Private equity is still in the soup, but lending is improving and there are plenty of opportunities for trade buyers. James Harris reports

'It's a difficult time to be in private equity,' says Mark Humphries, a partner at advisory firm Catalyst Corporate Finance. Of the 151 deals involving UK targets in September, only five involved private equity acquirers, according to research by Zephyr.

This follows a wider trend of market difficulty for the asset class. A recent report by the Centre for Management Buy-Out Research (CMBOR) reveals that only 31 UK private equity-backed buy-outs were completed between July and September, the lowest number since 1984.

Private equity has had to eat a bit of humble pie: 'Firms are not demanding high returns. They are prepared to accept lower yields in a transaction. Deal volumes have halved but there are still the same number of private equity firms, so there are more people chasing fewer deals.'

The lack of debt in the market has hit private equity particularly hard. Humphries adds: 'Trade buyers were previously pipped to the post by private equity firms, who were using high debt multiples to price trade buyers out the market. That's no longer the case.'

Embattled firms have been forced to retreat into their portfolios, and as Humphries notes: 'They have been let down by the banks – debt multiples haven't improved, nor has the cost of lending.'

Bank debt remains on the back foot, but deal-starved businesses are turning to vendors to finance acquisitions. 'We're seeing vendor finance replace debt finance. In this kind of environment, buyers are finding it hard to raise money, so vendors are often willing to raise it themselves,' says Humphries.

Although acquisition finance remains slow, bank lending has not completely disappeared. 'Liquidity is getting better. Banks are slowly coming back to the market and supporting businesses.'

Feeling the strain

As insolvencies creep up, distressed deals have become a common feature of the deal landscape. In fact, global M&A deals involving bankrupt or distressed companies reached $233.1 billion (£147.7 billion) in the first nine months of the year, an increase of 354 per cent on the previous year, according to Dealogic.  

Given the scale of the increase, it is surprising to hear that Steve Currie, another partner at Catalyst, expected to see more. Says Currie: 'There are more distressed acquisitions than last year, but compared with other downturns, banks are behaving differently. They are willing to restructure where historically they would have let businesses default. This means that businesses are being nursed through the recession, and are not selling.'

While many industry sectors 'are still on their knees', the public sector and especially healthcare has proved resilient. Currie says: 'Anything that involves government spending seems to be flavour of the month.' Deals under £500 million in September include Medline's acquisition of SunChoice, as well as New Zealand Pharmaceuticals' purchase of Dextra Laboratories.

However even healthcare is feeling the strain. In the two healthcare deals that Catalyst has worked on this year, both target companies were once part of the same group: 'In 2007, someone would have been prepared to buy the whole group. Now companies only want the parts that are of use to them, so we had to split the business.'

Humphries is not overly despondent: 'Trade buyers that are well capitalised can pick up high quality businesses at a reasonable price, without having to outplay private equity.'