Gresham Monitor shows first signs of upturn in middle market M&A cycle. UK companies waking up to new capital gains tax breaks

UK managers are expecting to undertake more transactions this year than in 2001 - a welcome signal that the sharp slowdown experienced in mergers and acquisitions activity in recent quarters is set to reverse. And the Government initiative to reduce or exempt capital gains tax on business asset disposals is starting to have a positive influence.

These are just two findings in the latest edition of the Gresham Monitor. The Monitor is a twice- yearly survey of the middle market commissioned by Gresham Trust, the private equity house which specialises in investing in this key sector of the UK economy. In this issue, Gresham sought a "snapshot" view of one highly topical issue - the level of transaction activity in the sector - while monitoring select aspects of the financial performance and outlook of the middle market businesses interviewed.

Highlights:

Half of the middle market companies surveyed expect to undertake a transaction in the year ahead.
Nearly a third expect to raise external finance and more than a quarter anticipate buying another company.
27 percent say they are much more likely to carry out a transaction in 2002 than in the previous 12 months.
28 percent feel the changes in capital gains tax will influence their decision to do a deal this year.
Overall levels of optimism about business growth prospects are little changed since the previous survey in June 2001, a flattening of the trend after 12 months of steady decline.
A quarter report that turnover has fallen. Over the past 18 months there has been an overall decline in the percentage reporting higher turnover and a comparable rise in the number reporting falling turnover.
28 percent are planning job cuts in the next 12months which suggests the situation has not worsened from previous surveys. Two-thirds of those predicting lower staff numbers envisage a decline of between 1 and 10 per cent.

A third of the manufacturers surveyed say they are more likely to do a deal this year than last against a fifth of service firms. Similarly, privately owned companies are more likely to undertake a transaction in the current year, ie two-thirds of those surveyed against a third of publicly-quoted subsidiaries interviewed.

Gresham believes that the slowdown in volume and value of private equity deals, which partly reflected investors' reluctance to pay unrealistic prices, has created pent-up demand for financing. At the same time, the boom in large, technology investments flattered the overall figures in previous years. This diverted the focus away from the core of the private equity market - businesses in less fashionable sectors but with ambitious management keen to benefit from private equity financing.

Companies in the middle market sector still need funding. And, with more realistic prices there is scope for substantial growth in the private equity market.

Paul Marson-Smith, managing director of Gresham Trust, said today: "Well before September 11, there had been a general slowdown in the level of mergers and acquisitions activity. Since then, the marketplace has continued to be very quiet compared to recent years. The Monitor's findings provide the first concrete signs that middle market managers are actively considering doing deals - echoing our view that 2002 will be a good year for transactions.

Previous Monitors highlighted middle market companies' complaints over worsening tax burdens. It is encouraging to see a growing awareness by managers of the Government's initiatives on capital gains tax to help the middle market."

The survey highlights the differences in financial performance and outlook experienced between the manufacturing and service sectors. Manufacturers are again reporting tougher conditions than service companies with 27 per cent experiencing lower turnover against 22 per cent of their service sector counterparts.

Equally manufacturers are more pessimistic about growth prospects for their business than service companies (25 per cent compared to 16 per cent of the service sector). As might be expected, a greater percentage of service companies (57 per cent) than manufacturers are setting their business plans based on the expectation of economic growth in the UK. But in light of the length of time in which manufacturers have been in recession, it is heartening that 40 per cent are building their plans on the basis of economic growth.