UK: Consolidation Play In The Recruitment Sector - Market View From A Financier

Last Updated: 10 August 2008

Paul Saunders of Lloyds TSB discusses what serial consolidators are up to in the recruitment sector and his thoughts for the future in light of the credit crunch.

At the start of the year there was a buzz of activity as business vendors tried to sell ahead of the capital gains tax changes, which came into effect on 6 April. Perhaps unsurprisingly, the tight timescales, coupled with widespread negative headlines predicting economic slowdown, threw the majority of transactions off course.

At that time I was working on a deal, which we did not get away, that reflected the impact of an over-inflated valuation and a willing buyer unable to reconcile market forces and reach a compromise acceptable to both parties. I suspect there were similar examples during this very active phase.

From a banking and working capital perspective, the impact of depressed stock market valuations meant we were in an excellent position to offer debt alternatives to enable transactions where underlying future earnings were strong and sustainable.

Feeling the effects

But now we are starting to see the consequences of the credit crunch. There is talk of capital restrictions and liquidity tests to ensure that banks are making the most effective use of their risk-weighted assets (RWA). So how is this likely to affect the recruitment sector?

The sector is, and will continue to be, a consolidation play. Merger and acquisition activity will continue, needing both equity and debt providers to step up and participate. Fortunately, the receivable (the money owed by the end user to the recruitment company for the placement of temporary workers) is the prime asset and offers excellent security for a working capital provider. Estimates suggest that around 60% of recruitment businesses have used or will use a working capital facility at some point. Our experience supports this and, given the inflexible cash outflows typical in the industry, particularly in the temporary placement/ contractor market, invoice finance will continue to play an important role in the funding mix for both listed and unlisted companies.

Stricter lending criteria

In my view, the sector will not be affected materially by the pervading market dislocation. However, given RWA requirements, long-term senior debt may not be as easily available as before or will be priced at a level that turns the finance director's head – perhaps even get it spinning! This will of course depend on future earnings potential and a cashgenerative track record that will continue to allow acquisitive businesses to get the facilities needed to complete a transaction.

What are acquirers looking for?

  1. Synergies with, or relevance to, the occupational sector or sectors in which they currently operate.

  2. High-quality second-tier management.

  3. Opportunities to take out costs and make efficiencies in all facets of operation.

  4. Good financial management and future earnings potential.

  5. Strong back office operation or the ability to influence the performance of, say, day sales outstanding.

  6. A recognised brand.

  7. International footprint.

  8. Contracts with high-quality end users.

We have also seen an expanding interest in buying what may be classed as 'distressed businesses'. They may have Crown arrears or seem to be going nowhere, but have a solid market presence in their location or sector. So the consolidation play will continue to drive activity for the rest of this year.

Forecasting the future

The recruiters I speak to say this year has started well and that it feels like the industry is bucking the trend. But ask a recruiter to predict what will be happening six months from now and they get fidgety. There are some other features that are important to confidence being maintained going forward.

There is still a skills shortage in a number of key areas and the flexibility that higher priced candidates are able to demand will ensure that the IT and technical recruitment sectors remain strong. Although some two years away from implementation, the recent agency workers announcement will make recruiters and end clients consider the implications of workers' rights and the extent to which they will reduce the benefit of flexible resourcing.

Over the last five years procurement functions within the major end-user companies have driven down margins through preferred supplier list tendering. My view is that this is not sustainable. There is evidence of recruiters being dragged into master vendor relationships as second-tier providers – having previously provided services directly to the end user – and then being required to reduce margins. This gets even worse if the master vendor then sits on payments or fails to recover payments because it has to drive out costs to make the contract pay.

Expansion into Europe and the rest of the world continues to provide a hedge against market fluctuations in the UK economy. We have seen evidence in interim market statements that growth in the UK has been lower than forecast, but overseas markets have been performing on or ahead of expectation.

Good prospects for acquirers in 2008

In conclusion, performance in the sector over the first six months of the year has not been the disaster that some people were expecting. Even in the financial space, hiring has continued despite some job losses. There will be consolidation as businesses struggle to preserve value. Those with stronger balance sheets will be able to obtain finance from a market which is hung up with capital adequacy issues but still has a key role to play in the future expansion of the sector. The recruitment sector grew by more than 7% last year and will, I believe, again show year-on-year growth in 2008.

My advice to acquisitive listed companies in the current climate is to participate as there will have to be a reality check by sellers on value, resulting in great opportunities. The downside of course is that sellers who can afford to wait will wait! Finally, use a financial partner who knows the sector and is prepared to be innovative to enable the transaction to complete.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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