Three months on and BREXIT still doesn’t appear to mean much yet on the surface. But these are very early days and perhaps we’re looking at more of a drag than a blow to the UK economy following this summer’s developments? This week we’re thinking about how the M&A landscape is shaping up – via these early indications – and our latest thinking in real estate. In summary: initial uncertainties are fewer than expected, but we can’t count our chickens and BREXIT isn’t the only show in town.
Fewer unknown unknowns keep UK economy on track
As S&P noted earlier this week, the sky didn’t fall in over the summer. Initial survey data reflected the shock of the vote; but official figures – including the service sector data for July out this morning – are benign enough. Today’s data also shows consumer confidence bouncing back and the UK’s current account deficit growing, but coming in smaller than expected, although the UK is still very much reliant on the ‘kindness of strangers’.
Those strangers may well be comforted by the subdued economic reaction, which is undoubtedly in part due to resilience of the UK economy. But it should also be noted that BREXIT hasn’t really played out as previously ‘advertised’. Initial uncertainties have been kept to a minimum over the summer. Article 50 hasn’t been triggered. The leadership of the Conservative party and ultimately the UK was determined quickly. The Bank of England acted swiftly – not just on interest rates, but to becalm the banking sector and other central banks have chimed in with further support.
More drag than bang?
So Chicken Licken (or Chicken Little for our younger readers) can probably stand down, but it’s still very, very early days. I’m not sure how much store we can put by anyone’s forecasts at this point in proceedings; but it is interesting to note that most analysts remain pessimistic beyond 2016. S&P still expects BREXIT to hit ‘over several years’, taking 2.1% off GDP growth between now and 2018. The OECD recently upgraded their UK GDP forecast by 0.1% for 2016, but cut 2017’s expectations by 1%. The UK’s economic resilience has shone out this summer; but the message remains that we should not underestimate the long-term complexity of working towards a deal or the impact of secondary effects.
Like the dramatic fall in sterling, which will inevitably have an impact on purchasing power and consumption in the end. The impact on retail prices is delayed somewhat by the backlog of inventory, hedging and the reluctance of retailers to increase prices – especially in competitive grocery markets, where the Bank of England has found supermarkets “re-engineering” products with smaller packages! But in non-food, prices are rising. According to the FT, Alert – the trade magazine for independent electrical retailers – estimates that 80% of suppliers have put up prices.
Pensions have also taken a further hit from the fall in yields related to the Bank of England’s post-BREXIT reaction. Contributions to defined benefit pension schemes will need to rise by over £2bn to £10.9bn in 2017, according to Mercer. FTSE 350 pension deficits rose by £50bn in August to £189bn – the biggest monthly widening on record. The problem for consumers with defined contribution schemes is no less acute – which is ultimately a problem for the UK as a whole.
It’s vital to remember that the impact of BREXIT really isn’t something we can assess in a few months. A run of recent BREXIT-related profit warnings also caution us about making snap judgements on early figures.
M&A story – BREXIT and beyond
What does this mean for M&A? It’s a mixed picture in these initial stages. As we predicted, domestic focused deals, those involving large-cap companies, private equity and inbound deals with strong imperatives – such as in the technology space – have largely continued. The pipeline hasn’t been emptied by BREXIT. Of course, some deals have been scuppered by uncertainty and currency moves and there does seems to be more caution below the large caps and some reticence on both sides of the channel whilst so much in terms of trade and free movement of labour is up in the air – indeed, labour comes up as one of the hottest topics in our discussions.
Again, we have to say these are early days. Although, we’ve also pondered if BREXIT could provide an incentive to transact in some cases. Weaker sterling could incentivise overseas buyers – although the share prices of internationally focused companies have also risen. The low yield environment provides a great incentive for private equity and pension funds to transact – where else are the returns? Certainly not in the corporate bond market, which makes for an attractive funding option. We also expect portfolio and strategy adjustments as BREXIT plays out. Some companies may also be forced sellers, not least those with growing pension fund deficits to plug.
But, we’ve also surmised from our recent discussions is that BREXIT isn’t the only – or even the chief – concern in many deal discussions. US deals are being held up or even scuppered by election uncertainty. When two candidates are so diametrically opposed in an election too close to call, companies will be concerns about strategy resets whoever wins. Elsewhere, we also have European banking issues and upcoming elections in France and Germany. BREXIT isn’t the only show in town.
London Prime under BREXIT pressure?
It’s interesting to note at this point that whilst UK consumers still seem to be spending at the tills and borrowing on their credit cards, they do seem to have pulled back from the housing market. Is this is a sign of long-term BREXIT anxiety standing in contrast with short-term confidence? I suspect that’s too simplistic an analysis, especially given the fact that the housing market was volatile before BREXIT for a number of reasons.
In our latest real estate paper, we look at the impact of BREXIT on the London prime residential sector, taking into account the other forces in play before the vote – fluctuating consumer confidence, the change in stamp-duty policy, affordability and sterling exchange rates. All of these continue in the post-BREXIT environment. Our research on transaction levels in London’s five most expensive boroughs does suggest that historically there has been little evidence of a clear link between currency strength and transaction levels – although it should be said that it is many, many years since we’ve seen a fall this big in the value of the pound.
And that is the vital point here: we are all in uncharted territory. Our initial thoughts in this market is that the change in market conditions – BREXIT and otherwise – could have far reaching impacts in terms of land release, contractor stability, pricing (especially in marginally prime locations) and inspire rethinks in the private and public sector. Ultimately, our analysis suggests that the market is unlikely to be staging a dramatic recovery in the short term and in this complex and evolving situation, flexibility and resilience will be vital qualities. You can read more <here>.