The vast majority of UK midmarket venture capitalists expect the volume and value of mid-market transactions to increase or at the very least stay the same over the next twelve months, according to a survey conducted by Grant Thornton Corporate Finance.
For the fourth consecutive quarter, the majority of VCs said they expected the highest returns from their investments in the business services (20 per cent), healthcare (15 per cent) and financial services (11 per cent) sectors.
However, clipping at the heels of financial services, perceived returns from the IT sector have shown a marked increase. Just two per cent of VCs predicted this sector would generate the greatest levels of return back in first quarter of 2004 compared to nine per cent today.
"The outlook for private equity investors is clearly very optimistic", said Tony Dunn, partner at Grant Thornton Corporate Finance in Birmingham.
"UK M&A activity is at its highest level for ten years, and private equity has undoubtedly been a major driver in sustaining such upbeat deal activity. Having achieved some lucrative exits in 2004, VCs will be entering 2005 in bullish mode and aggressively scouring the market for new investment opportunities.
" Whilst private equity houses will not be throwing caution to the wind, buyers continue to outnumber sellers which is creating competitive trading conditions and good prices.
" Healthcare, business services and financial services have in recent years been the primary hunting grounds for private equity houses. In particular, financial services has recently seen a huge rise in popularity, which is reflected in the fact that almost a third of VCs expect deals to come from this sector. However, the re-emergence of interest in IT illustrates that VCs are starting to expand their horizons and explore new industries for investment in 2005.
"Having had their fingers burnt during the dotcom boom, a lot of investors have shied away from the IT sector and interest in this market dipped somewhat. However, our statistics bear up to the fact that there is now renewed interest in this area.
"The recent IPO of Google has only served to raise awareness of the returns that can be made in the computer activities sector, and as corporate profitability remains strong in the UK, businesses will be more amenable to upgrading computer systems. This will further bolster the recovery of this sector."
VCs expect the financial services (29 per cent), healthcare (14 per cent) and retail (12 per cent) sectors to show the greatest level of consolidation during 2005. Within healthcare, care homes were tipped as the most likely sector to see consolidation (67 per cent), as evidenced by recent deal activity, followed by private hospitals (17 per cent).
With regard to retail, the non-food sector was singled out for consolidation with the vast majority of private equity investors choosing this (90 per cent) over the food sector (ten per cent).
Commenting on the consolidation of the healthcare and retail sectors, Mr Dunn added:
"The healthcare sector has been ripe for consolidation for some time now.
"Care homes still occupy a very fragmented market, but are nonetheless a very sought after investment due to robust revenue streams, strong asset backing and the increasing longevity of the UK population. Care homes and retirement complexes fetched some excellent prices during 2004, but without a platform investment, they can be a hard market to break into.
"The recent announcement that Bupa is planning to dispose of 15 of its hospitals highlights the increasing investment opportunities within the private hospital market too.
"Looking to the retail sector, softening consumer spending and rising interest rates have hit pockets of the industry very hard. Weak Christmas trading for a number of retailers and burgeoning levels of personal debt is leaving some smaller retailers vulnerable to the advances of the larger players.
"The stage has been set for some attractive deals in 2005. The accessibility of bank debt, strong corporate profitability and lighter portfolios will ensure that venture capitalists are eager to transact."