UK M&A: what is driving the pick-up in activity?
There has been a marked increase in bids from overseas companies underlining the relative valuation opportunity offered by the UK equity market.
The start of 2018 has been a record one for announced global mergers and acquisitions (M&A)1, and the pick-up in UK activity has been equally striking, with year-to-date UK M&A values (ending May) the highest ever. Counter to the rising tide of protectionism, there has been a surge in cross-border activity. UK-quoted companies have attracted a significant amount of overseas bid interest, including approaches from US, Japanese and European companies.
FTSE 100 targets have included the broadcaster Sky, which has attracted a proposal from US cable group Comcast (to rival the existing one from 21st Century Fox) and specialty pharmaceuticals company Shire, which has recommended an offer from Japanese peer Takeda. Investors in UK equities have also welcomed a steady stream in the year to date of new foreign interest for FTSE 250 companies2.
Following several quarters of robust global growth, executives are generally optimistic about the future and in expansionary mode, and the availability of credit to fund deals remains strong. Uncertainty around the UK’s long-term relationship with the EU following Brexit has created very favourable conditions for them to acquire world-leading UK-quoted companies.
The weak domestic macroeconomic outlook resulting from Brexit has seen many international investors shun UK equities. This has resulted in their relative underperformance (see chart below) and the market’s valuation is now very attractive versus other major regional stockmarkets. Sterling weakness has also been a spur to potential overseas buyers.
Fund manager view
Alex Breese, UK Equities, says: “Due to the uncertain domestic macro outlook the UK stockmarket remains significantly out of favour with global asset allocators. As a result of this extreme negative sentiment, relative valuations are very low. It is these attractive valuations, combined with sterling weakness and the low cost of financing, which are proving so enticing to overseas buyers and consequently we have seen a marked increase in corporate activity in the year to date. We believe that this trend is likely to continue whilst these conditions remain in place.”
The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Past performance is not a guide to future performance and may not be repeated.
M&A pick-up in context
The steady flow of interest for FTSE 250 companies has included recommended bids for financial technology businesses NEX Group (which owns unique and strategically attractive capital market infrastructure) and Fidessa, a trading software provider. At one stage, Fidessa had confirmed competing interest from three overseas parties.
Selective investors are seeing opportunity too, with activists disclosing stakes and global private equity groups making approaches for UK-quoted companies.
The above is a timeline of FTSE 350 companies which became the subject of new bid interest in the first quarter of 2018. In the majority of cases the interest was from potential overseas trade buyers. It is highly uncertain how much of this, or the other bid interest disclosed since the end of Q1 will translate into completed transactions, or what the final value of any transactions will be.
A number of the potential deals confirmed in the year to date remain at a preliminary stage. Whether a bid interest progresses far is subject to a whole host of uncertainties and, in many cases it falls away at an early stage (International Paper of the US has withdrawn its interest for (Irish) FTSE 100 packaging firm Smurfit Kappa, as has French shopping centre owner Klépierre for UK-quoted peer Hammerson). M&A transactions need to pass through multiple stages, meaning that lead times can be extremely long – rumours relating to the 2016 acquisition of SABMiller by Belgium brewer Anheuser-Busch(AB) InBev first began circulating in 2013.
The below graphic from the Office for National Statistics (ONS) provides some long-term perspective. It is based on transactions involving UK companies, and tracks completed inward M&A totals since 2000, breaking out the contribution of the four very-high-value transactions (valued at more than £10 billion) in 2016. These very-high-value transactions included the purchase of SABMiller by AB InBev, the acquisition of chip designer Arm Holdings by Japanese technology group SoftBank and the purchase of BG Group by Royal Dutch Shell, which ONS classifies as a Dutch company3.
Economic activity waxes and wanes and the period of time in which an economy moves from a state of expansion to one of contraction, before expanding again is known as the economic, or “business cycle”. Many major economies have experienced a long period of uninterrupted growth and, as a result, seasoned market participants are on high alert for any signs of irrational exuberance, such as frenetic levels of M&A – such exuberance tends to feature late in the business cycle.
Equity markets also tend to approach their peaks late in the business cycle and so the longevity of the current bull market could also be seen as a potential source of concern. Announced global M&A (and, according to the ONS data, inward UK transaction values) were elevated in 2000 and 2007, respectively at the height of the dotcom bubble, and in the build up to the global financial crisis.
Fund manager view
Sue Noffke, UK Equities, says: “Although Brexit has unnerved some international investors, others are attracted by the combination of the valuation opportunity and relatively weak level of sterling. These are undoubtedly the factors that have given rise to the pick-up in corporate activity. There have been a number of high profile takeover approaches for UK businesses, the majority of which have come from overseas predators, as well as a number of stakes taken in UK plcs by activist investors. On a cautionary note, M&A often becomes a more prominent feature as the business cycle becomes more mature and corporates start to exhaust their organic growth opportunities, while also wanting to make the most of readily-available cheap debt financing.”
The recent burst in announced global M&A does not amount to a sell signal, but instead reflects a catch-up effect, says Citi Research. Despite the record-breaking start to the year, Citi finds that announced M&A relative to aggregate global market value still remains well below previous market peaks (see chart below).
1. Mergers and acquisitions, or M&A for short, is a general term that refers to the consolidation of companies or assets through various types of financial transactions. ↩
2. The next most established tranche of companies quoted on the London Stock Exchange outside of the FTSE 100.↩
3. See https://www.ons.gov.uk/businessindustryandtrade/changestobusiness/mergersandacquisitions/bulletins/mergersandacquisitionsinvolvingukcompanies/jantomar2016↩