What’s driving mergers and acquisitions growth?
Mergers and acquisitions action is on the up, reports Ian Harper, but what's driving it?
Mergers and acquisitions (M&A) are back on the menu.
Over the past few weeks, Heinz and Kraft have agreed in principle to combine the two businesses, to create the fifth largest food and beverage group in the world, with revenue of around $28bn (£19bn). The deal to link up Heinz – best known for its iconic baked beans and ketchup – with Kraft, which owns Maxwell House coffee, Jell-O and Philadelphia cream cheese among other top brands, was brokered by private equity stakeholders led by arch-investor Warren Buffett.
Meanwhile, Royal Dutch Shell announced an agreement to buy oil and gas exploration firm BG Group in a deal that values the business at £47bn, creating a combined company with a market cap that could top £200bn.
Aside from the headline-grabbing megadeals, activity is heating up in the market generally. European deal volumes for H1 2015, according to the recent Deloitte M&A Index, look set to be 8 per cent up on the same period last year, with the Index recording $583m (£399m) worth of deals by 18 March.
BCMS has seen evidence of this in the number of deals completed year on year, coupled with a noticeable increase in deal size over the last two years
Deloitte says Europe is emerging as the preferred target region for inbound acquisitions, with the lion's share in the technology, media and telecommunications (TMT) sector. The key drivers are the decline in oil prices, dollar appreciation, the rise of China as a global player in M&A and pressure from investors to focus on top-line growth, the company says.
In the UK, the recently released Mergermarket 2014 UK Trend Report noted that UK M&A hit a post-crisis high value during 2014 after a relatively flat five-year period.
Some 1,338 deals worth £94.4bn accounting for 17.5 per cent of the total European M&A value (£539.3bn) were completed in 2014, and while the UK wasn't the most targeted country (France was), the total UK M&A value rose 23 per cent compared with £76.7bn in 2013.
However, in terms of deal count, the UK was the main focus, with 1,238 deals or 21.4 per cent of all European deals – some 500 more than second-placed Germany.
UK M&A growth factors
According to Colin McLean, managing director of SVM Asset Management: "In the UK, small and mid cap businesses see the potential to improve liquidity and spread their share register. In some areas, there are a lot of private businesses for sale or demergers from larger groups. I think the latter is probably the biggest factor, as investors like to see purer businesses or think that the dull growth of the biggest groups can be addressed by re-focusing – for example, Glaxo."
With growth being scarce, he says: "Companies are looking for ways to acquire stuff to rationalise, or to improve ratings and growth by dumping non-core or slower growth/lower margin divisions." Examples he cites include Clarkson, the world's largest shipbroker, buying its rival, RS Platou ASA, and the Newport- based Martin & Co buying L&G's estate agency business.
At BCMS, the top-ranked international sell-side adviser for 2014, Jonathan Dunn, MD of the major transactions team, says one of the main drivers is rising business confidence. He says: "BCMS has seen evidence of this in the number of deals completed year on year, coupled with a noticeable increase in deal size over the last two years."
The pharmaceuticals sector has been particularly fertile for M&A along with telecoms and healthcare
Other drivers, he says, include the desire to secure a footprint in a new market or rapidly scale up operations in an existing market, such as the January 2015 acquisition of TEW Engineering Ltd by NASDAQ-listed LB Foster Inc.
Jonathan adds: "Access to new technologies, products and services is likely to underpin strategic acquisitions in 2015. For example, the expansion into a synergistic field of food processing... was the rationale given by German organisation Probat when it acquired Scottish manufacturer Ladco Group."
He says that while US corporates have been "active acquirers of UK businesses" partly due to US legislation, which requires them to pay 35 per cent to repatriate profits made overseas, this may be less of a factor in the future.
As he explains: "The Obama administration has outlined plans to introduce a one-off levy of 14 per cent on corporate cash held offshore, followed by a 19 per cent tax on future earnings. Time will tell what impact this will have on the appetite US acquirers have for UK companies. In the meantime, there is no let-up in demand."
Richard Bolton, Head of Corpfin at Experian, says: "The pharmaceuticals sector has been particularly fertile for M&A, along with telecoms and healthcare."
Jonathan notes: "We've seen a noticeable increase in the appetite for niche manufacturing businesses, particularly those that employ 'hard to replicate' processes or supply products that cannot be made elsewhere in the world at a lower cost. Alongside UK manufacturers, engineering firms have been prized by international acquirers looking to expand their operations. In the UK, service sector businesses have also enjoyed significant acquisition interest, making up close to 20 per cent of BCMS deals in 2014."
The government has been championing the Uk as an attractive investment by ensuring corporation tax rates are competitive
One "hot service sector" prediction for 2015, he says, is recruitment "which is seeing lots of M&A activity".
Rod Mathers CA, corporate finance partner with Henderson Loggie, says many acquirers have gone after businesses that complement their core activities: "Given the difficult experiences of the last five years or so, companies have been concentrating on their core business. I see this focus continuing to dictate the pattern of activity in the immediate future."
Rod says this means that, in practice, "large corporates are seeking acquisitions of technology businesses to improve internal processes, drive cost reduction and give them competitive advantage".
Why is the UK M&A-friendly?
Market conditions aside, legislation and tax are playing a key role. Jonathan Dunn says: "In general terms, the UK provides a highly stable legal, fiscal and political environment in which to do business. The UK also displays none of the protectionism that can be seen in other developed economies, in stark contrast with France, where both GE and Siemens encountered difficulties in their attempts to acquire Alstom in 2014."
Ewan Grant CA, a partner in Baker Tilly corporate finance, says: "The government has been championing the UK as an attractive investment for foreign purchasers and, indeed, domestic ones by ensuring corporation tax rates are competitive compared with other countries. With corporation tax low, new guidelines around GAAR [the General Anti-Abuse Rule], TUPE [Transfer of Undertakings (Protection of Employment) regulations] and tax allowances on profits achieved from new patents under the Patent Box scheme, the UK continues to be an excellent investment for foreign purchasers."
Borrowing to acquire is still a challenge, given where the banks are. The companies with the cash may be stealing a bit of a march, and getting in on the best deals
How are deals being funded?
Keith Anderson CA, MD and head of corporate broking at Investec Bank, says that the public markets have taken some business away from the mainstream M&A market as private equity houses have looked to dispose of their assets through initial public offerings (IPOs), rather than sell to trade buyers, over the last 24 months.
He says: "A number of slated IPOs have ultimately gone down the trade sale route, such as MandM, Trainline and Wood Mackenzie, but the willingness of investors to pay up for IPOs has brought some added competition into the M&A market."
Ewan Grant says access to capital is better than it has been for some time, "with many private equity houses being open, and genuine, about the size of their war-chests and eagerness to spend, if the price is right".
He adds: "The banks are also playing a strong hand in funding appropriate transactions and many corporates are finding support for M&A where previously there was none."
Richard Bolton at Experian says: "Debt is cheap, with historically low interest rates, and much more readily available than it has been, for the larger corporate players at least. Many companies are still sitting on substantial cash reserves having shored up their capital position post-recession. Businesses feel confident in making high-value transactions and deal multiples are currently very high."
He adds that vendors are increasingly open to more diverse deal structures and deal types, typified by the purchase of 100 per cent of the shares in a limited company, or its trade and assets, usually by an incorporated private or public company.
Lyn Calder CA, corporate finance director at Johnston Carmichael, says: "While there are still some good bargains available in the market, multiples are definitely rising from where they were a couple years back. Where an acquisition is delivering a strong strategic fit for a purchaser, we are, in some cases, seeing significantly high multiples."
Gareth Magee, partner with Scott-Moncrieff, says that current conditions favour companies with cash: "Borrowing to acquire is still a challenge, given where the banks are. The companies with cash may be stealing a bit of a march and getting in on the best deals."
where an acquisition is delivering a strong strategic fit for a purchaser, we are seeing high multiples
Outlook for deals
Colin McLean is positive: "Prospects look good. Bigger investing institutions need to increase mid cap exposure, and are not clear they will get that from mega cap [companies]. The performance difference between mid cap and mega cap encourages funds to share in deals and IPOs of mid cap companies and those in the lower half of the FTSE 100."
Jonathan Dunn believes large infrastructure projects will have a trickle-down effect on SMEs in related sectors, building confidence and creating employment. He says: "UK infrastructure, with its need for continuous investmentand maintenance, will continue to stimulate acquisition demand. Accordingly, those companies active in developing or maintaining infrastructure should attract higher valuations."
He adds: "Construction M&A is also resurgent, as both companies and suppliers benefit from the upswing in activity in that space since 2012. This is most pronounced in the south-east of England."
Rod Mathers says: "Banks are lending money again, albeit on a more prudent basis. Un-invested private equity and venture capital money is at an all-time high, and there is an active angel investment market. Combined with the fact that companies are performing better and have confidence to invest in growth plans, plus a proactive adviser community, the M&A deal market is looking positive for 2015.
Ian Harper is a Freelance Business Journalist. This article was first