Buyout boom looks like fizzling out

News Analysis: Venture capitalists are going to find it much harder to raise money

VENTURE CAPITALISTS are circling around the smaller end of the London stock market. Sherwood, the lingerie supplier, yesterday became the latest quoted company to reveal that it had received a bid approach from its management. Sherwood's executives, backed by a group of unnamed financial institutions, have tabled an indicative bid of 48p per share, valuing Sherwood at pounds 53.3m.

This particular deal may founder, because Sherwood's two non-executive directors have ruled that the bid is too low and have therefore blocked the management's financial backers from doing the necessary due diligence they need to carry out before making a definite offer.

However, the bid is part of a more general trend for quoted companies to take themselves private. Last week Ushers, the regional brewing group, announced plans to launch a management buyout. Regal Hotels and Allied Carpets are also in talks about similar deals.

In the past year a string of companies, ranging from Radius, the computer services minnow, to printing giant Watmoughs, have been transferred from public to private ownership.

This trend has helped to propel the sums being committed to management buyouts to a record high. According to figures compiled by the Centre for Management Buyout Research, transactions worth more than pounds 12bn were completed in the first nine months of the year, compared to pounds 10.5bn in the whole of 1997. At the peak of the previous boom in 1989, buyouts totalled just pounds 7.5bn.

A major player in the public-to-private arena is Alchemy Partners, a firm set up by Jon Moulton, a venture capital veteran with years of experience at established houses such as Schroder Ventures, CVC and Apax.

Alchemy has backed the buyouts of listed firms such as Instem, UK Safety, Wellman and Radius, and has been linked with Allied Carpets and Regal Hotels. Although Mr Moulton insists he is not behind the Sherwood bid, he sees plenty more opportunities for similar deals.

"Small companies are deeply out of favour with institutions, so there are lots of willing sellers," says Mr Moulton. He points out that in one morning he had been offered six possible deals, although only one looked like an attractive investment.

Alchemy's activity is all the more surprising given that the rest of the venture capital industry has suddenly gone very quiet. Despite the record figures, deals have more or less dried up since the stock market went into reverse.

The reason, according to established venture capital houses, is that vendors are still holding out for high prices. Meanwhile, the turbulent state of the bond markets means that venture capitalists can no longer raise large amounts of debt to help pay for the deals.

"Vendors are not willing to recognise that the business they were auctioning last week is not worth as much as it was," says Tom Lamb, managing director of Barclays Private Equity. "And banks tend to get more cautious at this stage about underwriting large tranches of debt."

With equity markets plunging, venture capital groups could also be left hunting for an exit from their investments. This could become especially pressing in the next few years, given the huge amounts that have been committed.

"Over pounds 32bn has been spent on deals by private equity groups in the UK in the past three years, but on average only pounds 7bn a year is raised through new issues," says Mr Lamb. "How are they going to find exits for them all?"

Mr Moulton remains sanguine. He argues that some companies are so undervalued by the stock market that they can pay off the debt they take on with cash flow. "The others are going to have to merge, build by acquisition or wait for a more optimistic market for small companies," he says.

Alchemy also has a different funding structure which allows it to raise cash more flexibly. Rather than raise a huge fund and then spend the next few years trying to invest it, Mr Moulton's backers allow him to draw down up to, say, pounds 10m a year from them when he needs the money.

Nevertheless, observers believe the value of management buyouts and buy- ins is set to fall sharply. Mr Lamb points to the previous cycle, when the value of deals plunged from pounds 7.5bn in 1989 to pounds 3.1bn in 1990.

Apart from being more careful with their money, Mr Lamb reckons that venture capitalists will also have to spend more time with their existing investments as the economic environment gets tougher.

"Executives will be running out of the maternity ward where they were trying to give birth to new deals and up to casualty to patch up the walking wounded," he says.

Meanwhile, public-to-private deals are becoming harder to do. Institutions which have watched the value of their shareholdings plunge sharply in just a few months are unlikely to sell out for the usual 30 per cent premium.

These transactions can also be expensive. Rob Keve, an investment manager at Tufton Capital, which specialises in turning round troubled companies, points out that it can cost up to pounds 1m to take a company private.

"If the whole deal is worth pounds 10m, that's a significant proportion of the investment just in transaction costs," says Mr Keve.

What's more, there is no guarantee of success. By tabling a bid the venture capitalist puts the company into play and risks attracting the attention of rival buyers.

According to Mr Moulton, the trick is to "get a big stake up front and try to move very quickly". In time, his strategy may well prove to be the right one. But in the current climate, few venture capital groups are likely to be ready to follow his example.

A public-to-private buyout of Ushers, the regional brewing group, is being backed by Alchemy Partners