Earlier this month the Office for National Statistics announced that the UK economy dipped into recession, having contracted for the last two quarters of 2023. That is not an encouraging start to the prospects for 2024. However, although there are undoubted challenges in today's economy, it is clear to me that there is good reason we should nevertheless remain upbeat.
Following the private equity "chill" which set in after the Truss-Kwarteng budget in autumn 2022, many M&A market observers were expecting that this new year would see us emerge into a run of positive activity. Despite a number of acquisitions being spoken about and Term Sheets in circulation, that might now be judged overly optimistic.
Some larger London corporate firms have actually cut back their M&A teams, which does not demonstrate much confidence in their home markets, and a quick canter through some of the current issues gives a sense of the headwinds. Firstly, interest rates are running at comparatively high levels (The Bank of England base rate is sitting at 5.25%), so acquisitions involving leveraged debt are more expensive.
Secondly, geopolitical uncertainty is significant. Despite some concerns that the tragedy unfolding in the Israel-Gaza conflict might spill-over into a broader conflict in the region, that seems to have been avoided so far – but diplomatic tensions remain high. Similarly, the Russia-Ukraine war grinds on mercilessly, meaning that Russia remains frozen out of trading activity with the West and any prospects for inward investment into Ukraine are still remote for now. The upcoming US election is characterised by increased polarisation and both of the presumptive candidates, Biden and Trump, are focused on their domestic issues.
The pros and cons of the UK leaving the EU continue to be discussed at length. Goldman Sachs estimates (according to its report published on 14th February) that Brexit sliced about 5% off UK economic growth, as we "significantly underperformed" against comparable advanced economies. The EU itself only narrowly avoided recession in the second half of 2023.
So why is there cause for optimism?
Firstly, the energy sector remains a hot spot of activity. For example, the largest reported M&A deal (in terms of value) in Scotland in 2023 was the acquisition by Repsol of the 49% minority shareholding in its UK joint venture from Sinopec for around USD 1.1 Billion. Aberdeen-headquartered Ithaca Energy completed its IPO and premium listing on the London Stock Exchange at the tail-end of 2023 at a headline valuation of £2.5 Billion. So, despite industry concerns about the fiscal situation (the Energy Profits Levy, in particular), the UK oil and gas industry remains a robust success story and we are working with many Scottish oil services companies as they internationalise their native Scottish expertise and class-leading engineering skills, especially into the Middle East.
As regards the Energy Transition, the potential for offshore wind in particular has been recognised since before former Alex Salmond, then the First Minister, said that "Scotland could be the Saudi Arabia of renewable energy" in 2008. We are seeing meaningful volumes of deals now trading renewables assets, including onshore windfarms, as infrastructure investors place their bets for the medium-to-long-term. Initiatives such as the Energy Transition Zone in Aberdeen are also giving physical form to the innovation being fostered around renewables, hydrogen, carbon capture and adjacent activities which will help achieve the necessary net zero carbon target. If we get all the structural aspects right to support the Energy Transition eco-system, there is the potential that Scottish companies could be global leaders into the next century. The support provided by the Net Zero Technology Centre and Opportunity North East deserves special praise in this regard.
Secondly – and relatedly – the technology sector is Scotland's beating heart of innovation. As I have written previously, the degree to which all modern businesses are underpinned by technology is obvious. Both private equity and trade deals in the software and broader IT services sectors therefore remain strong, with healthy multiples – especially for companies that have a software-as-a-service offering. The stickiness of these recurring revenues remains very attractive to investors and acquirers. If current initiatives are successful in ensuring that the next generation of kids have good STEM capabilities, then these are industries that will provide manifold opportunities. We are currently helping a large number of energy tech companies in a variety of sub-sectors to build out their commercial operations and maximise value.
In conclusion, while deals may take longer to complete due to the desire to mitigate risk by extensive due diligence and earn-out structures; while the cost of capital may be higher than in the recent past; and while increased regulatory burdens, such as the National Security and Investment Act, lengthen deal timetables, deals are still getting done and by focusing on the key sectors of the future, Aberdeen can transition from being the oil capital of Europe to being the poster child for the Energy Transition.
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