Gambit review of the year
Key Observations From This Year
Transaction volumes increased by 23% year-on-year, a key indicator of returning confidence. Acquisitions accounted for 73% of all transactions, driven partly by the return of corporates to the market who, still restricted by challenges of debt availability, but needing to grow market share, have targeted acquisitions to diversify service offerings and increase scale.
We also saw consolidation, notably within the healthcare staffing sub-sector which, during the fourth quarter, accounted for 9% of all transactions, as companies positioned themselves for the anticipated increase in demand in 2014.
We expect to see transaction levels continue to increase driven by hungry mid-caps looking to increase their market rating and satisfied by an increasing level of vendors who have waited for economic conditions to stabilise and valuations to improve before starting a process. Market confidence and momentum have been key drivers of M&A activity in 2013 and will continue to be so in 2014.
The year has been dominated by a number of high profile acquisitions by global private equity buyers which have driven up average deal values. This is particularly evident in the oil and gas and energy sectors, notably the investor buy-out of USG Energy BV by Rabo Capital and the acquisition of Swift Technical Services Limited by Wellspring Capital Partners LLC during the year.
Other notable transactions include the recent acquisition of Alexander Mann Solutions by US Private Equity firm New Mountain Capital for £260 million. The oil and gas and energy sectors will continue to attract interest in 2014 but with valuations high and the majority of the leading players having changed hands recently, it is questionable how long the bubble will last. Our view is that with corporates and private equity investors remaining hungry for acquisitions, we are likely to see other sectors such as IT and engineering, where demand for skills is high, attracting significant interest in 2014.
Equity markets have delivered good returns through the year, with a 16.7% and 26.6% increase across the FTSE All-Share and FTSE Support Services index respectively in the last 12 months. Human Capital companies outperformed the market with the businesses tracked by Gambit delivering a 62.6% increase in share prices, coupled with a 35% rise in EV/EBITDA multiples between Q1 and Q4. There were stellar share price performances from a number of mid-caps including Empresaria Group Plc, Matchtech Group Plc and Staffline Group Plc, the latter two also delivered significant increases in market profile and rating during 2013.
Going into 2014 there are a number of quoted companies who will be looking to enhance their market rating to both create shareholder value and, in terms of M&A, enable them to compete more effectively for the acquisition opportunities we expect to come to market. With business optimism amongst CFOs running at its highest point for almost four years, we expect 2014 to be a busy year.
Summary: Favourable M&A conditions are expected to continue for mid-market Human Capital companies...
To acquire: The outlook continues to improve and as confidence returns, conditions are ripe for consolidation as key players with capital to deploy continue to acquire and vendors begin to explore exit options. Valuations are set to continue to improve in-line with public comparables, indicating that buyers should act sooner rather than later
Private equity: Human Capital is an attractive sector to private equity investors evidenced by a number of high profile exits during the year. Specialist sectors such as IT and engineering will see high demand as a result of skills shortages from the retiring & lsquo;baby boomers’
Financing: The debt market remains challenging, with debt capital difficult to obtain and more expensive. Greater flexibility exists from alternative debt capital markets and structures including higher leverage and longer maturities
Human Capital Industry Overview
2013 will be viewed as a pivotal year in the UK’s economic revival. The end of 2013 saw the Autumn Statement reflect economic optimism as George Osborne raised forecast GDP to 1.4% for 2013 from 0.6% announced in the Spring, whilst 2014 forecasts were increased from 1.8% to 2.4%.
At the same time, the Manpower Employment Outlook Survey for Q1 2014 reported a seasonally adjusted Net Employment Outlook of 5% growth in staffing levels whilst unemployment levels are at their lowest since 2009.
A further indication of increasing confidence is the recovery of permanent recruitment, with fees up 17% in the last quarter of 2013 for Hays’ UK operations and headcount increasing 8% in the last six months for SThree, as announced in both companies latest results. This is a positive indicator and bodes well for the prospects of the sector for 2014.
The Autumn Statement included a number of announcements that will impact the sector, including the abolition of employer NIC’s for staff under the age of 21, which will incentivise businesses to take on young staff, in turn reducing youth unemployment.
A further reaching announcement was the Government’s intention to prevent the avoidance of employer NIC’s and circumventing employer obligations via the use of false self-employment through umbrella and Personal Service Company (“PSC”) arrangements. The announcement suggested legislation will be implemented by April 2014 which will be a struggle to produce in such a short timescale. Anything that will be both effective and necessarily targeted will take time and require in-depth consultation.
Gambit’s view is that, regardless of time frame, the legislation is likely to be disruptive. As such, all recruiters reliant on intermediaries must prepare themselves and review current staffing contract models. Opinions are divided as to whether PSC arrangements will become unviable, yet an update of IR35 is likely to prevent the use of the right to send a substitute along with further legislation in the Finance Bill 2014 in-line with updated off-shore intermediary legislation. A trend likely to emerge is the gravitation towards larger umbrella organisations due to a perceived correlation between size and compliance, leading to further consolidation of smaller providers. For vendors, the profit margin achieved from the use of umbrella organisations will increasingly become disregarded in financial due diligence, affecting valuations.
Other regulatory changes affecting the sector include the recent judgement by the Employment Appeals Tribunal that Agency Worker Regulations only apply to & lsquo;temporary’ workers, i.e. those with a stated end date in their contracts. This potentially opens a loophole to place workers on open-ended contracts, thus no longer being subject to AWR. Further, with over 1,000 recruitment firms reaching their staging date for pensions auto-enrolment between April and July, the Pensions Regulator has begun to target the sector as part of an in-depth look at compliance issues. The stage is set for 2014 to be a year of challenges and opportunity.
2014 and Beyond: Leaving the Past Behind
Human Capital Q4 2013 M&A Market Review
The recruitment market has changed significantly as a result of the credit crunch and economic downturn. The past years have been hugely challenging times for the sector as a whole and it has most certainly been the worst recession for the industry ever. Clients, given the huge economic uncertainty and drying up of credit markets, halted or slashed hiring projects and there was inevitably significant margin pressure. There has also been a trend to more self-sourcing from clients via leveraging on social media platforms albeit in respect of more generalist types of roles. The survivors who came out strongest all have one thing in common, holding fast to core values of service while re-organising businesses and streamlining processes and internal infrastructures in alignment with the delivery of digital strategies. Many businesses have given greater focus on developing a deeper understanding of client’s needs which has lead to solution based, rather than transaction based, service offerings and as such to a partner position with higher added value to both clients and professional candidates.
One of the keys to success has been the ability to develop and deliver a diversification strategy, entering into new geographies and/or sectors for defensive and/or offensive reasons capitalising on market opportunities that promise greater profitability. A number of smaller and medium sized staffing and recruitment businesses have taken the strategic decision to expand into the emerging markets with strong growth potential. This geographic diversification has proven to be very important given the disproportionate impact of the financial crisis within developed (particularly) Eurozone markets. Furthermore a global presence also enables staffing and recruitment business to search globally and deliver talent domestically, enabling clients to get ahead and providing more opportunities to the professional candidates.
Following the recovery and growth of the US staffing industry, the UK market looks to have turned the corner after last summer (with continental Europe still lagging behind). In the UK, consumers have a positive outlook for 2014 as they expect market conditions to continue to improve. Latest unemployment figures show the UK rate is dropping with permanent hires on the increase. Consumer optimism about job security and opportunities has increased and, according to latest reports, UK job vacancies are increasing at the fastest pace in many years. The UK staffing industry therefore enters 2014 with a positive outlook. The war for talent is about to start in more sectors than technology alone and the landscape is likely to move from a & lsquo;buyers’ to a & lsquo;sellers’ market. The bottom line is that those staffing and recruitment businesses that have been focusing on transforming and adapting their business models in recent years will be best placed to develop and grow.
Expense schemes – Caveat Emptor
Recruitment has always been a fast moving and exciting sector to work in, with lots of client and candidate demands to juggle, but usually the satisfaction of knowing you’ve done a great job helping people and made a decent living as well. Life is, however, getting more difficult, in particular at the volume end of recruitment as both clients and aggregators have pushed agency margins down to sometimes unsustainable levels. Sensing an opportunity, many umbrella organisations and professional advisors have stepped in with their answer, be it a travel and subsistence scheme, a pay day scheme or some other variant. Such providers have made very significant amounts of money, some of which has been passed back to the recruiters as recompense for their involvement. Suddenly the operating margin is greatly improved and all is well with the world&hellip.except, is it? Depending upon how the scheme is devised and operated, the recruiter using a scheme can be setting themselves up to be an Aunt Sally, taking all of the financial risk whilst the umbrella takes the majority of the gains. Recent announcements should act as a warning to users of such schemes.
HMRC say they have shut down a number of schemes and presented the Directors of the recruiters involved with massive personal tax bills, and will pursue their personal assets for recovery. The advisor of course has no liability.
The Minimum Wage Unit of HMRC also say they have successfully recovered large sums for workers whose pay was taken below the National Minimum Wage by pay day schemes, again all paid for by the recruiter.
Schemes relying on self-employment status are coming to an end following the Autumn Statement, but the risk to recruiters following a PAYE inspection will remain for the next six years.
The Gangmaster Licencing Authority has publicly stated they will withdraw the licence of a holder who operates any type of tax scheme, and they have the full support of HMRC to do so.
All this means that life is going to get considerably tougher for recruiters who rely on their profitability through a tax scheme. In the short term, some recruiters face considerable loss unless they act quickly to change their business model. However, I’d argue that this is good news for the industry in the longer term.
For the majority of us who have resisted entering into such schemes, we will again be able to compete on a level playing field by providing good service in a low-risk and efficient manner. The ability to deliver reassurance of compliant supply models will become key. In the face of ever-increasingly complex legal and tax compliance requirements, even the most traditional staffing supply models will require scrutiny.