Sector Valuations

A look at the relative multiples paid across different sectors on the sale of large private companies.

This month we are featuring the annual BDO Stoy Hayward study of multiples paid for large businesses by industry sector. This study is part of the Private Companies Price Index (PCPI) and the Private Equity Price Index (PEPI) that is published quarterly. The graph above sets out the average multiple of earnings paid for private companies by trade buyers (PCPI) and private equity buyers (PEPI) compared to the trading multiples of public companies by sector for the period Q3 2007 to Q2 2008. The mean price paid for private companies in this index is £21m.

To recap, the PCPI/PEPI study tracks the relationship between the current four month rolling average FTSE Non-Financials price/earnings ratio (p/e) and the p/es currently being paid on the sale of large private companies to trade and private equity buyers. The FTSE Non-Financials p/e is calculated from the p/es published in the FT. The private company p/e is calculated from publicly available financial information on deals that complete in the quarter.

With regard to private company exit prices, this data would ideally be calculated more frequently, but due to fluctuations in the volume of deal flow, it is not always possible to produce a statistically valid sector-by-sector price index. As a consequence, the information produced here should be treated with caution for valuing companies today, as the private company exit multiples shown by sector are a historic three-year average. However, it does illustrate the wide range of ratings placed on different sectors


Healthcare and Education

Investor interest in quality healthcare and education opportunities remains buoyant in spite of weakness in the debt markets and other economic sectors. The strong defensive qualities of this sector make it a natural area for continued investment. The sector's popularity is primarily due to its government-backed revenue streams. The opportunity to benefit from the inevitable increase in outsourcing to the private sector of healthcare services historically provided by the NHS is also attractive. Additionally, the ageing population of the UK continues to fuel demand for the provision of specialist care. There has been observed an upward trend in the amount of deal origination by generalist equity houses in the healthcare arena, while healthcare sector specialists are enjoying more favourable conditions as interest in the sector has improved and financiers return to a bricks-and-mortar approach. The difficulties in the debt markets have generated an increase in the number of client enquiries relating to funding solutions with companies often seeking to raise funds via the sale of minority equity stakes.


Business Services

There remains a steady flow of M&A activity in the business services sector despite the difficult economic conditions in the UK. Acquirers and investors continue to be attracted to the trend to corporate and government outsourcing of services and the relatively long-term nature of contractual relationships. Several large groups and mid-caps remain acquisitive, as they seek to diversify the services they offer and they have the cash to do deals. Private equity investors remain positive about niche services, especially in specialist areas of facilities management and business process outsourcing. While it is far tougher for recruitment and training providers, deals are still being done - driven by the need for consolidation although valuations across business services have fallen to more sustainable levels.


Retail

The consumer is clearly now feeling the effects of the credit crunch. Banks have shown reluctance to lend to the sector at the levels experienced in 2007 which has impacted the price acquirers can pay for retail assets. In addition, profitability has been hit by a combination of rising costs and lower levels of consumer spending. Consumers are becoming increasingly savvy in their purchasing decisions, researching products and prices on the internet and focusing spending on the real 'must haves'. We therefore expect robust performance from strong brands which give the shopper a reason to part with their cash, with weaker brands likely to suffer.


Real Estate, Property and Construction

In contrast to last year, the waves resulting from the failure of the US sub prime market have had a huge impact on the fortunes of the UK real estate market. The biggest challenge is the change in attitude of the banking market. Principally, the market must decide how to overcome the equity funding gap caused by the banks retreating to historic levels of lending last seen in the early 1990s. Lending on purchase cost (as opposed to value) is the new reality for the market. With senior debt levels averaging 70 to 75 per cent of purchase price, and private investors backing away, where will the equity come from? Mezzanine funding could plug part of the gap. On a positive note, the sharp decline in values in the commercial market over the past year has allowed the market to return to more affordable position resulting in the fundamentals for investing in property becoming more favourable.


Financial Services

There has been a marked slow down of mid-sized corporate M&A activity in the financial services arena in the past year as the credit crunch has thrown the banking, insurer and finance provider acquirers into turmoil making them almost exclusively internally focused. Despite this, the financial services sector has offered attractive opportunities for private equity houses where multiples increased 13 per cent to 17.5 times from 15.5 in Q2 2007. However, cash rich trade buyers desperate to buy good brands have been able to trump private equity bids.


Readers will note that the data collected was for the period Q3 2007 until end of Q2 2008. At the time of writing things are very different. At the end of Q3 the FTSE 100 stood at 5600 whereas during October the index has gone as low as 3700. As such, it is likely Q3 and Q4 will be very different from the previous quarters in terms of p/e ratios in public companies and multiples on the sale of private companies. One thing for certain is that by the end of the year we are going to be seeing much lower multiples. However, with so many transactions on hold due to funding problems and general uncertainty, collecting enough data to ensure meaningful figures will be a challenge.


In conclusion, as the problems with the economy continue it is likely that businesses that are dependent on banking or property will find that prices have softened considerably in the last few months.

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