This week’s post comes from Steve Ivermee, Managing Partner, UKI Transaction Advisory Services at EY.
UK M&A activity continued to slow in Q3 2017, with volumes and value down year-on-year. But, there’s a more complex and developing story behind the headlines. It’s one that’s partly driven by the fallout from Brexit, one that’s partly a product of the race for technology and growth – and one that reflects a particularly enduring relationship.
In Q3 2017, overall UK deal activity fell by over a third in value and almost a fifth in volume compared with Q3 2016. UK M&A data can be lumpy and distorted by one or two significant deals on a quarterly basis, so it’s worth also taking a longer view to help smooth the data. If we look across the last nine months, value is up by 9% compared with the same period in 2016, but volume is down by 11%.
Overall, deal sentiment is looking weaker in 2017.
But is this a fall or ‘normalisation’ of activity? It’s probably too soon to tell – and to say what is ‘normal’. In strictly volume terms, we seem to have returned to the post-financial crisis level of deal making – i.e. before the recent peak. Although, the world is a different place with different M&A drivers, such as: the fallout from Brexit; rising populism; greater geopolitical risk – but also improving global growth; and increasing digital disruption.
So, altogether, it feels like we’re starting a new chapter with plenty of new, but also some familiar themes.
Stronger domestic focus
The most obvious change in 2017 has been the increased focus on UK domestic M&A, which stands in stark contrast to the fall in activity overall. There’s been almost £60b of UK domestic M&A in the first three quarters of 2017 compared with £23.6b in the same period of 2016.
What’s behind this rise in activity? We think there are two primary drivers at work:
- UK companies are upping their defensive activity in response to a weaker economic outlook. It’s in response to new challenges, but it’s obviously a well-travelled path to use M&A to generate increased revenue or operating synergies through increasing scale and reducing competition.
- UK companies are using M&A as a lower-risk alternative to R&D. It’s quicker to buy than build to compete in the digital race and UK companies are especially drawn to M&A as a lower risk growth and margin strategy. Our research shows that the value of M&A is closer to total business investment value in the UK than in either the USA or the Eurozone – and we’ll publish more on this soon.
Meanwhile, the trend line for inbound M&A has turned down since its post-Brexit spike. Sterling has recovered some ground of late, theoretically raising the price of UK assets – although we don’t want to overplay the currency impact. A 20% price drop is unlikely to convince a company to acquire an asset it didn’t want or need; but it might re-evaluate a target where the numbers suddenly add up.
Sterling’s fall may have initially boosted inbound activity as companies rethought some deals; but its on-going impact is likely to be more limited.
It’s more likely that greater uncertainty in UK economic forecasts is creating greater uncertainty in buyers and lowering inbound activity. There is always the possibility that this will reverse as and when we make progress on Brexit. The UK is an open economy, still has attractive assets and remains an attractive M&A destination.
Outbound (unexpectedly) down
Outbound activity also seems to have taken a break in Q3 2017, bucking a trend in recent quarters for UK companies to look abroad for deals. The opportunity to take advantage of rising global growth – in contrast to less certain UK prospects – had been trumping the fall in sterling. This doesn’t seem to be so much the case in Q3 2017.
A rise in risks at home and abroad could be discouraging companies to take the leap into new markets. But, we’re at risk of second guessing on what might be a blip in the data. I’d suggest that the imperative to buy in growth markets is still there, Moreover, companies do seem to adapting their strategies to look beyond short-term uncertainty – with some necessity!
The renewal of old relationships
There’s one other trend that absolutely leaps out of the page in Q3 2017, although it’s nothing new. Four of the top five inbound deals in Q3 17 involved US companies buying UK assets. There’s also been plenty of movement the other way, despite the fall in sterling.
This is a long-term ‘special relationship’ that seems resilient to Brexit or currency moves. Why might that be?
- For UK companies acquiring in the US – as per other outbound deals – US growth seems to be worth the price and the fall in sterling against the dollar since Brexit.
- US activity in the UK has focused on technology – around a third of deals in the last year – and industrial products. Both arguably have Brexit resilient features.
The other element from both sides, that shouldn’t be underestimated, is long-standing trust and understanding – necessary to deal making on an individual and macro level. The UK and US roughly share a common language and also have much in common economically and in legal and business practice. These factors seem to outweigh other negatives or uncertainties.
Given that M&A thrives on reciprocity and trust, uncertainty and protectionism remain threats to activity; but companies are developing strategies to cope with the former and on the latter it’s not a one way street. Populism is the dominant force, but there is greater political nuance in the discussion – around national champions for instance.
This isn’t yet translating into movement on the ground. Companies embarking on international deals still a multifaceted regulatory landscape.. But, there does at least seem a greater willingness to rethink some aspects of regulation in the 21st century, to meet the demands of globalisation, new technologies and technological convergence.