“There’s a wall of money looking for a home,” a financier told me after one in a flurry of recent private equity-funded acquisitions. Where better a home for these billions than in, well, homes?
Build-to-rent specialist Sigma Capital last month became the latest residential company to recommend selling up to private equity (PE). The £118m approach by PineBridge Benson Elliot was struck at a 36% premium to the previous day’s price. This follows Blackstone’s £1.24bn move for St. Modwen Properties, at a 21% premium. The latest wave of buy-outs dates to last October with Lone Star’s £647m acquisition of retirement housing leader McCarthy & Stone.
Across UK industry as a whole, 113 deals worth £27bn have been launched in 2021, most prominently the potentially (at least) three way battle for supermarket Morrisons, worth at least £9.5bn and counting. Global deals have surpassed $0.5trn since January – a record for PE, which entered the public consciousness with KKR’s 1988 swoop on RJR Nabisco, immortalised in the book and movie Barbarians at the Gate.
PE companies often target under-valued, misunderstood or unloved companies and then try to extract as much cash as possible, to repay their often eye-watering debt funding and, if all goes to plan, generate even richer returns and fees. In the process, they often break up target companies, sell them on or return them to the stock market. Their time horizon for this process is generally around five years.
Cashflow is king in PE, but property has always been a coveted ingredient in its alchemy
That doesn’t sound long, but it can be an eternity versus the stock market’s attention span. McCarthy & Stone was struck at a seemingly parsimonious 115p, a 9% discount to tangible net asset value (TNAV), subsequently nudged up to 120p.
But the company had endured a series of profit warnings since returning to the stock market in 2015, having previously been taken private at a far more sumptuous 125% premium to TNAV amid a buy-out frenzy in 2006. Largely new management had drawn up a compelling mixed-tenure strategy to reduce its exposure to slowdowns in the secondhand sales market, emphasised during last year’s lockdowns. But this was likely to take up to five years to fully execute – probably longer than increasingly jittery shareholders would endure.
Cashflow is king in PE, but property has always been a coveted ingredient in its alchemy. Take, for instance, St. Modwen. ‘St Mod’ was also in the process of change, now focusing on property’s sexiest sector, sheds, plus housebuilding, mainly in Middle England and creating value by bringing housing and logistics land through the planning system. At a modest 1.24x TNAV, there seems adequate scope for generating greater cash than implied by pre-bid share price.
Future PE bids
Cost-cutting, however, is an inevitable feature under new PE owners. Lots can be slashed outside public ownership – slimmer boards and not paying for brokers, investor relations teams, glossy annual reports or ‘ESG mission statements’.
If there are any further PE bids in the sector – and I’m sure there will be – the likelier candidates might include hybrid groups, niche operators, ‘urban regenerators’, privately owned firms with no obvious succession plans … or just plain cheap. Rental income is a particular attraction.
Less obvious would be the rationale in bidding up a volume housebuilder. They are industrial scale development machines, buying swathes of land and efficiently pumping out homes. But the main players trade at around 2x TNAV – towards the top of the usual cyclical range. It’s hard to imagine a Harvard Business School grad extracting better deals on land or bricks than a wizened Persimmon area manager.
The share prices seem to reflect this. The biggest housebuilders’ shares, which had risen by more than a third in a year, drifted down by 6% during June, reacting to fundamentals like cost inflation rather than buy-out speculation.
But never say never. That wall of money may be starting to be deployed less judiciously. The FT’s Lex column recently argued that, with buy-out firms sitting on $1.5trn of undeployed capital, the valuations of deals were becoming stretched and their once stellar returns were starting to slip to below that of the seemingly more pedestrian public markets. Even barbarians sometimes get beaten up.
Alastair Stewart is an equities analyst and consultant
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