Interest rates and multiple compression in the UK

June 14, 2023

by a searcher from Harvard University - Harvard Business School in London, UK

Hi everyone,
I am searcher based in the UK and I have spent the past few weeks looking at a rollup opportunity. I have found a few healthy businesses in the space and I am engaging with sellers.

Here are some factors that I like about the space:
-businesses in the space generally generate 25-35% EBITDA.
-business in the space can be acquired for £1M for £250K EBITDA (≈4x multiple)
-while there is room for growth, these businesses have a cap for organic growth
-from the data collected, the multiple arbitrage kicks in very nicely at approx £1M EBITDA where your multiple goes to ≈8x. This would be the main value creation driver.

However, I am having second thoughts based on this:
-With interest going up###-###-#### %) to fund acquisition, debt becomes much less obvious as a value creation lever and I am not expecting it to go down anytime soon.
-Because of the higher interest rates, I am thinking that might slowdown activity for larger buyers to acquire us after we rolled up a few businesses and that it might compress our multiples.
-On the other end, I hear that small-mid cap PEs have record levels of dry powder which might take years for them to deploy.

Anyone has thoughts on this?

Reply by a searcher
from University of Oxford in London, UK

The other lever which is more subtle but no less real is in a high interest rate and high inflationary environment you should plan for more consistent price increases which will "inflate away" the debt on your balance sheet. The question is how hard it will be to pass through those price increases and whether you have, for instance, fixed price agreements in place. Also you should consider if cost increases from your suppliers will be passed to you. But in theory in a high inflationary environment you should as a "real asset" owner be very attractive to LPs/investors trying to move away from cash.

Reply by a professional
from Lancaster University in London, UK

Hi Ben, anecdotally a number of our smaller PE clients are telling us that the issue they are having is more around finding the right opportunities rather than around access to funds. I would also agree with Timi though, in the current market, an 8x multiple would represent a very good return. As always, one never knows what the future holds, by the time you have completed your rollup plan the market may look quite different to the way it looks today.

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