In this second blog looking at funding our way out of this crisis, I’m looking at the sources of equity that might be called upon to balance out our unsustainable debt position.
Businesses are pouring funds into reopening - and our economy needs to be weaned off the Job Retention Scheme, which is currently supporting around 9 million people, or 30% of our private sector workforce!
So where might fresh equity come from, of the magnitude that we’re talking about? It is estimated that through this COVID-19 period, private companies in the UK are creating an unsustainable debt legacy of around £100bn! The government will need to play a part for sure, so expect something to come from the conversion of COVID-19 debt into long term instruments, partially convertible to equity.
Beyond this, yet more new money will be required to re-float Great Britannia. For our economic stability and planning, we need to know how government intend to fund this. Whether that’s through long term bonds, taxation, or packaged into something that can be run as a long-term fund and refinanced/sold off in packages.
Government will use its influence from this programme to support long term policies including Brexit, green energy, protecting strategic assets and ‘levelling up’ across the regions. It must also decide where to take the debate on dividends and bonuses paid by those companies who have relied upon government support. My guess is that, despite being unpalatable for some, these can’t be held back beyond the short term without harming the normal functioning of capital markets.
What is the role for Private Equity? Private Equity (PE) funds are a growing force, deploying hundreds of billions of dollars globally, willing and able to take out all but the behemoths of global corporates. Private equity houses need to spend their funds or they don’t get them back again. They need to deploy capital during times of change and be willing to buy and build! Whilst sometimes shunning publicity, or being accused of churning a quick buck, UK PE houses can deploy around £20bn a year and often bring management experience and expertise to promising businesses that need it.
However, £20bn is obviously not enough to cover a £100bn problem, not least when PE funds need to deliver growth and returns, rather than simply fill a hole. Secondly, Government has wider social and political goals and its hurdles for investment and returns are therefore different. Squaring this circle is central to the problem of cash deployment.
The PE model also requires investment alongside debt leverage! Bank appetite is somewhat satiated by all that is going on right now. We are yet to see whether the banking sector will see financial stress to add to the undoubted operational stress that it is suffering right now. This will mean that PE cannot provide the answer, just a welcome part of it.
Where else will equity come from?
- Corporate buy outs, including from overseas! Expect to see consolidation to achieve scale and to bring together both friends and competitors from sub sectors which are either close to one another or indeed cyclically opposite and need each other’s support. Think food service and food retail, energy and automotive, ice creams and umbrellas!
Corporate buy outs also allow the trickle-down of some of the £17bn in new equity that has been raised through UK public markets since 1 March.
The corporate world does not solve itself like this alone, however. Many sectors that are relatively unaffected by COVID-19 are still suffering some disruption which causes havoc with their normal balance of supply chains, sales channels and operations. Expect many corporates to be carefully managing their own challenges before jumping into bed with other people’s problems!
- High Net Worth Individuals and Family Offices have reserves built up, often over many years and have limited choices of where to seek a return. So won’t they appreciate the opportunities that come from stakes in businesses with great potential, but that are weighed down by COVID-19? I think that the risk appetite required to look at equity investments in corporate Britain in Q3 2020, compared with more traditional diversified funds from trusted investment providers will be very hard to contemplate, however.
Our world needs new answers. This is going to take a combined focus from government (central and local) and overseas investment alongside all of the above, in order to drive our way through the new reality and avoid years of austerity and fiscal tightening.
Finally, spare a thought for the charity sector. The less fortunate in society face even greater challenges right now and the charities who support them face much reduced income and social distancing operational challenges of their own. We might all look wider than our own professional and personal challenges right now.
Thought for the week - An army's effectiveness depends on its size, training, experience, and morale, and morale is worth more than any of the other factors combined.
About the author: Richard Peberdy leads KPMG’s National Markets Deal Advisory business. An Economics graduate, he has spent the last 25 years helping our clients develop their strategic business models and then fund and execute their corporate development ambitions.