The view from the Direct Investments team – Bernard Dale Q1 2023

News: Insight & Opinion | 2 January 2023

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"Clients will be aware of the multiple challenges faced by the UK economy, with many sectors hit by multiple headwinds in 2022. It therefore has been gratifying to see the resilience of our portfolio and the proactive approach of our management teams, working with us to drive profit and value", says Bernard Dale, Managing Partner at Connection Capital.


Clearly, our portfolio is not immune from these headwinds, but neither are they affected equally. One noticeable trend is in the ‘bounce-back’ we are seeing in traditional industries such as manufacturing, which were hard-hit, especially by demand falling and supply chain issues resulting from Brexit and Covid-19. In the second half of 2022, thanks in large part to actions taken by management, we have seen a number of these deliver good profit growth and strong trading momentum as we enter 2023.

Much work has been undertaken to mitigate the impact of rising energy bills, which in some cases are significant, and wage costs. This has pushed management to implement more efficient processes and cost controls, and to find ways to award pay in a manner that both satisfies staff and works for the business, for example apportioning wage rises to benefit the lowest paid the most within an overall wage increase. Input cost increases have had to be passed on and by and large, these have been accepted by customers and we have targeted management teams on maintaining and where possible, improving margin. Not an easy task.

In consumer-facing industries, profit growth has become more reliant on opening new sites rather than rising consumer spend, with portfolio businesses like 23.5 Degrees (92 sites), The Light Cinemas (11 sites) and Rosa’s Thai (33 sites) expanding their footprints.

It’s also worth mentioning that the type of investments we make and their pricing and gearing, which are typically a lower multiple of EBITDA than mid-market deals (3rd party debt is an average of 2.1x in our management buyout (MBO) and cash-out private equity deals), means our portfolio is well-placed to cope with the effect of interest rate rises. 

Last year was a good year for realisations for our clients and we expect similar activity to continue. With many of our portfolio companies now exceeding £5m and in some cases, £10m EBITDA, this attracts the interest of international buyers, who are prepared to pay top dollar for the right business, as we saw with the successful sales of Carter Accommodation, JCRA and Tempcover. We have a selection of promising-looking realisation targets for 2023.  

We have started to see a noticeable step-up in new investment opportunities after a relatively quiet summer of 2022. A significant proportion of the pipeline includes “partial realisation” or “cash-out” deals where business owners seek to realise a portion of value of their shareholding while capital gains tax (CGT) is low, without selling up entirely – continuing a trend which has been developing for some time. We expect this to remain the case for the next few years as, the most likely trigger for any change to CGT rate is following the next general election, which is not anticipated to be until Spring 2025. These cash-out investments tend to be MBO-like in quality of earnings and management (compared to growth capital deals) but can be lower risk as they have lower debt and recovery capitalisations and the investments are often ‘in the money’ on Day 1. We think these are attractive opportunities for clients with a good blend of risk and return.

We continue to consider prospective new investments across all sectors, including consumer industries, business services, manufacturing, IT and healthcare. Although valuations remain high in certain industries, generally prices are coming down, with market data from Preqin/Pitchbook indicating a fall by c1.5x EBITDA from the peak of 2020, creating good buying opportunities. We will, of course, be looking to take advantage of this ‘dip’ in pricing with our goal remit remaining that of buying into companies at £10-30m entry values and exiting at £30-50m+ and delivering a target of at least a 3x return on