This week’s blog comes from Michel Driessen, a Senior Partner in EY Transaction Advisory Services.
Sometimes one day can really captures the corporate zeitgeist. Global deal values were already running at a near record. UK M&A hit its highest level in over a decade in the first quarter. But the US$120b of deals announced in just 24 hours at the start of this week emphatically underlined the strength of global deal intentions.
In this week’s Capital Agenda Blog I’ll explain why I think this day of deals was exceptional, but by no means a blip, in what should be another busy year of deal making. I’ll illustrate this with the latest UK data, which gives us insight into why and where UK companies will be transacting in the coming months
It was an exceptional 24 hours by any standard. By Monday morning (UK time) we’d seen US$120b worth of M&A announced, including three US$10b+ transformational deals in telecoms, energy and retail. But this day of deals didn’t come out of the blue. Deal values hit US$1t in the first quarter of 2018, the most since Q1 2000. Yes, there are arguably more risks. But, so long as these are still being offset by the pressing need to remodel portfolios – both technologically and geographically – and by high stock prices and cheap borrowing, we should still see high levels of global deal making in 2018.
UK M&A shifts up a gear
Similarly, the UK’s turn in the deal spotlight isn’t an aberration, with UK M&A reaching $120b in the first quarter – around double the level seen in the same quarter last year and the highest since Q1 2007. Again this doesn’t look like a blip. A record 65% of UK respondents to EY’s 18th Global Capital Confidence Barometer (CCB18) expect to be actively pursuing deals in the next twelve months.
Why is the UK deal space looking so active in 2018? Obviously, the UK is subject to the same global portfolio drivers we outlined above and this is motivating many companies to transact. But there are also some specific UK deal motivations and, to understand these, I think it helps to look at this from the domestic, inbound and outbound point of view.
In CCB18, UK companies put the UK top of their list of investment destination. I’m not surprised to see both this both result and the recent leap in domestic M&A values – now led, of course, by the Sainsbury-Asda deal. I expect to see more sector consolidation as UK companies look to build market share and cut operating costs in the face of sluggish domestic growth.
This slowdown – and rising costs – are putting UK earnings under considerable pressure. The percentage of UK companies expecting local earnings to improve fell to 45% in CCB18, compared with 59% six months ago. Our latest Quarterly Analysis of Profit Warnings also showed the impact of rising overheads on margins, also pressured by the need to invest in new technology and new business models to compete against nimbler new entrants. UK respondents ranked inflation as the biggest risk to their investment plans in CCB18 – ahead of market volatility. Automotive and Transportation and Consumer Products & Retail – two sectors under considerable disruptive, competitive and cost pressure – lead the way in UK domestic deal values so far in 2018.
CCB18 also shows the UK slipping from third to fifth in the global respondents rankings of investment destinations. But, on the ground, the picture is more nuanced. True, a handful of mega deals have provided a significant boost to deal values at the start of 2018, whilst deal volumes have slipped a little year-on-year. But the size of these inbound deals into the UK in themselves could be read as a vote of confidence – at least in the companies targeted.
Obviously, there are still concerns over growth and life post-Brexit. But, the UK isn’t out of bounds in the areas where it excels. So far in 2018, 27% of inbound deals have targeted Technology, which outranks Financial Services – the next most popular sector – almost three to one. Life Sciences tops the deal value list, followed by Media & Entertainment. The US remains the most frequent buyer in the UK by a very considerable distance – making up 42% of purchases. It will be interesting to see if the UK maintains this position given increasing overtures from elsewhere in Europe.
Meanwhile outbound activity has steadied, but remains low. The start of this dip seems to coincide with the vote to leave the EU and the subsequent fall in sterling. That said, its recent revival – albeit now dented – didn’t perk up activity. I don’t think we should be surprised by that. As I’ve written elsewhere, companies aren’t motivated by short-term movements in currency and price isn’t the number one factor in driving deals. A weaker pound will make it harder to make deal sums add up, but other geopolitical reservations are more likely to have stalled activity.
Is that about to change? ‘An increase in cross-border deal making’ is identified as the number one M&A theme for UK executives in CCB18. UK companies certainly have a stronger motivation now to look beyond their concerns and these shores to secure stronger overseas earnings streams and EU supply chains. The US is still the number one outbound destination in deal volumes and values for UK companies. But CCB18 indicates that UK companies may have more Europhile intentions in the next 12 months, with Ireland and the Netherlands replacing the US and India in the top five target destinations. The need to plan for life after Brexit – especially for those with exposure to EU supply chains and regulations – is perhaps hitting home.
A regulatory journey
What’s also going to be very interesting in the coming months is how regulators deal with these bursts of deal activity. The debate is wide open in two difficult areas:
The first is the willingness of regulators to allow consolidation in industries where just a handful of major companies remain in ‘old school’ terms, but major online players wait in the wings. Do regulators judge on the basis of what we have now, or second guess where we’ll be in five, ten, twenty years’ time?
The second is the willingness of countries to allow greater cross border activity, as companies increasingly see a world without borders. The UK’s position is especially interesting in this regard. It has no equivalent of US or European agencies that act as arbiter on inbound transactions. On the other hand, foreign buyers of significant UK assets are being asked to offer more binding guarantees. It’s a broader journey for the UK as it reinvents its position in the world – and one that could have significant implications for inbound buyers.