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Gambit publishes Human Capital M&A market review

Key observations from this quarter

Transaction volumes increased 11% on the previous quarter and were 21% up on the comparable period in 2013, a sign of the continuing confidence and appetite in the market.  This is a trend we expect to continue during 2014 as buyers and sellers take advantage of opportunities available in terms of benign market conditions and attractive multiples.  Acquisitions continued to dominate transaction activity with specialist areas such as IT, Engineering and Energy attracting particular interest in addition to online businesses which represented 9% of all transactions. 

Notable transactions this quarter included Impellam’s acquisition of Career Teachers Limited, a specialist education recruitment business to complement Celsian Education and LinkedIn Corporation’s acquisition of, a job search start-up which has developed an algorithm to evaluate a job seeker’s match for a particular job and, at $120 million, its largest acquisition to date.  There were a number of positive market signals during the quarter. 

Unemployment fell by 77,000 taking the jobless rate to 6.9% for the first time since 2009.  The REC Report on Jobs published in March revealed that permanent placements rose at their fastest rate for four years in February with growth across all sectors and regions.  March saw the fastest rise in permanent salaries since July 2007.  In terms of trading updates Hays produced another impressive set of results seeing its strongest quarterly growth for six years.  This was underpinned by 14% like-for-like growth in the UK and Ireland, driven by a growth in permanent fees of 25%. 

Robert Walters delivered a 21% growth in UK net fee income compared to the same quarter in 2013 with Matchtech continuing its strong trading performance with an increase in net fee income of 19% for the six months to January 2014.   Human capital companies have continued to deliver good returns in the equity markets with share prices increasing by 13% during the quarter.  A number of quoted companies have stated their strategic objective of delivering acquisitions during 2014 to achieve growth plans.  Rising share prices, a continuing improvement in market ratings through increases in EV / EBITDA multiples and available cash enables such companies to pay a full market price for such acquisitions and still be earnings enhancing.

Summary: Favourable M&A conditions are expected to continue for mid-market Human Capital companies...

To acquire: The outlook continues to improve and conditions are ripe for consolidation as key players with capital to deploy continue to acquire and vendors begin to explore exit options

Private equity:  Human Capital continues to be attractive to private equity investors evidenced by current levels of deal flow. We expect to see specialist sectors such as IT and healthcare attracting particular interest in the coming months

Financing:  The debt market remains challenging, with leverage remaining difficult to obtain and margins still above long-run average. Greater flexibility exists from alternative debt capital markets and structures including higher leverage and longer maturities

Where are we in the human capital valuation cycle? 

There is a widely held belief by business owners and investors that valuations in the human capital sector broadly follow a seven year cycle.  We consider the validity of this below in the context of historic data and current market conditions and assess the implication for businesses.  

The human capital sector has started 2014 in a buoyant mood with unemployment continuing its fall, permanent placements and salaries on the increase and corporates in a positive frame of mind both in terms of appetite for investment and M&A activity.  This sentiment has been enhanced by a series of strong quarterly trading updates from a number of public interest companies with significant operations in the UK.

Whilst all this is undoubtedly positive news for human capital businesses, cyclicality remains a key issue for companies operating within the sector.  The prospects for the sector are inextricably linked to the wider economic cycle through business confidence levels, corporate investment and employee turnover.  The key challenge for companies and shareholders is predicting where the sector is in its cycle and the optimum time to be making decisions on M&A activity. 

The chart below tracks valuation multiples against EBITDA levels of public interest human capital companies over the last 20 years.  As the chart highlights, the colloquial seven year valuation cycle in the human capital sector is seemingly well established and predictable.  Whether the cycle is seven years or nine years is a moot point and this will vary by sub-sector.  The data suggests that, whilst valuations will continue to increase in the short term, we are one to two years from the next peak in the general market.

With the current recovery based largely upon a somewhat fragile economy and economic downturns becoming increasingly difficult to predict, correctly anticipating the timing of the next peak is of critical importance.

So what are the implications for shareholders looking to realise value from their investment or acquirers looking to increase scale or differentiation?

For owners looking to sell, maximising value from an exit is of profound importance as a one-off opportunity to generate a return from years of commitment and sacrifice.  Valuations are on the increase and this is expected to continue for the next 12 months.  For certain specialist sectors such as oil and gas and engineering, the current multiples being paid in excess of 8x EBITDA do not appear sustainable in the medium term and the peak may well have occurred.  A significant number of shareholders have held on in recent years waiting for market conditions to improve.  For such individuals the choice is clear – realise value now to take advantage of the rising tide in valuations or defer and gamble on the next cycle.

In terms of acquirers, conditions are ripe for acquisition activity as corporates with high levels of capital to deploy look to increase scale and differentiation, both key drivers of valuation.  There is also increasing pressure on a number of mid-caps to deliver growth in shareholder value through improved market ratings which will further drive activity levels.  Acquirers do not want to be seen to buy at the top of the market, so for corporates, attention needs to be given to reviewing acquisition criteria and priorities at the earliest opportunity, given the lead time needed to find a suitable target and execute a transaction.

There is no need to panic but whether or not you are looking to sell or acquire in the short term, the next few months will be a critical time to carefully review strategic plans and objectives and to formulate an acquisition or divestiture strategy.

Human Capital Industry Overview 

The market has started 2014 where it left off in 2013.  There is a palpable sense of optimism across the industry in the face of positive economic data, companies looking favourably at investment in infrastructure and headcount, increasing appetite for transactions and a continuation of the upward trend in share prices and valuation multiples.  First quarter trading updates from some of the leading recruitment companies leave little doubt that the recovery in the UK market is well established.  The Budget included a number of measures that will impact the sector including proposals to support 100,000 more apprenticeships for young people.  This is inevitably good news for the youngsters concerned and is a help to SMEs, as it will subsidise wages costs while the individual is in training.  Whilst this has been widely welcomed by the industry, there is a feeling that the measures announced could have gone further by way of additional tax breaks to help 16-24 years olds in particular who are three times more likely to be unemployed that the rest of the workforce.  In terms of other announcements, it was no great surprise that the Chancellor announced the Government’s intention to review the rules underlying the tax treatment of travel and subsistence expenses.

On the subject of travel and subsistence claims the ruling in the Reed case announced last month has sent a warning note to companies operating umbrella arrangements.  The Upper Tax Tribunal upheld the ruling in 2012 that PAYE and NICs should have been paid on the entirety of salaries (including expenses) paid to Reed’s directly employed temporary workforce between 2001 and 2006.  For any organisations operating such schemes the key aspects of the case centred on the ability of the employer to demonstrate a mutuality of obligations between worker and employer both during and between assignments.  Further, the need to fully disclose the details of any schemes to HMRC at the time of seeking any dispensation to avoid this being re-opened at a later date.  Adding to the already significant regulatory burden on companies operating in the sector the Onshore Employment Intermediaries Legislation came into effect on 6 April.  The government has received a number of submissions from leading industry bodies which has resulted in some concessions, including delaying the introduction of reporting requirements and associated penalties until August 2015.  In addition, the potential personal liability for directors of staffing companies or managed services providers for the PAYE and NICs of workers supplied by them has been removed in the event that fraudulent documents are provided by a client or provider indicating that PAYE and NIC has been deducted elsewhere in the supply chain.

The Recruitment Sector – Like it or not, you cannot ignore it

With the size and reach of the recruitment sector and its impact on the wider economy, you cannot ignore it.  Clients, candidates, employees and investors all have a vested interest in the prosperity of the sector. With the P/Es for UK listed recruitment businesses ranging from under five to over 21 and EV/EBITDA multiples of between 4.3 and 18.1, it is clear to see that investors either like it or hate it.  2014 looks like being the start of a boom period for the recruitment sector having ended 2013 on an upbeat note with transaction volumes increasing by 23% during the year and a 63% increase in share prices.  As public confidence increases, businesses expand and look to invest in their infrastructure and workforce.  According to the recent REC report on jobs, permanent placements rose at their strongest rate for four years in February.  The share prices of a number of stocks in the sector have grown rapidly as investors see the potential for growth.

There are significant drivers for consolidation in the market and mid-sized firms such as Pertemps, Staffline and Fircroft have declared their ambitions to break the &pound1 billion turnover mark for the UK.  Quoted companies including Hays, Adecco, Impellam and Randstad’s turnover are already over or close to the &pound1 billion mark in the UK.  With the total UK market reportedly at c. &pound26 billion, larger businesses continue to dominate in the UK.

Scale and differentiation continue to be key attributes which drive valuation and market ratings.  Investors are attracted by size as this creates stability of income and earnings over a longer period outlook, with diversification adding an ability to spread risk across geographies and service offerings.  Scale and differentiation are attractive to clients as recruitment businesses can provide a one stop shop to deliver all of their recruitment needs.  International clients want procurement on a global scale, but even small clients now want a joined up recruitment process.

Large recruitment businesses have expanded their online channels of communication, using social media to reach their audiences, to engage with clients, candidates and employees and to add value.  Recruitment firms have learned to become experts in change management to ensure that organisations maintain the talent and skills that they need.

People employed in the sector seem to love working in it.  Seven of this year’s Sunday Times 100 Best Companies to Work For were recruitment companies as were 20 of the 100 Best Small Companies to Work For, including three of the top five.

Candidates appear to love the sector, with reportedly over one million temporary workers currently registered with recruitment businesses.

There is no doubting it is going to be a very interesting few years for the recruitment sector and its various stakeholders.


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