Carve-outs and bolt-ons surge as COVID prompts firms to refocus
Corporate and private equity dealmaking has been heavily disrupted since the onset of COVID-19 last year. The pandemic has prompted many firms to pause their more ambitious investment programmes and instead focus on bolstering their existing portfolios or undertaking long overdue restructuring in order to cut costs.
This has led to bolt-on acquisitions becoming one of the most prominent dealmaking trends over the past year, as firms seek to strengthen their existing businesses. Research from Rickitt Mitchell earlier this year found a 35 per cent increase in the number of UK private equity bolt-on transactions in 2020, from 276 in 2019 to 370 last year.
Bolt-on acquisitions involve takeovers of smaller companies in the same line or an adjacent line of business to existing businesses in a portfolio. They represent solid, low-risk strategic investments during uncertain times, as well as offering the benefit of acquisitive growth at a time when organic growth is constrained.
Alongside this, there has been an even bigger increase in corporate carve-out deals during the pandemic, with a report from Mayer Brown claiming that the value of UK corporate carve-out deals had increased from £765 million in 2019 to £10.1 billion in 2020.
There are numerous factors driving the huge increases in these types of deal and the question of whether this will persist will play a massive role in shaping the post-COVID-19 M&A market.
What’s driving the increases?
Bolt-ons
At a time like this, dealmaking would ordinarily be booming. The end of the Trump presidency has brought increased political stability, while the continued emergence of sectors such as medtech and cybersecurity offer lucrative new avenues of investment.
However, the uncertainty brought on by the pandemic has forced many to rethink the kind of ambitious acquisition strategies that see private equity firms and big corporate companies invest huge sums in emerging sectors.
Instead, many are turning inwards in order to come through the pandemic in the best shape possible. This has driven an increased focus on core operations, which has in turn fuelled a rise in bolt-on acquisitions as companies look to solidify and build upon existing operations.
Bolt-ons also offer companies the opportunity to address the issues raised during times of crisis. For example, Rickitt Mitchell found that enquiries regarding firms with digital or tech expertise increased during the pandemic. This trend was driven by the need to digitise and improve cybersecurity capabilities while employees worked from home.
In July 2020, self-invested personal pension (SIPP) firm Curtis Banks announced a pair of acquisitions that illustrate two of the key motivating factors behind bolt-on deals during the COVID-19 pandemic: bolstering core operations and responding to the new normal.
The two deals saw Curtis Banks acquire fellow SIPP provider Talbot and Muir for £16.5 million - potentially rising to £25.3 million - and fintech firm Dunstan Thomas for an initial £21.5 million - potentially rising to £27.5 million.
Curtis Banks Chief Executive Will Self said: "We continue to look for the right types of business to grow Curtis Banks in the right way and believe Talbot and Muir and Dunstan Thomas are excellent strategic fits.”
Talbot and Muir, a rival firm, represented a classic bolt-on deal, bringing Curtis Banks new clients and distribution routes as well as a workforce that understood the culture of the SIPP industry.
"Talbot and Muir and Curtis Banks are comparable in terms of culture, service offering, distribution routes and client base and further consolidates our market position as one of the largest UK providers of SIPPs and SSAS products”, Will Self commented. “We are confident this bolt-on acquisition will deliver materially enhanced earnings for Curtis Banks.”
Dunstan Thomas, on the other hand, typifies a more modern type of bolt-on: one that fits into the company’s desire to digitise. The Dunstan Thomas acquisition came after Curtis Banks had invested in a new digital platform to underpin the launch of its Your Future SIPP service.
As such, Dunstan Thomas fit into the company’s growth strategy, with Will Self calling the firm “a core enabler for our future growth”.
The two deals saw Curtis Banks acquire fellow SIPP provider Talbot and Muir for £16.5 million - potentially rising to £25.3 million - and fintech firm Dunstan Thomas for an initial £21.5 million - potentially rising to £27.5 million.
Curtis Banks Chief Executive Will Self said: "We continue to look for the right types of business to grow Curtis Banks in the right way and believe Talbot and Muir and Dunstan Thomas are excellent strategic fits.”
Talbot and Muir, a rival firm, represented a classic bolt-on deal, bringing Curtis Banks new clients and distribution routes as well as a workforce that understood the culture of the SIPP industry.
"Talbot and Muir and Curtis Banks are comparable in terms of culture, service offering, distribution routes and client base and further consolidates our market position as one of the largest UK providers of SIPPs and SSAS products”, Will Self commented. “We are confident this bolt-on acquisition will deliver materially enhanced earnings for Curtis Banks.”
Dunstan Thomas, on the other hand, typifies a more modern type of bolt-on: one that fits into the company’s desire to digitise. The Dunstan Thomas acquisition came after Curtis Banks had invested in a new digital platform to underpin the launch of its Your Future SIPP service.
As such, Dunstan Thomas fit into the company’s growth strategy, with Will Self calling the firm “a core enabler for our future growth”.
Carve-outs
Times of crisis often prompt firms to undertake restructuring that they have perhaps previously postponed. COVID-19 has been no different and this is a key driver behind the massive increase in carve-outs.
Carve-outs see companies divest non-core business units, enabling them to refocus on their core offering and cut costs. This rationale, the need to focus on core operations, is essentially the same one that drives companies to pursue bolt-on acquisitions. As such, the trend for bolt-ons could be seen to feed into the increase in carve-outs and vice-versa, due to the appetite to do deals on both sides.
Last year, leading dealer management systems provider CDK Global announced that it had reached a deal to sell its CDK International business to US private equity firm Francisco Partners for slightly over £1 billion, around a 15x multiple of the division’s EBITDA.
CDK President and CEO Brian Krzanich gave some insight into the thinking behind the deal: “With this transaction, we can now focus on executing the next phase of our growth journey and spotlight our attention on our North America business.”
“CDK has made significant progress over the last two years in strengthening and expanding our core business to be customer-centric and a leader in technology for our dealers, OEMs and partners and we have seen the positive results of our investment efforts. We are now well positioned to expand our activities and create new revenue streams with even stronger growth prospects.”
CDK COO and interim CFO Joe Tautges added: “While we believe the International business is a great asset and are very pleased with the compelling valuation, it largely operated independently, with specific technology, sales and operations tailored to the International markets. The sale of this business strengthens our balance sheet and provides significant financial flexibility in support of our goals to drive value and to accelerate growth in our North America business.”
James West, partner at Mayer Brown, commented: “The pandemic has triggered an intense focus on core businesses for a lot of corporates. Even at the best of times, business units within corporates have to compete for executive time and finance. Those business units far down the list of priorities might be far better off sold to another owner.”
CDK President and CEO Brian Krzanich gave some insight into the thinking behind the deal: “With this transaction, we can now focus on executing the next phase of our growth journey and spotlight our attention on our North America business.”
“CDK has made significant progress over the last two years in strengthening and expanding our core business to be customer-centric and a leader in technology for our dealers, OEMs and partners and we have seen the positive results of our investment efforts. We are now well positioned to expand our activities and create new revenue streams with even stronger growth prospects.”
CDK COO and interim CFO Joe Tautges added: “While we believe the International business is a great asset and are very pleased with the compelling valuation, it largely operated independently, with specific technology, sales and operations tailored to the International markets. The sale of this business strengthens our balance sheet and provides significant financial flexibility in support of our goals to drive value and to accelerate growth in our North America business.”
James West, partner at Mayer Brown, commented: “The pandemic has triggered an intense focus on core businesses for a lot of corporates. Even at the best of times, business units within corporates have to compete for executive time and finance. Those business units far down the list of priorities might be far better off sold to another owner.”
From a cost point of view, carve-outs enable companies to save time and money by simply divesting parts of their business that they may otherwise need to invest in restructuring. These sales also help to generate funds which can be invested back into the business or used to reduce debt piles.
The increase in carve-outs during the COVID-19 pandemic reflects all of these motivating factors. According to a recent Aurelius survey of corporate and advisory professionals, 92 per cent think an increase in carve-outs during the pandemic will be attributable to firms refocusing on core operations; 69 per cent say it will be partly driven by the need to generate liquidity; while 38 per cent say that the need to reduce debt burdens will drive carve-outs.
Another potentially strong motivating factor during the pandemic will be the desire to increase share price valuations. For private equity firms, carve-outs can enable them to improve their valuations by disposing of business units that generate lower multiples, boosting their share price through disposals of underperforming assets.
Will bolt-ons remain popular?
There are several factors that point to an ongoing trend for bolt-on acquisitions. Primarily, with COVID-19 uncertainty remaining persistent, bolt-ons offer a low-risk route to growth. At the same time high levels of business distress and companies offsetting non-core business units should mean that opportunities to do bolt-on deals are rife.
These factors should continue to make bolt-on deals particularly attractive to private equity firms, especially as they come under pressure from investors to generate growth by utilising the “dry powder” they have accumulated during the pandemic.
There are, of course, potential drawbacks to bolt-on acquisitions that could see their prominence fade if the pandemic begins to recede. As a means of generating growth, bolt-ons are reliable and can often work well in conjunction with an organic growth strategy. However, as a route to acquisitive growth, they are somewhat slow and time-consuming. Once the pandemic is over, companies may target more rapid, large-scale growth strategies in order to recover from COVID-19 and make up for lost time.
However, for the time being, COVID-19 is a very present consideration and remains as unpredictable as ever. While this is the case, bolt-on acquisitions offer the perfect way for companies to generate acquisitive growth now, whilst simultaneously laying the groundwork for more ambitious post-COVID growth by boosting their geographic reach, bolstering and refining their core offering and growing their customer base.
In February 2021, global fund, corporate and private client services provider completed the £12.5 million acquisition of UK depository INDOS Financial and its subsidiaries.
The acquisition, JTC’s fourth bolt-on since 2018, reflected the company’s strategy of targeting organic growth in its core business, alongside an acquisition and integration strategy.
INDOS Financial offered JTC both a strategically important acquisition for its fund services offering and added to its scale in Ireland, one of its priority markets.
Following the acquisition, Nigel Le Quesne, CEO of JTC said: "INDOS is a business of real quality which operates in a strategically important part of the fund services market. Having collaborated with Bill and the team several times, it is clear that their deep expertise, commitment to service excellence and proven ability to innovate and grow makes INDOS a great addition to the JTC platform.”
“The transaction also adds further scale in Ireland, a priority market for the Group, and the UK, where our London team has more than doubled in size over the last 18 months due to client demand. We offer a warm welcome to our new colleagues and are excited to bring the benefits of the acquisition to existing JTC clients and to providing INDOS clients with an even richer suite of global services and the full backing of the JTC Group.”
The acquisition, JTC’s fourth bolt-on since 2018, reflected the company’s strategy of targeting organic growth in its core business, alongside an acquisition and integration strategy.
INDOS Financial offered JTC both a strategically important acquisition for its fund services offering and added to its scale in Ireland, one of its priority markets.
Following the acquisition, Nigel Le Quesne, CEO of JTC said: "INDOS is a business of real quality which operates in a strategically important part of the fund services market. Having collaborated with Bill and the team several times, it is clear that their deep expertise, commitment to service excellence and proven ability to innovate and grow makes INDOS a great addition to the JTC platform.”
“The transaction also adds further scale in Ireland, a priority market for the Group, and the UK, where our London team has more than doubled in size over the last 18 months due to client demand. We offer a warm welcome to our new colleagues and are excited to bring the benefits of the acquisition to existing JTC clients and to providing INDOS clients with an even richer suite of global services and the full backing of the JTC Group.”
According to Rickitt Mitchell partner Neil Mitchell: “As the ‘new normal’ has begun to emerge, we expect both new investments and bolt-on transactions to remain high for the foreseeable future. PE houses are still sitting on large war chests that they need to deploy to satisfy investors, and opportunities will remain for companies to grow dramatically through strategic acquisitions throughout 2021.”
Will the surge in carve-outs persist?
As with bolt-ons, the persistence of COVID-19-related uncertainty means that the main drivers of carve-outs (the need to restructure; cash flow management; refocusing on core operations; debt reduction) will continue to be relevant.
Reflecting this, Aurelius’ study found that 89 per cent of corporate and advisory professionals expect carve-out acquisitions to increase in 2021. As per the same study, 76 per cent of respondents feel that record levels of corporate debt in the UK and EU will continue to drive carve-outs this year, with 68 per cent also saying that companies headquartered in countries most economically impacted by the pandemic will continue to make non-core disposals.
Aurelius CEO Matthias Taubl said: “The collective insight of our investment and advisory network confirms that we are reaching a tipping point in the level of corporate divestment activity. COVID-19 continues to create uncertainty, despite the commencement of the vaccine roll-out, which will likely lead to an increase in and acceleration of deals, as corporates seek to shore up balance sheets and simplify their operations. The landscape is primed for special situations investors and there are strong carve-out and turnaround opportunities across Europe.”
Arguably the key reason why carve-outs are expected to increase this year, rather than level off or decline, is the fact that existing debt piles and cashflow issues will become particularly troublesome if and when government COVID-19 financial support is withdrawn. Without this vital funding, companies may increasingly turn to carve-out disposals to free up funds, cut costs and raise capital.
Aurelius UK MD Tristan Nagler, disruption of COVID means 2021 should see “European and global corporates look to rationalise their portfolios after a year of government support. As an experienced special situations investor with a strong track record in complex carve-outs, we clearly see this moment as an opportunity.”
Private equity dry powder will also be a crucial driver of a continuing interest in carve-outs. Mayer Brown noted that US private equity firms, in particular, were sitting on large piles of cash and many were actively exploring carve-out opportunities in the UK as they look to invest this accrued capital.
Conclusion
As organic means of growth are stymied and large-scale acquisition strategies continue to be put on hold, bolt-on acquisitions and carve-out deals continue to make strategic and financial sense for companies that aren’t merely looking to scrape through the pandemic.
Bolt-ons enable acquisitive companies to bolster their existing portfolios, whilst also offering the ability to proactively respond to the “new normal” created by the pandemic by acquiring small businesses that improve, for example, their digital or cybersecurity capabilities. For those with an eye on their post-COVID growth, they can also help to lay the groundwork for a more complete growth effort in the wake of the pandemic.
For companies looking to restructure, meanwhile, carve-out sales offer the opportunity to refocus on core operations while raising funds, improving cashflow and reducing debt.
Although distinct, carve-outs and bolt-ons both offer companies the chance to respond to the COVID-19 crisis and grow out of it, rather than merely standing still and hoping to scrape through. As a result, these kinds of deals look set to remain extremely prominent within M&A for as long as COVID-19 remains a significant consideration.
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