You can bank on some more mega mergers yet

The Jonathan Davis Column
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It was without question a tale of two big corporate deals in the stock market this week - one that looks like working well and the big one which fell to earth. Wednesday's announcement of a tie-up between Commercial Union and General Accident is one of those deals, like Lloyds/TSB, which seem to make such obvious and logical sense that you wonder why it has taken so long to happen. You don't need a business degree to see that there are potential benefits to be had from pooling two long-established companies which are experiencing growing competition and need to attack both their revenue and cost structures if they are to generate better returns.

It won't make them better companies per se (General Accident already, rightly, has the reputation for being quicker to adapt to the tougher new industry environment than the much sleepier Commercial Union), but it will give them a fresh opportunity to get their act together more quickly than they could do on their own.

The trick, of course, has been to bring the two sides together in a harmonious way. It is interesting to see that the companies were advised respectively by Morgan Stanley and Goldman Sachs, a sign of how rapidly the American investment banks are moving into a lead role in UK corporate finance. Even a few years ago, the idea that two of the biggest US investment banks should be taking the lead in such a deal would have been unthinkable.

The Glaxo/SmithKline Beecham saga is a more dramatic, if less savoury, story all round. Viewed from a broad international perspective, the case for a merger was also clear cut, and one reason why the deal was greeted so favourably by the market, which marked both companies' shares up by handsome margins when it was announced - a reversal of traditional City experience, which holds that only one side normally benefits from a big merger of this sort.

The fact that the deal has unravelled so abruptly, ostensibly because of arguments between the two companies about which management team should command the lion's share of the top jobs, is a useful reminder that the momentum towards big company mergers and acquisitions is not quite as inevitable as the investment bankers would have you believe.

It has left the management of SmithKline Beecham in particular looking vulnerable. Having pulled out of one merger deal, with the American company American Home Products, in order to throw in its lot with Glaxo Wellcome, the company is now in a state of limbo - publicly advertising the fact that it needs to combine with another large company, but seemingly unable to bring such a deal to fruition.

Barclays, which has allowed itself to appear as if it is desperate to strike a deal with a rival bank, is in danger of finding itself in a similar hole.

From an investor's point of view, the run of big company deals - both successful and abortive - is important. It is no accident that the three sectors where most of the big deals have been happening are pharmaceuticals, banks and insurance. These are precisely the sectors which, as I mentioned last month, have been leading the advance of the FTSE 100 index for most of the past 18 months.

The three sectors accounted for more than half the index's advance last year and are, in essence, the reason why the Footsie index has so massively outperformed the small and medium-sized sectors of the market for most of that time. This trend, as my chart shows, has continued in the first few months of this year.

If the run of deals dries up, then the market is likely to suffer a hangover, just as it did the day after the Glaxo/SmithKline merger was called off. But my view is that we are not yet finished with the consolidation process, certainly in banks and insurance. Nils Taube, Lord Rothschild's stock market adviser and one of the shrewdest investment brains around, has been skewing his funds towards the financial sector for at least two years. As manager of one of the best performing European funds over the last 30 years, who brings a genuinely international perspective to his stock selection, he was one of the first to see that pressures which were driving banks and insurance companies to combine were bound to persist.

As long as the drive towards European integration persists, that pressure will also persist. Like Anthony Bolton of Fidelity, another leading fund manager, Taube has demonstrated that there is an awful lot of money to be made by picking up early on a broad theme of industrial change and running with it as long it persists.

If it does persist, you can be certain that several of the recently demutualised building societies and insurance companies will find themselves in the way of a bid or a merger proposal. Don't rush, in other words, to take your profits on those windfall shares, despite their strong gains since flotation. As we learnt this week, while the drive towards consolidation in the drugs industry has faltered, the trend is still very much alive in financial services.

'Money Makers' by Jonathan Davis, a study of Britain's most successful professional investors, has just been published by Orion Business Books at pounds 20. To order a copy at the specially discounted price of pounds 15 (including postage and package) call 01903 736736, quoting the reference number MMJD.

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