Just finished reading a really very interesting report from early September by the equities team at Morgan Stanley in Europe. The report – “Macro Meets Micro: Private Equity Returns to Europe” – paints a very compelling picture of unprecedented levels of activity for PE funds in Europe.
Here are the key conclusions from the report:
“Private Equity activity on the rise... M&A activity in Europe over the last year has fallen sharply and, when measured as a proportion of equity market cap, currently sits close to historical lows. While overall M&A activity remains extremely subdued, one clear area of strength has been demand from Private Equity. Exhibit 3 shows that Private Equity activity as a proportion of equity market cap has reached the highest level in a decade in Europe. In fact, when measured as a proportion of overall M&A activity, Private Equity activity in Europe is at a record high (Exhibit 4).
… more so in Europe (especially the UK) than elsewhere… Europe is often seen as a more challenging region for Private Equity funds to invest in for a variety of reasons, including higher regulatory costs, unionization levels, a more challenging political environment, as well as tougher tender and shareholder protection rules. However, while Private Equity volumes have been on the rise globally through this cycle, the rise has been perhaps most notable in Europe. Exhibit 5 shows too that the UK has been a particular beneficiary of an increase in Private Equity activity.
… especially in Media, Industrials and Consumer Services. Exhibit 6 shows the proportion of M&A activity in each European sector over the last year that is accounted for by Private Equity activity. Media, Industrials and Consumer Services rank highest on this basis. In this report we have analysed a number of top-down conclusions of what worked with many of our sector analysts, where private Equity activity appears particularly relevant, to analyse these trends and implications in more detail.
Private Equity activity is bucking the trend in public equity markets in three important ways. From a top-down perspective, the rise in Private Equity activity is significant given their investments appear to be bucking the trend in public equity markets in three important ways, all of which we explore in more detail in this section.
1. Private Equity activity goes against the rise in short-termism in public equity markets
2. Private Equity activity is providing an important offset to broader equity outflows
3. Private Equity activity appears to be spurred on by the record low cost of capital
For me, though there are two really compelling afterthoughts – PE grappling with grey sectors and building a stock screen for target businesses.
The first is that private equity may be about to play a pivotal role in those industries about to get flattened by the sustainability agenda and the push for decarbonization.
Here’s the Morgan Stanley observation:
“Private Equity is more willing to engage with ‘grey market’ exposure. While Sustainability issues can hardly be described as being too short-term focussed, as
Sustainability investing has risen sharply, at times it has seemed that there is no price too cheap for stocks that score poorly from a Sustainability perspective. Some
of the analysis in the following sections mentions explicitly that Private Equity appears more willing to engage with ‘grey market’ exposure than other market
This analysis shines through clearly in the second key observation – how we screen for European stocks that could be the focus of PE activity. The MS team have built a Private Equity Screen “which tries to identify undervalued stocks based on metrics commonly used by Private Equity investors. The screen ranks stocks on five criteria: 1) EV to Fixed Assets, 2) FCF to EV yield, 3) Price to Book Value, 4) Dividend Yield and 5) Interest Coverage. “
The screen currently identifies the following 17 overweighted stocks, many of which are in sectors slap bang in the middle of the ESG backlash (I’ve highlighted them in bold):
Anglo American, Fiat Chrysler, Tenaris, Repsol, Covestro, BP, Glencore, Continental, Taylor Wimpey, Michelin, Randstad, ArcelorMittal, Tesco, Telefonica Deutschland, LafargeHolcim, SES and Vodafone