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The Brexit effect: private equity firms shun UK for Europe

Brexit concept – UK and European flags waving in the wind

John Sinik wants to remain in the UK but says he could soon have no other choice but to leave. The private equity executive is being courted by other European countries, including Portugal and Italy, to move his firm there and pay substantially less tax than what he pays now in the UK.

The California-born Mr Sinik says he is conflicted. On the one hand, the UK offers good schooling for his children and it has been his home for over two decades. The UK is still the major European financial hub and it makes sense for his private equity group Metric Capital to be based there.

Yet, his companys ties with the UK have diminished sharply. Metric Capital has not done a single leveraged buyout in Britain since the Brexit vote in 2016 because his fund invests in euros, and the risk of being hit by currency volatility is too high.

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Most of the people the business has hired over the past two years have been for new offices in countries such as Spain, Germany and France as it looks to get involved in those countries deal flow. He still thinks the UK is the place to be for private equity firms but he says political uncertainty about the countrys future relationship with Europe is pushing it close to breaking point.

The gap between the UK and other alternatives such as France, Italy or Spain is shrinking rapidly, he says from his central London office. We could go tomorrow.

Given the tax incentives available in some other countries, a number of executives have already left and others are seriously considering it. Johannes Huth, European head for US buyout giant KKR, moved to Paris in 2017 as France overhauled its tax regime to make the country more business friendly.

Mr Huth has been downbeat about the prospects of investing in the UK because of Brexit. Many firms have been increasingly reluctant to do deals in the UK because of the uncertainty.AnaCap, for example, downgraded the UK as a top-tier investment destination in 2017.

Some buyout groups have been operating from what they see as a worst-case assumption that the UK crashes out of the EU with no deal which analysts believe would lead to the country being unable to hire easily from Europe and could also prompt a large drop in sterling against the dollar and euro.

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But Brexit has inverted the terms of trade for private equity in Europe. At least in the short term, many firms are extremely wary about doing deals in the UK given so much that is unknown about the countrys political and economic future. In some cases, investors in deal funds are even demanding exposure equal to no more than a third of their funding in the UK.

Executives also worry that the UK may end up with a leftwing government, lead by Labour leader Jeremy Corbyn, who has called for higher corporate tax and increased income tax for top earners, and has a much more sceptical approach to private equity dealmaking. Some money managers, like private equity veteran Edi Truell, have already taken their fortunes out of the UK ahead of a possible Labour government.

At the same time, some of the European countries that once accused private equity of representing a rapacious and unwelcome form of capitalism have seen a boom in deals and are bending over backwards to attract London-based firms and executives.

If we find that it is harder to hire talented Europeans to work in London to complement our British staff due to Brexit, we will be forced to consider moving the office, says Mr Sinik.

While the value of dealmaking in Europe, excluding the UK, rose 13 per cent to €63.9bn in 2018, the UK itself saw a 12 per cent fall to €16.7bn last year.

Smaller markets have boomed in recent times. Private equity investments in Spain have more than doubled from €2.3bn in 2015 to €6bn last year, according to Invest Europe, and France saw a rise from €11.5bn in 2015 to €16.2bn last year only marginally lower than the UK, the data showed.

While buyout bosses postpone major investments in the UK, until they gain clarity over Brexit, some of the largest deals are happening elsewhere. The three biggest in Europe last year took place outside the UK, including Carlyles €10.1bn acquisition of Akzo Nobels speciality chemicals business in the Netherlands, and CVCs purchase of Italys Recordati, a pharmaceuticals business, in a €5.9bn deal.

Spain is one of many countries in Europe where private equity was once considered by politicians and businesses as an unwelcome, aggressive form of capitalism. Yet buyout funds are, for the first time, convincing owners of businesses there that this is the right time to sell.

However, there are fresh worries that the Socialist partys recent re-election may dent interest at least in the short term for deals in Spain. France, traditionally Europes second-largest market for private equity deals, saw strong growth despite recent social unrest.

The Nordic countries also saw stronger rises in activity relative to the UK, according to Invest Europe. Denmark, for instance, saw a huge increase from €1.8bn in 2015 to €3.1bn last year. Swedens investment went from €1.8bn in 2015 to €2.8bn in 2018.

Last year was also a record for UK investors in the Nordic market, according to figures from Norwegian private equity investor Argentum. London-based private equity group Cinven bought Swedish cargo group Envirotainer in a €1bn deal, while Bridgepoint bought Swedish risk and compliance services provider FCG, an indication of how established British buyout funds are looking beyond the UK.

This record activity is an indication of the influence of Brexit for other European markets, including ours, says Joachim Hoegh-Krohn, Argentum chief executive and a private equity veteran.

Simon Turner, co-founder of Inflexion, which recently raised 1bn for two funds to fund deals mostly in the UK but also Europe, says his firm is still primarily interested in opportunities in the UK but is running much wilder worst-case scenarios in light of Brexit.

The main issue forprivate equity firms when it comes to British companies is the difficulty of assessing the risk they are acquiring. Even seasoned investors such as Howard Marks, who have made hundreds of millions of dollars investing in high-risk situations, are not sure how to go about investing in the UK.

Whether to invest in anything is always a question of the relationship between price and value, as well as the outlook for value, says Mr Marks, the co-founder of Oaktree Capital who has made himself a billionaire from a career of investing in complicated deals such as raising large distressed debt funds to invest in undervalued assets. I dont know enough about these things to know whether the balance is currently attractive.

He adds: All I know is that value in the UK is reduced from what it was two to three years ago, because Brexit introduces so much uncertainty and downside risk . . . maybe theyve moved down so much that assets are cheap.

Even investors, such as sovereign wealth funds that have a long-term view when it comes to buying assets, have shied away from the UK. A report by IE Business School in Madrid showed that some of the largest sovereign wealth funds invested $1.8bn in the UK last year, compared with $21bn in 2017.

Many investors are sitting tight given the uncertainty surrounding the Brexit process in the UK, says Matt Rees is a partner at law firm Proskauer, whose clients include sovereign wealth funds such as Singapores GIC. The appetite for investors to invest in the UK has taken a sharp decline.

A partner at a multibillion euro buyout fund in Europe says: Our investors are very worried about Brexit. If I buy a business in the UK and get it wrong, they will say you idiots, you took a big bet and you got it wrong. You wont be thanked for that. The dealmaker adds: People are not getting paid to be contrarian heroes.

Firms such as London-based Silverfleet Capital are being asked by some of their investors to cap UK investments at no more than 30 per cent in their funds. We still do UK deals on the margin but if you get a chance to invest in something not exposed to Brexit, why wouldnt you? says Gareth Whiley, managing partner at Silverfleet.

Buyout funds Apax Partners and Warburg Pincus recently agreed to take UK-based satellite company Inmarsat private in a $6bn deal where most of the groups revenues come from outside its home country.

Proskauers Mr Rees stressed that it is not all doom and gloom. There have been flurries of activity at certain points as well, so its not like the tap has been turned off. When good assets come to the market there is still capital chasing assets and the UK is still seen as a strong market for investment by our clients in the long term.

On the flipside some investors are also interested in companies being sold at a discount because of the Brexit uncertainty. Private equity investors are looking at undervalued UK corporates but with non-UK-revenues, like Inmarsat, because thats where they find less competition and less pressure on pricing and they are not taking the risk of the UK economy, says a private equity adviser.

However, this person adds: If they knew whats going to happen in the UK with Brexit, even if it is a bad outcome, at least they would be able to price it in. Thats not the case right now given uncertainty.

Mark Redman, executive vice-president and global head of private equity at Omers, warned of a continued pause in activity for the time being. He says: there will be, [and] there already has been, a hiatus.

That could easily continue for a few years given the uncertainty that were facing at the moment and [whenever] we end up working our way through it. As for Metric Capitals Mr Sinik, he is not about to buy any assets in the UK.

We were previously willing to take the currency risk of investing in the UK. Today we are more cautious about the foreign exchange risk, he says. The potential of the UK crashing out of the EU, and the resulting risk of a major drop in sterling, influences our investment decision making. Naturally, this has raised the bar for investments in the UK.

And although he remains tempted to leave the UK, hes still hoping for a political miracle.

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