This week’s post comes from Steve Ivermee, Managing Partner, UKI Transaction Advisory Services at EY.
We’ve just experienced the biggest first half for global deals on record. Meanwhile, total UK deal values in H1 2018 were only surpassed by H1 2007, with domestic and inbound activity leading the charge.
In my regular catch-up here on the UK deal market, I’m going to look at why the stars have been well aligned for UK M&A and think about what could upset this near-perfect combination of means, motive and opportunity.
It’s been a remarkable start to 2018. At over US$332b, the total value of UK deals in H1 2018 was only beaten by the US$425b deals in H1 2007. Given all the uncertainties in the UK economy – not to mention the prospect of further monetary tightening and rising geopolitical and trade tensions – this seems extraordinary. A handful of mega deals did significantly boost deal values. But the fact that overseas companies were willing to invest so much into UK companies is significant in its own way. Volumes also moved back up, a further sign of confidence.
What’s driving this trend and can it last?
There’s been a change of pace in capital markets in 2018, but it’s subtle. This is still a global bull market. UK equities fell from January to March, but have since recovered lost ground. There’s a little more push back in debt markets; but loans and bonds are still being issued at exceptionally low yields. To this picture we can also add improving European and buoyant US earnings, with US cash and earnings further boosted by US tax reforms, not to mention record dry powder in private equity.
What this adds up to is companies – especially US companies – having significant means to do deals. It’s no coincidence that five of the top ten UK inbound deals in H1 2018 were led by US companies. Inbound deals were the main driving force in the sharp rise in UK deal values in H1 2018.
Of course, the purchasing power of overseas investors is further enhanced by the weak pound, but I don’t think this is the main reason why buyers continued to flock to the UK.
If we look that those inbound deals, a handful of mega deals did help to propel inbound values to near-record levels in the first half of 2018; but deal numbers rose too. The UK was second only to the US in terms of the number and value of inbound deals in H1 2018, with over US$203b spent on 412 transactions. This is well ahead of third place Germany, with US$44b of deal value and 255 transactions.
Above all, I think this sustained interest in the UK reflects its advantages as an open and innovative economy. These two features in particular tie in perfectly with the global corporate drive to meet the disruption challenge head-on. Business investment remains subdued; but companies needing to move fast are understandably adopting a ‘buy’ rather than ‘build’ strategy.
If we look at the top 10 inbound UK deals/bids so far in 2018, three relate to Telecommunications, two to Healthcare and two to Computer & Electronics. All sectors where innovation and convergence are significant global trends. The fact that overseas companies have sought to gain technological advantage by acquiring here, suggests that they still see the UK as a leading centre for innovation – an attraction that seemingly outweighed economic concerns in H1 2018.
In terms of domestic deals, slow growth is a further motivation to transact. At just under US$85b, domestic UK deal values are at their highest first half level since 2007 and deal numbers are rising, with the biggest UK deals focused in highly competitive sectors such as retail, business services and finance. Slower growth is encouraging companies to look for technological solutions to improve productivity, but also to engage in some old-fashioned consolidation to reduce costs and take out competition.
Opportunity also aligned with means and motive in H1 2018. Shareholders remain broadly supportive of acquisitions – even at elevated deal values – recognising the strategic rationale of the motives outlined above.
Meanwhile, companies are making more assets available, again linked to the trends outlined above. In EY’s recent 2018 Global Divestment Survey, the proportion of UK businesses planning disposals doubled year-on year. Companies are recognising that if they don’t have the time or capital to adapt a business to the new digital age, then they should dispose of assets to release management capacity and funds to invest elsewhere.
What could go wrong?
The stars have aligned so perfectly for M&A in the last year or so that one has to ask how long this balance can last – especially given the build-up of downside risks at home and abroad.
Rising interest rates don’t close deal pipelines immediately – especially if companies have a strong motivation to transact. Lower growth could inspire more deals. But, less liquid markets are more volatile, with instability amplified by geopolitical tensions. If markets and earnings fall, this will affect the ability and confidence of companies to transact. Riskier mega deals could be the first to drop.
Trade is another complex factor. Further trade war and Brexit uncertainty could hit confidence and limit visibility. Although, investment could still flow out of necessity, if companies need to change their operating structures to adapt to new trade conditions. Our recent UK Attractiveness Survey showed a significant rise in consumer goods, manufacturing and transport investment in the UK; whilst UK outbound investment rose by 35% year-on-year in 2017 – the highest recorded outflow.
It will be interesting to see if this translates into more outbound UK M&A – the only category that dipped in volume and value in H1 2018. Increasing protectionism may also hinder cross-boarder activity. Arguably the hottest global issue in M&A at present is cross-border security. Last month the UK government released a white paper that proposed a significant extension to the scope of deals considered to be a potential ‘security risk’. There are similar measures being developed, or in place, in a number of countries including the US, China, Australia, Germany and France.
So, the UK isn’t alone in facing a difficult balance between the need to protect national interests and the need to attract investment and keep its companies at the forefront of technological development. But, considering the UK’s current situation and standing as an open and dynamic economy, there is a great deal at stake.