Hamish McRae: Nationalists, take note: there's no end in sight to the cross-border merger boom

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The Independent Online

We are seeing a wave of international takeovers - and it looks set to run for some time yet.

Some of these have created political fallout. The main headline grabbers have been the Dubai Ports World bid for P&O, which controls a number of ports in the US, and the Mittal Steel bid for Arcelor, which is a big employer in Luxembourg, Spain and France. But E.ON, the German power utility, is also causing a storm in Spain, where it is seeking to buy Endesa. And were Russia's Gaz- prom to use its financial muscle to buy foreign companies (and there have been rumours of a bid for Centrica of the UK), expect even more of a row.

Of course, cross-border takeovers create tensions that those within national boundaries do not. But now the proportion of foreign bids is growing and the new economic giants of India and China are starting to emerge as potential suitors.

We are going to see much more of this for several reasons. One is that there is a lot of money around: companies worldwide are cash-rich and can borrow at very low interest rates. Another is that alternative investments appear unattractive, for the corollary of being able to borrow cheap is that you get very poor returns on that spare cash. Yet another is that national savings have built up in East Asia, creating a new pool of liquidity that will eventually seek better returns.

So companies seem cheap, particularly so in the UK. The first graph shows price/earnings ratios for four major markets at the end of the past six years, and two points emerge.

One is that every market is vastly better value on this measure than it was in 2000.

The other is that the UK market, at 13.9, has the lowest p/e ratio at the moment, so in this sense it offers the best value. That leads to the question: why is it so cheap? FTSE 100 companies get rather more than half of their earnings from outside the UK, so buying our shares is more about buying prospects for the world economy than it is a bet on Britain. In any case, the UK has grown more swiftly than most other countries through the past six years, so there would be no obvious reason for under-rating it - if anything, the reverse.

Part of the answer lies in the forced selling of British shares by UK pension funds. In order to meet regulatory requirements and be sure of meeting their liabilities, UK funds have had to switch to other assets, particularly bonds. The effect has been to put a downward pressure on share prices that other markets have not suffered.

Pension funds have probably completed most of this switch by now, removing the pressure and allowing the market to start recovering again. However, the whole process been unfortunate, to say the least. Over the past century, equities have proved a vastly better investment than bonds, as the right-hand graph, from an ABN Amro study on global investment returns, shows. Given a record like that, it is hard to believe shares will now do worse than bonds over the next 100 years.

If, however, this is tough on pensioners and companies with final salary schemes, it has created an opportunity for investors who are not pushed into bonds. The two key questions - and this goes for all markets, not just the UK one - are these. To what extent have share prices been supported by corporate activity? And to what extent is the current level of corporate activity likely to be sustained?

On the first, there can be little doubt that were takeovers and mergers suddenly to become unfashionable, there would be sharp falls in all the major markets and perhaps particularly in the UK. Values may indeed be low by the standards of the previous six years, but they are pretty normal on a long historical perspective. In the US there is a dearth of savings, and household savings in Britain are still quite low - far too low given the demographic profile. They will gradually pick up, but whether they will flow towards shares is less evident. We have had three years of rising prices and sooner or later there will be one when prices fall. So yes, shares are indeed supported by takeover expectations.

On the other hand, it is hard to see that activity stopping soon. Those three years of rising share prices stifled mergers, partly because would-be bidders reckoned there was no hurry to act; why not wait a bit and buy cheaper? It was also partly because many companies wanted to rebuild their own balance sheets. And it was partly because it was a hard climate in which to make share offers to finance bids.

So it could well be that we are still working through the backlog of corporate restructuring. If that is right, this process has some way to go.

A lot depends on continued expansion in the world economy. Because both UK and eurozone growth slackened last year, we tend to think that the world was having a tough time. The reverse was true: we don't yet have full data but global growth last year may well have been at a 10-year record. That is all the more astounding when you consider it was achieved against a backdrop of higher energy prices and higher US interest rates.

That growth will not stop easily and it seems reasonable to expect another two or three years of this cycle. Markets cannot yet see the end of the expansion phase.

There are concerns, of course. One is that the burst of cross-border bids will lead to more overt nationalism. You can see that in Spain at the moment, where the government is looking at ways of changing the law to keep the Germans out. But usually money wins in the end, and the pool of money seeking good-quality investments grows larger every day.

The less obvious issue is the way in which governments around the world will use regulation to nudge companies into following policies they espouse. If you cannot stop a German company buying a Spanish one, you can at least ensure it manages its pricing and investment in ways that fit in with Spanish national objectives.

All governments do this: look at the way in which the UK administration manages the North Sea tax and depletion regimes. One of the key areas of national competition will be creating new regulatory structures that make the best use of international money.

And money is both greedy and cowardly. It will rush to where it can get the best returns but flee at the first sight of political risk. So there will be losers as well as winners from the current merger boom.

How Ireland's light touch turned to gold

British business rode to the rescue of Gordon Brown last month. January is the big month for company tax receipts and there was a huge jump. It now looks as though the Chancellor will be able to meet the financing projections made in his pre-Budget report, though not those of the Budget itself last spring.

But success in the short term may mean failure in the long. In other words, you can always crank in more revenue now but that may be at the cost of scaring away your market. That would be the view of Charlie McCreevy, the EU commissioner for internal markets and services, who was the Irish finance minister in the late 1990s. He cites his own country's experience with taxation, and particularly company taxation.

"Reduced tax rates generated higher economic activity, greater taxpayer compliance and a surge in the tax take for the Exchequer," he writes in the foreword to The Case for Reducing Business Taxes, a pamphlet from the Centre for Policy Studies.

The paper, by Charles Elphicke and William Norton, looks at the experience of Ireland, Australia, South Africa and the Czech Republic, all of which made significant cuts in corporation tax. Revenues over the period of the reduction rose by between 43 per cent (South Africa) and 11 per cent (the Czech Republic). By contrast, corporation tax revenues of countries that did not make big changes - the UK, US and Japan - were static.

You could say that it is much easier for small economies to attract inward investment, and hence increase their revenue base, than it is for large. So what works for Ireland would not necessarily work for the UK. But Mr McCreevy thinks it would work for the rest of Europe: "I am a committed advocate of lower taxes and tax competition in the European Union - because I am committed to the economic success of Europe as a whole."

He may well have a convert in George Osborne, the Tory shadow Chancellor. He was in Ireland a couple of days ago seeing how the Celtic Tiger had been so successful, and came back praising Ireland's low-tax model.

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