Reaching out into oil and gas
A shortage of cheap, readily available debt has dealt a double blow to buy-outs this year in terms of their size and number. The latest figures from the Centre for Management Buy-out Research show PE deals in the £100 million to £500 million bracket dropped to £3 billion in the first half of the year, compared with £7 billion in 2007. The total size of the market in the first six months of 2008 was £11 billion – its lowest since 2004.
In contrast, the oil and gas industry has seen a flurry of buy-out activity, claiming two of the five largest global buy-outs in the first six months of the year: oil services firm Expro International’s £1.6 billion buy-out backed by a consortium led by Candover; and the bated breath, yet-to-complete CHC Helicopter C$3.7 billion (£1.8 billion) PE deal sponsored by First Reserve Corp.
The sector has emerged as an attractive target for buy-out groups looking to capitalise on booming oil prices that have caused energy companies to up their spending on exploration and developing reserves.
EXTREME CONDITIONS
Hydrobolt, a manufacturer serving the oil and gas industry, was bought by its management team for £16 million in April. The MBO was backed by Octopus, with £4.5 million from its Private Equity and Intermediate Capital funds. The investment has given the management, led by group managing director Jamie Simpson, the financial clout to buy out the founder of Hydrobolt and its sister company Studbolt.
Octopus’s investment, together with the £8 million debt package provided by HSBC and the roll-over of the management’s existing investment, will enable the Wolverhampton business, which manufactures fasteners for use in extreme environments, to grow organically in the North Sea market as well as put in place its international expansion plans.
“In a marketplace where many sectors are a little uncertain, oil and gas is an industry that you can be fairly confident about for the foreseeable future. The high oil price makes it a good sector to enter,” says Chris Allner who heads up unquoted activities at Octopus.
MEZZANINE LOANS
Allner, who leads the team that invests between £500,000 and £8 million in growth companies, says he hasn’t seen amounts of senior debt contract in mid-market buy-outs because the lower end isn’t as highly geared.
“The banks are being tighter, putting more covenants in place and the cost of that money is more expensive, but there’s not been a dramatic change for us.”
Stuart Nicol, director of Octopus Intermediate Capital, adds: “We are finding that people are taking on less debt because they are looking at the market more defensively.
“In a deal like Hydrobolt, Octopus Private Equity took our mezzanine funds to enhance its returns. We are talking to other PE houses that are taking our mezzanine finance to protect the downside, making sure their investments can survive a worsening trading environment. Clearly all these options present different risk/return profiles for providers, so they are priced accordingly.”
Octopus Intermediate Capital raised £45 million last year and has completed four deals to date, with investments ranging between £1 million and £4 million. In November, the fund made its maiden investment in Funeral Services Partnership for £2.8 million together with Aberdeen Asset Managers Growth Capital, which invested £5 million.
“Mezzanine, or junior equity, in these types of deals enables private equity and management to maximise returns without putting the repayment pressure on the business that would come from using bank debt,” says Nicol.
INVESTMENT STRATEGY
With the UK buy-out market falling to its lowest point in four years, the investment house is treading cautiously with acquisitions to its portfolio companies. One such addition was the acquisition of Brandspace by Promotion Space Group, a Cheshire-based business that organises promotions in shopping centres across the country.
Octopus backed the deal in May following its initial investment in April 2007. “Promotion Space made an acquisition of a competitor taking them to the number-one position in the market. This was a good way for us to enhance the returns for our funds at a time when quality deal flow is relatively limited,” says Allner.
“Now is not the time to be rushing out there to do lots of new transactions. Pricing is yet to adjust to a level that makes it attractive to do a new equity deal. We think that will change quite rapidly and that the next six months will be a more attractive investment environment than the last six months.
“It’s a case of holding one’s powder dry and making sure we can capitalise on the opportunities that are going to come up in the next six to 12 months.”