Hamish McRae: We are moving into a period of high merger activity, and it has some way to run

Growth in UK business investment has been pretty flat for the past eight years
Click to follow
The Independent Online

The boom in mergers and acquisitions worldwide - and the parallel boom in IPOs - raises intriguing questions about share values and the state of the global economic cycle.

These include whether the boom in acquisitions means shares are still undervalued? Or this more a function of the excessive liquidity pumped into the system by the central banks? Does the fact that, despite the recovery in activity, we are not in the frenzy of 1999 mean that this economic cycle still has some way to run? And then there is the more parochial question: if there is not much money in the corporate sector why do UK companies invest so little?

Some perspective. We are particularly aware of M&A activity here in the UK because so many UK companies are on the receiving end of bids. High-profile bids such as the one for BAA give the impression that the entire country is for sale. If we will sell Heathrow, what won't we sell?

To some extent this is the result of pension regulation, with pension funds here being forced to reduce their equity holdings, whereas funds on the continent are encouraged to increase them. All right, it is not as cut and dried as that for our regulatory system does not specifically require pension funds to switch from equities to bonds, but that is the practical effect.

If, however, you look globally the recovery in M&A is not running at quite the heady levels of the last peak 1999. The first graph shows that during 2005 the number of deals was nudging towards the previous peak but the value of deals was still well below it. We will have to wait for another six months to know the figure for this year but intuitively there is not quite that heady bid fever. The level of bids in any case does seem to be related quite closely to the level of world stock markets (see second graph) and we have yet to surpass the last peak. If history were to repeat itself with any precision, which of course it won't because each cycle is different, you would say that the bull market in both shares and corporate activity is likely to have at least another couple of years to run. There is some froth and that seem to be associated with the newer sources of investment funds, most notably private equity. But the froth is not yet too alarming.

Still, the boom in takeovers does demand scrutiny for it is in any case a global phenomenon rather than a British or American one. One perspective comes from Investec, the fund managers, in a recent paper. They argued that the M&A cycle encourages a certain amount of cynicism on the grounds that they don't add value for shareholders but that studies that suggested this had themselves to be taken with caution. These were usually done towards the end of the cycle and were influenced by the end-cycle backlash. A study by HSBC suggested that shareholders of the companies that were sold did indeed benefit, while those of the buyers were just about square. Seen in that perspective maybe the shareholders of BAA, and of all the other companies that have been bid for by foreign interests, have done rather well. They do, after all, have money from their shares, which can then be reinvested. The country as a whole does not lose wealth, indeed arguably it gains it.

Nevertheless a real concern remains, for there is a loss of management control. You could argue that if the UK can, so to speak, outsource the management of its companies to foreign interests that is fine. If the foreign management is better then we gain from it. You sometimes hear the argument that non-national management will favour their home country for investment but that is hard to sustain.

As it happens yesterday there were some new figures from the Department of Trade and Industry on inward investment in the UK. These showed that over the past year there had been 1,200 inward investment projects, up 14 per cent on the previous year, generating 34,000. The US remains the largest investor and Japan the second largest but India has become the third, a fascinating snapshot of a change in the global balance of economic power.

If foreigners invest in Britain why don't British companies? Well of course they do but not in the measure that one might expect. The third graph shows how growth in UK business investment has been pretty flat for the past eight years, in fact since the first year of the Labour government. Given the lag in investment planning that looks almost like a political response: we don't trust this government so we won't increase our investment. Actually I don't think that is the case because the business community does not think like that: if it can see profitable investment projects it will invest. But it remains a concern that investment has not picked up despite strong, or strong-ish, growth, for this suggests considerable underlying caution about the future.

These figures come from a study by PricewaterhouseCoopers. It thinks that there may be some measurement bias and that these figures may be revised upwards as they have in the past. But it notes too that there was some loss of economic confidence last year. Growth was slower and many companies were forced to make provision for pension liabilities. It also notes that evidence that the relatively less favourable UK company taxation and regulatory regime is losing us internationally mobile investment is anecdotal at this stage.

The bigger and maybe more encouraging point is that as the balance of the economy shifts further away from manufacturing and towards services you might expect a lower level of investment. Per unit of output, services require less investment than manufacturing. It is true that UK investment has not picked up as it has in the US and the US is an even more service-oriented economy than our own and that is a puzzle. It may be, too, though PwC does not make this point, that high public-sector investment is crowding out the private sector. Anyway PwC is assuming some pick-up in fixed investment this year and continued growth next.

There is a further point here: what is investment? Government ministers tend to use the word investment when they mean current spending, as in: "we are investing more into getting police officers on the streets". That is either sloppy use of language, or is designed to mislead. Still, in a service economy it is quite hard to know what is investment and what is spending. If human capital is the key input, as I think many of us believe, spending on increasing that human capital - going to a business school for example - really is investment. True, building a new swimming pool in the garden, which technically counts as residential investment, should more properly be considered to be consumption. On balance, though, I suspect we may be investing rather more than we think.

The big picture here seems to be that we are moving into a period of high merger activity, with a lot of international flotations (including from Russia), and that this period has some way to run. It will, however, be very sensitive to global share price levels. Viewed from a UK perspective, foreign acquisitions are quite welcome as they enable people to rebalance their portfolios. The thing to watch most closely, though, will be UK investment for this will tell us something about the underlying confidence of the business community.

Comments