Margareta Pagano: Big Bang: The unintended consequences
Turning super-rich US lending banks loose in the UK led to catastrophic takeovers – let's return to good old Eighties M&As
Sunday 21 February 2010
It's only now, more than 20 years on, that we are feeling the cold blast of the many unintended consequences which Big Bang has had on British corporate life.
One of these is the dramatic, and destructive, change in the way companies finance takeovers. Until Big Bang, there was no bank lending involved. When one company bid for another, it financed the purchase of its prey with shares. If there was a cash alternative, the company would raise new money by asking shareholders – or other institutions – to underwrite it, so increasing the pressure on the acquirer to justify its takeover. Thus, the onus was on the predator's chief executive and his directors to sell the deal first and foremost to their own shareholders.
Look back at some of the most successful deals of the 1980s to see how it worked before Big Bang opened the floodgates to American banks and their vast balance sheets. When BTR or Hanson Trust launched their takeovers – always assiduously well-researched – they financed those bids with their own shares, usually with a cash alternative. When BTR bid for Dunlop it was with shares, and the investors thought it a decent deal. Hanson did the same when it took over Imperial Tobacco. By contrast, when BTR bid for Pilkington – a takeover which provoked as much fury as Kraft's bid for Cadbury – the glass firm rejected the offer, partly frightened of the outcry, but really because it wasn't high enough and BTR's shareholders wouldn't stump up more. It was a similar tale at ICI, which also rejected Hanson's bid as not enough. Ironically, both ended up being taken over by foreigners.
There's a real purity to the mechanics of these bids; what you might call classic, old-fashioned M&A. Companies had to ask for shareholder permission to raise so much new capital, forcing investors to be active owners because they had to decide whether the offer was dilutive or earnings-enhancing. Takeovers of the past 15 years have been quite different; financed mainly by bank loans allowing firms to build up huge debt, often gearing up five times. Banks fell over themselves to lend money to ambitious company bosses, giving directors a false sense of complacency; allowing them to be greedy and lazy. The Cadbury bid shows how destructive bank lending can be to an acquirer. Even the ferocious Warren Buffett, one of Kraft's biggest investors, could not stop the bid – Kraft simply ignored his protests. Instead, it upped the cash element, by selling one business and pulling in bank lending from none other than British-taxpayer-owned Royal Bank of Scotland. Who can blame Cadbury shareholders, many of whom had bought at around £5, from gobbling up £8.50 a share? The sentimental argument that Cadbury should be saved as a British icon was never going to win at such a mouth-watering price.
If you look back at some of the more stupendously stupid bids of recent years, you can see how dangerous it is allowing companies to take on so much debt. Would shareholders in RBS have allowed Sir Fred Goodwin to go ahead with the ridiculously priced £50bn bid for ABN Amro if it had financed with more shares? You bet they wouldn't.
As far as I can tell, the problems arising from allowing companies to borrow so much don't seem to have hit the radars of politicians or regulators. The ideas for making takeovers tougher, and halt another Cadbury, have missed the point. Stopping hedge funds from voting during a bid unless they have held the shares for six months, or raising the threshold vote to 60 per cent, are just tinkering around the edges.
A cleverer idea would be for shareholders to insist that firms raise the money for a bid with more of their own shares by changing the articles of association to constrain them from borrowing too much – or at all.
It could even be that the problem is already sorting itself out as bank lending dries up. Indeed, Babcock's latest £1.2bn bid for VT has some of the hallmarks of a 1980s bid – the businesses are in the same industry so it claims that there is commercial synergy, Babcock will increase its share capital by 50 per cent to finance the bid, and its biggest shareholder is causing a stink. But it is, nevertheless, raising some £600m of bank finance, which is still rather high. The pressure is now on Babcock to prove to its shareholders that its prospective bid is value-enhancing, and that there is some industrial logic to merging with VT. This bid is set to be good, old-fashioned knockabout stuff – just like back in the Eighties. While most bids are value destructive, at least BTR and Hanson managed to improve earnings per share for their respective shareholders, and Babcock will have to show it can do the same.
Bankers will hate to have their lending cut back, but they can still get fees from underwriting and rights issues, and even lending to the new, merged companies. They should look on the bright side – they will have more money to lend to the small companies who need it most. And everyone involved would be helping to put the capital back into capitalism.
King listens to Kotlikoff's visionary ideas on banking reform – so should we
It wasn't just some of the City's leading figures who turned out to listen to Professor Larry Kotlikoff at the London School of Economics last week about his ideas for reforming the financial system, but also a surprising number of interested members of the public who had heard he was coming. Kotlikoff is the US economist who believes that unless we change the way banks operate, it won't be long before we are faced with another crisis. He is also the economist whose work was mentioned by Mervyn King, Governor of the Bank of England, at the last Treasury Select Committee, as worthy of further study by the authorities as they look for new regulatory structures.
At the heart of his reforms – set out in his book Jimmy Stewart is Dead: Ending the World's Ongoing Financial Plague with Limited Purpose Banking, published tomorrow – is that we need to protect taxpayers' deposits from the "hucksters and snake-oil men" who take risks with those retail deposits. His arguments for protecting deposits by banning banks from lending money not matched in cash reserves is compelling. In many ways his proposals – to create mutual funds that never own the financial assets they manage – put securities back centre-stage, and restore banking to the way it was practised up until the 1960s. Kotlikoff also spent time with King, along with other bankers at the Bank last week, talking around these ideas. Along with the Volcker plan for splitting retail and commercial banking, Kotlikoff's ideas deserve a much wider public airing. The first thing the next government should do is set up an independent commission to think through how global finance should and will develop over the next generation. As Kotlikoff warned us at his fascinating lecture, doing nothing by keeping the system as it is, is the radical, risky option – making the right changes is the safe one.
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