Cheap UK smaller companies remain attractive to overseas bidders

Low valuations made UK small-caps an attractive hunting ground for dealmakers in 2023 as they pitched their takeover offers with an average 50% premium.

Today’s research by Peel Hunt reviewed the year’s 40 transactions worth £100 million or more, with 18 deals in the fourth quarter the busiest period as the interest rate and economic outlook became clearer.

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M&A activity over the year was predominately in the smaller company space, with no interest in the FTSE 100 and just three offers for FTSE 350 companies. There were 13 in the FTSE Smallcap, 20 on AIM, plus another four companies outside the usual indices.

The average premium was 50%, which the broker said reflected the depressed valuations of many UK smaller companies. Six of the companies received a subsequent bump in the premium, which on average added an extra 12% to their offers.

Significant deals during the year included property portal OnTheMarket after the smaller Rightmove (LSE:RMV) rival was targeted by US real estate investor CoStar Group Inc (NASDAQ:CSGP) in a £99 million proposal.

That was one of the takeovers involving an overseas bidder, with acquirers based outside the UK representing 55% of deals by number and 64% by value. Activity was spread across sectors, with the technology and healthcare space the most in demand at 27% by number.

This included the technology consultancy Kin and Carta (LSE:KCT), which was valued at £239 million in December’s swoop by Valtech. Other small-cap targets included Frankie & Benny’s owner Restaurant Group, which agreed to be taken private following a £506 million approach by US buyout group Apollo.

With minimal IPO activity, the transactions mean a smaller UK stock market in 2024.

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This trend has been fuelled by 30 consecutive months of outflows from UK funds, which inevitably drives selling pressure and impacts on valuation.

Peel Hunt added: “Currently there are willing buyers (attracted by the valuations available and the probability of a successful conclusion) and willing sellers (due to fund outflows and scale of premia).

“In addition, the private markets are slower to adjust to tougher economic conditions, which means that acquisition multiples can be unrealistic.”

Peel Hunt points out the current negative trends are self-fuelling, as the poor performance of UK equities makes them appear less attractive to fund managers and retail investors and the reduction in liquidity reduces appetite from overseas investors.

However, it added: “This all sounds very negative – but the reverse scenario can happen, and can happen quickly. It really needs a trigger to break the cycle.”

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Factors that could reverse the trend include increased appetite by retail investors in the event of tax changes or increased allocation by pension funds and insurance companies due to government incentivisation or regulatory change.

The report concludes: “If we do see increased demand for UK equities, then valuations should improve materially, which would make an IPO a more attractive option.

“However, there are some deep-rooted issues in the UK regarding IPOs and the health of equity capital markets, which have material consequences for long-term economic growth.

“The fact that more UK companies of material size listed in the US rather than the UK in 2023 shows the extent of the issue.”