Why are European firms taking over Britain?
By
Simon Nixon Mar 23, 2006
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With a wealth of companies with commanding positions in world markets, UK plc is a fertile stalking ground for foreign buyers. But are takeovers affecting stocks? asks Simon Nixon
What’s new about the takeover boom?
It’s huge. Last year was the third-best year ever for takeovers, with deal activity at levels last seen during the dotcom bubble. This year could be even better. Bankers report frenetic activity behind the scenes, with no deal too big, or too complicated, to be ruled out. And for once, that may not be just the usual dealmakers’ hype. In Europe, $40bn of hostile deals were launched in January alone, compared to $93bn in the whole of 2005.
Much of the action is centred on the UK, which is proving a magnet for European bidders, such as Spain’s Telefonica, which bought mobile operator 02, and France’s Pernod Ricard, which bought Allied Domecq. Spanish bidders are now stalking airport operator BAA and Lloyds TSB.
Why are European firms buying here?
Because conditions could not be better for them. After several years of restructuring during the post-bubble bear market, European corporate balance sheets are strong, share prices are soaring and debt is extraordinarily cheap. The emergence of China and India is also driving a new phase of industry consolidation as companies prepare to compete in an increasingly global marketplace.
That is leading European companies to beat a path to Britain’s door for two reasons: first, because the UK market is the most open in the world; and second, because the UK companies they’re targeting are global players with commanding positions in world markets.
Are British companies doing deals too?
Not really. In fact, British firms have barely figured in the frenzy: most of the headline deals have involved foreign companies buying UK businesses. The only two £1bn-plus overseas acquisitions by UK companies in the last year were SABMiller’s acquisition of the Colombian brewer Bavaria and Old Mutual’s takeover of the Swedish insurer Skandia. Note, however, that both SAB Miller and Old Mutual are in fact South African groups with a UK listing. Last year, British companies spent £25bn on overseas acquisitions, exactly half the amount spent by foreign companies in the UK.
Why is this?
One theory is that British firms are more financially sophisticated these days than during the last mergers and acquisitions boom of the late 1990s, when they squandered billions on ultimately wasteful deals. We now have much tougher corporate governance codes, which are designed to rein in the empire-building instincts of bosses: independent chairmen and non-executive directors have to look out for shareholders’ interests.
According to this theory, European firms – thanks to their lower standards of corporate governance – are wasting money on deals that would never pass muster in UK boardrooms. The alternative theory is that UK boardrooms have become so boxed in by the new codes that they’ve become too risk-averse.
Does all this matter?
Not necessarily. Some people worry Britain will lose influence in the corporate world as head offices are closed and UK firms become divisions of foreign rivals. The fear is that the new owners will favour their own countries when it comes to important strategic decisions and that British managers will lose out on top jobs. But this doesn’t tally with the evidence, which shows that UK industries (such as the financial services industry) have thrived under foreign ownership. Multinational companies invest wherever they find the best mix of low costs and skilled labour. Until now, Britain has scored highly on both counts.
Are companies investing in other ways?
No. Worryingly, corporate investment is currently in very poor shape, rising last year by just 1.2%. Worse, the ratio of capital investment to sales and depreciation fell to a 20-year low at the end of 2004. That may partly reflect the falling cost of capital equipment, which means companies get more bang for their investment buck, and it is true that in an increasingly service-oriented economy investment is more skewed towards hiring staff than buying equipment. But the low investment figures have an alarming parallel in Britain’s poor productivity growth.
So where is the cash going instead?
A lot of it is finding its way back to shareholders via dividends and share buybacks. For example, BP last week announced a $50bn return of cash over the next three years. Last year, shareholders were handed some £30bn – equivalent to 1.6% of the total market capitalisation of the UK – courtesy of cash-rich corporates with no better idea of how to use the money.
Add that to the ordinary dividends investors received last year, of about 3%, and the yield on UK equities last year was close to 8% – up from 5.6% in 2004. That’s a phenomenal return when UK base rates are 4.5%.
Are UK shares worth buying?
For now, yes. As a result of takeovers, UK shareholders last year received £60bn – equivalent to 3% of the total market capitalisation of the UK market. Yet despite all the takeover activity, UK shares still do not look particularly expensive, trading on a price/earnings ratio of 14, compared to a long-term average of 18. That suggests there is plenty of scope for more deals to come. Investment bankers say they have record pipelines of deals.
But longer term, the health of the UK stockmarket and economy depends on new firms being created to replace those that are being sold. The current lack of investment in the UK economy suggests this isn’t happening and could be an early warning sign of tougher times ahead.
Simon Nixon is executive editor of Breakingviews.com
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