M&A bounced back quickly from COVID-19. Deal volumes returned to pre-coronavirus levels in H2 2020; 170 deals were completed in H1 2021, and a further 22 in H2 as of mid-August. A full year forecast of over 300 deals is a possibility. It might be tempting to think that everything is going back to the way it was before coronavirus, but it's becoming clear that how investors approach these deals is changing. So, it's vital to know what they're looking for, and stay up to date on changing trends in business value.
Figure 1 - value and volume of UK buyouts 2018-2021 H1
To help you navigate this active landscape and define value drivers, we asked mid-market private equity three major questions: how are you assessing business value, which factors are impacting your assessments, and where are you investing?
We've analysed their answers and identified the key points to share with you. The results indicated seven principal sentiments that are guiding investors' decisions now and in the near future.
It's striking that almost all our respondents agreed about the impact of coronavirus. 95% of our respondents said coronavirus had at least 'some impact' on their existing portfolio and 100% said it had at least 'some impact' on new investments. In both cases at least 30% said that the impact was 'significant'. Most respondents commented that the current circumstances have increased their focus on the strength and resilience of business models, as well as underlying earnings and the normalisation of adjustments.
The pandemic and attitudes to business model resilience is likely to have influenced investors' responses on the sectors expected to provide the highest growth in valuation multiples.
Unsurprisingly, TMT and healthcare received the highest rankings, and were expected to experience the highest valuation multiple growth (not necessarily highest multiples overall). Financial services, skills and training, support services and consumer markets were clustered together, but appeared markedly lower in the rankings. Industrials, automotive and real estate were considered most likely to see less acceleration of multiples.
Figure 2 - when considering the allocation of your time assessing a potential investment’s value, what % of this time is spent on the following:
Respondents predict a steady increase in the time they allocate to assessing ESG, data and information, and technology. After rising from 28% to 40% over the last three years, a slight increase, to 43%, is anticipated in the next three years. This indicates that the current interest in these factors is now strongly embedded in their considerations.
A strong 61% majority of respondents told us that 'wider stakeholder sentiment' is important to them: from pension funds to banking institutions allocating funds to sustainability or impact investing. As the profile of ESG rises on everyone's agenda we'll also see a gradual shift in its treatment by investors.
Figure 3 - thinking about ESG factors specifically, which factor do you consider has the greatest impact on changing your approach to ESG initiatives?
Figure 4 - do you consider your ESG approach to be a differentiator for you in respect of?
Roland Cohen, Chairman of the Global Steering Group for Impact Investing has described the focus of 21st century investors as “risk, return and impact". This suggests that sustainability is increasingly important in investor rationales. And, ESG's significance also stretches beyond the relatively modest yet emerging UK landscape of private equity investors when we look at the growing volume of capital in European impact investing: rising by 25% between 2015 – 2019, higher than the 12% global average.
Figure 5 - when considering ESG, which of the following best reflects your current approach to your portfolio?
Although 50% of respondents told us that their approach to ESG was 'philosophical' or 'systematic', only approximately half of those surveyed have appointed a head of ESG.
In contrast, almost all respondents agreed on the growing importance of ESG reporting. At least 44% capture 1-5 KPIs and 31% capture more than 21. Only 6% of respondents didn't measure any KPIs for ESG.
The four most popular KPIs were related to employees: 'diversity', 'training', 'satisfaction' and 'churn'. Energy consumption was the fifth most popular rated KPI. Employee absenteeism and the gender pay gap were also significant concerns. This prioritisation of employee-related metrics seems linked to the higher regard for social factors contributing to value creation.
While ESG factors are regarded as a means for both risk protection and value creation, there is still a weighting towards ESG (when grouped together) as a means for risk protection. However, social factors are considered more of a driver of value creation than the environmental and governance pillars.
Responding to the implications of all this data might seem daunting, but there are steps you can take to ensure that your business is in the best position for the next three years and the future as increasing focus will be on the requirement to measure and evidence the benefits of ESG and other strategies.
1 Effectively measure and articulate business model resilience and performance
2 Leverage your data insightfully
3 Create confidence for stakeholders with a responsible approach to people, supply chain, environment, and governance
The panel also looks at the increasing number of investors monitoring inclusion and diversity, and working with management teams and experts to shape an inclusive culture.
For more information and insight on how investors are redefining business value, get in touch with Maria Thomas.
