montagu Private Equity. The 173-year-old company was put up for disposal by Bermuda-registered Sea Containers, as part of a wide-ranging refinancing programme. Montagu in Manchester also backed the 70 million IBO of North Yorkshire-based Marlow Foods from pharmaceutical giant AstraZeneca in May, with debt from Montagu's former parent, HSBC.

Simon Pooler, director of Montagu's Manchester office, says the market is a steady one for buyouts. "The pipeline seems right, and it's a long term good market to buy in," he says. "Conditions are relatively neutral – they're not in boom, they're not in bust, they're just steady. The Northern companies are providing us with good quality deal flow. Non-core divisions of larger companies going through some sort of change tend to be the ones prompting most of our deals."

Debt for the Steam Packet deal was provided by Bank of Scotland Corporate Banking in Manchester. The package of 109 million is believed to be the largest sole bank underwrite to be completed outside of London for several years. "I think we were the only bank outside London who were quoting on the Steam Packet transaction," says Alastair Donald, Manchester-based director of structured finance. "It was a big auction process, and it is nice that it was an all North West based transaction. If larger transactions always disappear into London, the local professional community simply won't have the opportunity to earn their keep."

In July, the Bank of Scotland merged its structured finance teams in Manchester, Leeds and Newcastle to create one pan-Northern team headed by Donald. The buyouts market remains difficult, Donald says, although the team is currently working on two or three similarly-sized transactions. "There's no immediate signs of any huge change in activity," he says. "We are seeing the Leeds side of our business somewhat busier than Manchester just now, but it does tend to be cyclical."

Looking up
Other players do see signs of market recovery, however. "I think there is generally an upturn, though I wouldn't say it's dramatic," says Tim Edwards, director of Leeds boutique McInnes Corporate Finance. McInnes has advised on a string of deals in 2003, including the 3.75m MBO at Manchester-based Didsbury Engineering, led by Milton Keynes-based private equity network Hotbed Ltd; and the well publicised return of Yorkshire brewery T&R Theakston to its founding family.

"There's more opportunities knocking around, and more people looking at those transactions, whether that's vendors or acquirers," Edwards adds. "There's all the private equity money out there, and they're all very keen to back good quality companies. The problem they've got is there aren't many good quality transactions about."

Directors at 3i, the stalwart of the regional market, do see reasons to be cheerful. "We're very happy with our performance in the last year," says Andrew Garside, Leeds-based director for Yorkshire and the North East. "The market hasn't been great in terms of numbers of deals completed, but we've done very well."

The Leeds office completed two buyouts in the past year – the 56m buyout of Derbyshire-based construction equipment group Extec alongside 3i's Birmingham office; and the 10m buyout from Rolls Royce of VMS Group, a Gateshead-based company providing messaging systems for road and rail users.

The Manchester office, led by Mike Robins, meanwhile backed the 22m MBO of Rotherham-based Leger Holidays from MyTravel plc, a deal completed in just six weeks. "The market at present is definitely picking up and I'm pretty confident we'll do more than two deals in the next 12 months," Garside says. "In the last two years when the market has been quiet across the North, we've probably met over 200 companies and built relationships. That direct marketing has also started to produce leads and ideas that's increasing the number of opportunities for us. We've not just relied on the quiet market, we've gone out there to shake some trees."

All mouth and trousers
Most observers reckon that talk of a return to the activity levels of a few years ago is premature. "There's plenty of talk but a lack of deals," says Robin Johnson, corporate partner at Eversheds in Leeds. "We have a number of deals on the case, but whether any are going to get to fruition is another matter. You do need some of these to complete to get the market balanced right."

The first half of 2003 was particularly quiet, says Grant Berry, Northern regional director for LDC. "In 2002 we were very busy as an office – we completed three deals out of Manchester, and two out of Leeds – but it all seemed to stop at the beginning of 2003. It's only since June or July things started to pick up again," he notes. "There were about three or four quite chunky opportunities that we looked at, and the pipeline started to build up to normal levels."

In October, LDC invested 11m in the 60m take-private of fashion supplier and retailer Stirling Group. The Manchester-based group includes three businesses: a lingerie supplier to Marks & Spencer; a Far East sourcing business; and fashion brands including sports label Voodoo Dolls, which LDC plans to develop as a major global brand.

Equity investors are having to take a more creative approach to structuring and managing their buyouts, Berry notes. "The days are long gone when you undertake a transaction and immediately disappear off to find the next deal," he says. "If you think the exit is going to drive itself and expect to make a significant amount of money, those days are long gone. We are having to take some fairly creative portfolio management techniques to get some early wins."

The Stirling deal closely followed LDC's investment in and rapid realisation of Merseyside clothing retailer Ethel Austin. LDC invested 11m in the 55m IBO in June 2002, and after a rapid rise in profits engineered a capital restructuring which provided a capital gain of 30m while retaining a majority stake. "It was a very very clear example of a management team that became totally energised as a result of owning their own business," Berry says.

Also in the modern version of Manchester's traditional rag trade, Isis Equity Partners backed the 20m MBO of Americana, the company behind fashion brands Bench and Hooch. The deal was the first for Isis' newly opened Manchester office - a move that, in the words of one city advisor, "has given everyone a kick up the backside".

"We're very happy with how we've established ourselves in the market, and we have to keep working very hard to maintain that and develop our position further," says investment director Andy Gregory. "It is possible to come in and establish yourself in a new marketplace. The names of some of the team from round the country were known in the marketplace, and I've worked myself in this marketplace for 12 years, so as individuals we weren't coming in cold."

Private moves
The Stirling deal was also significant in marking the growth of regional public-to-private transactions, says Darryl Cooke, private equity partner at Addleshaw Goddards in Manchester, who advised LDC on the deal. "That's probably been a new trend for the region - historically, PTPs have been done more in London," he says.

Probably the most unusual take-private of the year was that of early-stage technology investor Axiomlab, which floated on AIM in August 2000. "That was a scenario where the stock market had fallen out of love with a business that was always going to be a very long term investment strategy," says Phil Adams of Altium Capital in Manchester, who advised on the deal. "It came to the point where although the institutions were quite supportive, they could understand the logic of taking it off the stock market."

Axiomlab used its own cash reserves to buy itself out, with shareholders offered the chance to either receive their proportion of net cash (at 0.85p per share, compared with 5p at flotation), or roll through their investment into the private vehicle. "It gave shareholders that flexibility, and a lot elected to go into the private vehicle," Adams says. "It fitted with the business model of the company - the ability to do it by that route was that it was able to use the cash it had."

Altium is currently working on a "very big" local MBO, Adams adds. "There are opportunities out there. I think Manchester is very well served from the VC point of view, but there hasn't been a huge volume of deals where VCs are investing," he says.

Small wonders
Despite the shortage of headline deals, the lower end of the buyout market has continued to enjoy reasonable volume, says Roger Powell, Leeds-based regional director of corporate & structured finance for the Royal Bank of Scotland. "Where volumes have been pretty strong, it should continue for the next year," he says. "It probably reflects there's been a narrowing in the gap between vendors' price expectations and what a management team are going to buy the business for. There's been quite a few deals which banks have done without involving VCs."

Buyouts at the lower end of the market are increasingly being done with debt only, helped by increasingly sophisticated structured debt facilities and low interest rates. "Over the last two years, this firm has made its money in buyouts from doing relatively simple debt-only buyouts," says Ian Marwood, partner at Grant Thornton Corporate Finance North in Leeds. "Lots of deals in the marketplace were relatively small, and a lot of them were in traditional industries. I think VC interest in the traditional moderate growth industries is unlikely to return in the short term."

Marwood's team is currently working on debt-only buyouts worth 17m and 13m. "You can do quite substantial deals as long as you have a vendor who's willing to take some deferral of consideration," he notes. "It's not just the fact that VCs aren't interested that drive you to adopt these structures. They are very good in many circumstances and meet the aspirations of management teams. Even if there was VC interest in some of these traditional businesses again, I think you wouldn't necessarily find the management teams rushing to invite the VCs in."

Company owners are taking a more realising view on pricing, says Tim Eve, partner at Manchester advisors TMG. "Quite a lot are taking on small transactions that don't really fit into the VC arena, and are taking a deferred option. That can be up to 5-7m because the equity requirement is minimal" he says.

"The funds are there for the right deals. They've never gone away, but there is an element of caution still around. What's happened is quality transactions are now coming through. People have been waiting for a boom market, but that's not going to occur as it did in the past. It will come back over a period of years but people will have to be realistic to get fair economic value for their business."

Equity funders at the lower end of the market are seeing plenty of opportunity, however. "Our view is that it's heading upwards quite positively really," says Phil Cammerman, managing director of Yorkshire Fund Managers, which focuses on investments of up to 5m. "We're looking at quite a lot of deals in Yorkshire and the North East, including a couple of buyouts which are quite significant proposals in terms of equity. I have to say it's better now than it's been for a year or 18 months. We have funds to invest which is really good and the general feel we have from our people on the ground in Sheffield, Leeds and Manchester is that things are beginning to move."

Among other funds, YFM manages the government-backed Yorkshire and the Humber Regional Venture Capital Fund, which in October invested an MBI at Harrogate catering equipment business Newscan. YFM also backed a 4m MBO at Hull-based Harlands Labels in a joint investment with Bridges Community Ventures. "We are the people with money to invest, and that attracts the potential buyouts out of the woodwork," Cammerman notes.


A tale of two cities
Just 40 miles apart across the Pennines, Manchester and Leeds are the twin hubs of business and cultural life in the North. There's a huge amount of regional pride tied up in the question of which is really the capital of the North, with both having fair claim in different areas. But in private equity, the Lancastrian city has the clear lead, with two or three times as many VC houses as its Yorkshire rival.

Many firms pool their resources across both sides, giving a stronger overall community. "I cannot think of a transaction where we've had to go outside of our local communities for advice, which I think speaks volumes for the quality of people on the ground," says LDC's Grant Berry. "Many of the local advisors have been doing transactions in the tens of millions for many years. Very big deals are rare, but there are plenty in the 25-100m range and those are for the regions decent sized transactions."

Manchester is particularly strong in the mid-market, says Darryl Cooke, private equity partner at Addleshaw Goddard. "I think it's interesting how the North West market is developing," he notes. "Manchester is a good centre for mid-market deals, but that doesn't mean they're just servicing the North West market." In March, Addleshaw advised the Manchester office of Barclays Private Equity on the 44m MBO of jewellery supplier DCK Concessions, based in Essex.

There are signs that Manchester is draining the Leeds market of some vitality, with a number of major investment houses concentrating their resource to the west. "It's clear there are less VCs in Leeds now than there were a few years ago," says Ian Marwood of Grant Thornton in Leeds. "I'm not a believer in necessarily running a business from one location to cover the whole of the North. If you base yourself in one location, everything naturally gravitates to that city."

Tim Edwards of McInnes Corporate Finance believes the shift is an issue. "It is a little bit worrying there have been people pulling out, although the people who have retrenched haven't been significant deal doers here anyway," he says. "My own view is it's always a cyclical thing. I would envisage in a couple of years if the market comes back up there will be people back here trying to open businesses."

Andrew Garside of 3i also argues for being on the ground on both sides. "Personally, I think it's quite hard to be consistently competitive unless you have a local presence. It's not impossible, because VCs from outside the Leeds area do get introduced to good deals," he says.

3i did however close its Newcastle office in October 2001, leaving businesses in the North East looking to Leeds or Edinburgh. "From a market perspective, it did make sense to have an office in Newcastle," Garside says. "Having a presence in a city is always a compromise between market presence and resource spread. We just thought it was better to have extra critical mass in Leeds, but there's no doubt there's critical mass in the two markets to support separate offices."