Takeover fever is back

As the Glaxo bid for Wellcome illustrated, the rush for mergers and acquisitions is on once again. But the motives of the companies behind these activities have changed considerably since the 1980s. William Kay investigates There is, however, a heavy weight of academic evidence arguing that mergers are not a miracle juice
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The Independent Online
Here we go again. Merchant banks' merger and acquisition departments, operating at little more than tick-over level for the past two years, have had their most stimulating week since the heady days of the 1980s, when it seemed sometimes as if one half ofBritish industry was bidding for the other half.

First, Cadbury-Schweppes confirmed that it was planning to bid for Dr Pepper, the US soft drinks group that also owns Seven-Up, in a deal that turned out to be worth £1.6bn when it was unwrapped on Thursday.

That was dwarfed by Glaxo's £9.2bn offer for its pharmaceutical rival, Wellcome. Then J Sainsbury, the supermarket group, put £290m cash on the table to buy Texas Homecare from Ladbroke Group.

But there was no stopping Glaxo. It then announced a £300m tender offer for Affymax, a US drugs developer.

These deals made British Aerospace and GEC's £570m tussle for VSEL - currently frozen by a Monopolies and Mergers Commission investigation - seem very small beer indeed. And Trafalgar House's £1.2bn tilt at Northern Electric, unveiled last month, began to look little more than an hors- d'oeuvre for the tastier dishes now being served up.

Suddenly, the London stock market was gripped by bid fever. At such times, there are fortunes to be made from spotting the next target. The rumours about a bid for Warburg, which had been flagging, revived briefly before they were overtaken by fresh speculation that Germany's Dresdner Bank would buy Kleinwort Benson or Schroders - or another London merchant bank.

Old favourites were soon dusted down. On Wednesday, £65m of TSB Group shares were traded, as the price rose 21p at one stage on hopes that the long-awaited bid might finally materialise. The insurers, Commercial Union and Guardian, along with Argyll Group, the supermarket owner, and United Biscuits were also the subject of renewed speculation as anything seemed possible once again after a spell when the suggestion of such deals had been greeted with a shrug and a dismissive wave of the hand by corporatefinanciers inured to lean times.

Even if none of these rumours comes to fruition, we have already seen more activity in money terms this week alone than in any year since 1990.

This has come none too soon for the City's merchant banks, whose profits have been under pressure from last year's falling bond markets. They were casting frantically about to replace the income they have been earning from new issues in the last two years, when, according to UBS, more than 163 companies were floated to raise more than £6.2bn.

But the flotation game has gone sour, as companies such as MDIS and Tadpole Technology have downgraded profit forecasts. On Friday, the directors of BAS International Holdings, the toys and giftware dealer, pulled its flotation "in view of present marketconditions" - three days after launching a publicity campaign for its coming to market.

So the corporate financiers have a direct incentive to persuade their more promising clients to consider expansion plans, takeover bids and cash-raising schemes. It is no coincidence that the Cadbury bid for Dr Pepper was accompanied by plans to raise nearly £400m through a rights issue. That puts even bigger fees into the pockets of Cadbury's advisers, Kleinwort and Hoare Govett.

However, alongside those incentives many industrial companies have completed restructurings and begun to look around for new sources of profit - like a weaker competitor.

Bob Semple, equity strategist at NatWest Securities, said: "It's clear that the UK corporate sector has been awash with cash for the past couple of years. But it has not been clear what companies were going to do with that cash. We have seen special dividends and share buy-backs, but what we have not seen until now is people spending in style."

David Freud, a corporate financier at the merchant bank SG Warburg, pointed out: "It's that time in the cycle, after the big new-issue boom last year. There is a difference of view between investors and corporates, and corporates are beginning to put different valuations on other corporates from those prevailing in the stock market."

That is vividly borne out by the bitterness with which John Robb, chairman and chief executive of Wellcome, believes the market failed to see that his company was turning the corner.

His plea echoes similar claims after the recession of the early 1980s, when predators such as Hanson and BTR pounced before their victims' share prices had caught up with the full implications of the upturn.

But this cycle will have its own characteristics, at least before boom turns to frenzy.This time global competition and the need to buy economies of scale have been the drivers.

Said Michael Hughes, chief strategist at Barclays de Zoete Wedd: "In the 1980s, merger and acquisition activity was motivated by the desire for diversification.

"Now there is a degree of competition unprecedented in this century. So people are identifying deals aimed at getting market share and pricing power, both buying and selling."

Peter Botham, an analyst at Henry Cooke Lumsden, the stockbroker,has taken the demands for cash and extra sales to compile two lists of potential bid targets (see tables).

Mr Botham said: "The market will increasingly be focusing on those companies with an underlying value greater than their share price currently accords them. Everyone thought VSEL was terribly boring, even though it had £300m in cash. But British Aerospace and GEC clearly thought it exciting enough."

His favourite is APV, the engineer, which has started to restructure but is still valued at only £170m despite sales of £900m.

But a heavy weight of academic evidence suggests mergers are not the miracle juice their proponents claim. In his recent study, Foundations of Corporate Success, John Kay, professor of economics at London Business School, said: "A review of studies of merger performance suggests that the effect on performance is more often negative than beneficial. Frequently, this is because this corporate activity is not based on a clear view of the firm's distinctive capability and an identification of the markets inwhich that capability is most effectively applied, but is the result of financial objectives - or simply the thrill of the chase."

Robert Heller, another widely respected management commentator, said: "There are a lot of greedy bankers around. All the big strategic plans seem to require big deals. All the usual motives are in play, and it will end in tears. At least half the merger deals will fail, but memories are short."

For this year and beyond, we can expect most bids to have at least a veneer of industrial logic. If the trend goes by the book, it will eventually be followed by the financial engineering that traditionally marks the high watermark of bid fever. In thesebids, the effect on the combined balance sheet and profit-and-loss account of bidder and target is more important than strengthening commercial operations.

That has been made more difficult by the new accountancy rules for treating goodwill and reorganisation costs. Once these could be buried in the reserve figures, but now they have to be deducted from profits. That makes the declared profit for the first year or two after the deal look worse than it would have done under the old rules.

But this is largely a matter of presentation. Analysts and fund managers can make up their own minds over whether a profits drop is "real" or not.

While the bids are by and for companies in the same industry, such allowances can easily be made. The big break in the trend will be signalled when we see a rash of cross-industry bids, such as that of Trafalgar House for Northern Electric.

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