Merger Monday sees rainmakers return to form
Four major deals in one day could signal a comeback for M&A activity. Richard Northedge reports
Sunday 19 December 2010
It wasn't the size of this week's bids that made the market believe mergers and acquisitions are back in fashion, but the number.
Four deals on one day were enough to earn it the "Merger Monday" monicker, even if they barely add up to one FTSE 100 company's market value. And after a prolonged drought for the City's rainmakers, such a shower of deals proved infectious. BP jumped in value by more than the total of those four acquisitions on rumours that Shell might bid for it.
"We're getting to that time of year when idle speculation can come into play," says Richard Hunter, the head of UK equities at stockbrokers Hargreaves Lansdown, who is a fan of BP on fundamentals rather than as a takeover stock. But he does believe the environment is right for a recovery in takeovers. "Four deals does not in itself mean anything, but the scene is set for further M&A activity in the next few months."
And if Merger Monday's sample shows anything, it demonstrates that this upturn is not limited to any niche in the market. Britain's Yule Catto is paying £375m for a European latex producer while America's General Electric is buying a UK-based oil business operating in South America. Anglo-Dutch Reckitt Benckiser, led by Bart Becht, one of the highest paid corporate chiefs in the world, shelled out for a private Indian pharmaceutical firm while publicly quoted oil group John Wood agreed a $955m purchase of the unquoted PSN.
The only pattern to glean from that diversity of deals is that directors previously scared to seal transactions have stopped prevaricating.
There have been previous Merger Mondays – bidders like to announce offers at the start of the week, having worked through the weekend when leaks cannot upset markets – and there have been bigger ones. In 2006, $90bn worth of US deals were announced at the start of one week provoking speculation that a hectic round of takeovers would follow. Indeed, as markets headed towards their zenith and before the credit crunch struck, bid activity did soar. Barclays and Royal Bank of Scotland outbid each other to buy ABN Amro, for instance.
But since those heady days, M&A deals have been scarce. Some companies are still trying to cope with bids made before the crash at unrealistic prices; others have been repairing their balance sheets. For others, survival has taken precedence over expansion. And for businesses that cut staff and closed plants during the recession, taking over a rival to add capacity makes no sense.
Nor has finance been readily available since the crunch. Companies that raised cash in rights issues did so to shore up their reserves and ratios, not to grow. Banks have been reluctant to lend to business and business has not been keen to borrow either: companies have been repaying loans rapidly to degear their balance sheets and to become independent of their lenders.
The £76bn of bids for UK companies this year is the lowest since 2003, according statisticians at MergerMarket, and the number of acquisitions is even less than seven years ago. The value of bids in 2006 or 2007 was double this year's, and the £102bn of bids made by UK companies in 2010 is dwarfed by 2007's £259bn.
But in recent weeks, several boards have taken the plunge and made offers for rivals. Capital Shopping Centres is trying to buy the Trafford Park retail centre and being bid for by Simon Property of the US, while France's Oberthur has approached UK banknote printer De la Rue.
Mike Lenhoff, the chief strategist at stockbroker Brewin Dolphin, believes the tide has turned for takeovers. "It looks as if the corporate scene is well on the way to recovery and corporations are keeping costs under control," he says. "The motivation is there and the policymakers are giving corporates the green light. It looks like interest rates are here to stay at this level, outside the UK at least. This could be a fertile backdrop for a lot of corporate activity and it's happening at all levels."
If buying at the bottom is the best time to bid, then merger activity should have taken off two years ago. Since then, the FTSE has risen by 50 per cent. "We never know when it's at a low," admits Lenhoff, but, he says, the mistake is not to bid after prices rise simply because they have risen. The art of decision-making is to look to the future rather than the past, and he argues that the outlook looks good from here.
Two years ago, boards could not be sure if company valuations would fall further. Directors could not be sure the economy would turn upward. The volatility of markets made decision-making difficult. But the recovery in the markets and the economy has now given companies the confidence to expand again.
"Corporate activity should be more or less correlated with the stages of the economic cycle and things are beginning to improve," says Lenhoff. Although the Government's austerity programme will hit demand, especially from public bodies, companies think they can now confidently see the direction of the economy. Firms used the recession to cut out waste, improve efficiency and strengthen their finances: they are now ready to move forward again.
Hunter says: "In the light of the financial crisis, many companies acted aggressively in controlling costs and many are sitting on cash piles. The question is what they are going to do with that spare cash. A lot of companies seem to be reluctant to take on more staff until the recovery is proven, but what else are they going to do with the cash? Share buybacks? Repay debt?" Bids can make sense, he says.
Some boards – and some shareholders – are braver than others. Lloyds's takeover of HBOS taught directors the dangers of agreeing deals without doing due diligence and there is still a fear of buying a business that turns out to have black holes. But this year's thwarting of Prudential's plan to buy AIA, the Asian insurance arm of AIG, proved to be a lesson in the dangers of hesitating.
And the brickbats thrown at Kraft for bidding for Cadbury has not deterred other overseas bidders from buying Britain's crown jewels. "There may have been jingoistic noises but that is not enough to stop others going ahead," says Hunter. Since the Americans bought the confectioner, Harrods has been bought by Qataris and the Camelot lottery group by Canadian pension funds.
But with private-equity funds no longer making big bids, public companies face less competition in launching takeovers and are thus more likely to win. The rising stock market means they can offer not only their quoted paper or cash, but they can also issue new shares to raise additional capital.
Yule Catto proved that last week with a £225m rights issue to finance most of its PolymerLatex acquisition. If a report from the Institutional Investor Council is adopted, such share issues could become much cheaper and thus more common.
Issuing shares to existing investors is the fairest way of expanding a company's equity base, but costs that were regarded as too high a decade ago have doubled since the 1990s. The Competition Commission declared the City's underwriting arrangements a complex cartel a decade ago when the cost was only 2 per cent of the sum raised, but recent rights issues have given City firms 5 per cent of the share sale proceeds.
The report from the council suggests more competition and greater transparency of fees will reduce that cost. It concedes companies are loath to shop around when their bankers have them over a barrel to refinance, but if directors are now in sufficiently strong positions to be making bids, they may feel confident enough to shun their existing advisers and choose bankers and brokers offering cheaper deals.
Will the City's enthusiasm for mergers and acquisitions still be there when the Christmas spirit has evaporated? The speculation that sent BP higher quickly ended when the US government sued the oil company, but smaller companies are either looking at what they can buy or building bid defences in case they are prey rather than predator.
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