According to Bloomberg, in each of the last four quarters there have been 1,000 Mergers & Acquisitions (M&A) or investment announcements involving UK companies. A record-breaking number. Some of these have been grabbing the headlines with Morrisons, the fourth largest chain of supermarkets in the United Kingdom, being the most obvious example.
In this Luna Perspective we will examine the root causes for this increase in M&A activity, why the UK is being targeted and, ultimately, is this good news.
Why is corporate activity on the up?
Like most things in life, if doesn’t feel like there’s one principal driving reason behind this but perhaps a multitude of reasons all bought together to make the perfect cocktail.
The first most obvious reason why M&A activity is increasing is that sentiment is improving. Economic growth globally is accelerating to record levels as we emerge from Covid induced recessions. This gives management the confidence that the outlook will be better and to invest for future growth.
The majority of businesses have come through Covid relatively well. There are of course certain sectors such as hospitality and travel & leisure that still stand out as the exception. Like individuals, companies are also awash with cash – because we’ve all been unable to spend over the last 18 months. Expenses have been slashed and we’ve found more efficient ways of working. Governments have also been key in supporting businesses with grants, loans and in the UK furlough.
If it’s not corporate’s that have built a war chest then US Private Equity firms certainly have during the pandemic, and they have been one of the bigger acquirers in recent months. US buyout groups spent $45 billion snapping up companies in Britain in the first half of 2021, Refinitiv data shows, more than double the next best first six months on record and almost 10% of the total $547 billion they spent across the world. Peel Hunt data in July showed 38 London-listed companies had either been acquired by private equity this year or were in the process of being acquired.
This has all cumulated in extremely high levels of cash sitting on balance sheets at a time when you get paid the lowest return for sitting on that cash because of historically low interest rates levels. Investors have therefore been asking firms “what do you intend on doing with these high levels of cash, it’s not earning anything in the bank and can be put to more efficient work”.
Why the UK?
An attractive entry point. The UK equity market and sterling has been unloved since the 23rd June 2016. A date that will long live in our memory – the date of the EU referendum. Since then, we have been going through a long torturous divorce. It has been an easy decision for overseas investors not to invest in the UK because of the uncertainty that Brexit created. Fast forward to 2021 and despite the fact that there’s still teething issues the vast majority of Brexit is sorted and behind us. However, investors minds are still plagued with the events of the last 5 years, and it will take time for these memories to be replaced with better thoughts!
To highlight the valuation discount that the UK trades at, please refer to the following graphs from Schroders. The first shows that global fund managers are returning to the UK Equity market and have gone overweight for the first time since 2014.
Whilst the second chart shows how extremely unloved the UK has become trading at a 40% discount the greatest in 30 years.
The UK is a good place to do business and there’s historic trust that has been built up over the years. One of the best ways to highlight this is the Covid vaccination response. The one shining light from the UK’s Covid response has been the vaccination programme that has enabled the UK to protect those most at risk and re-open the economy sooner.
Is M&A good news?
It depends! In the short term most companies are bid for at a premium meaning a knee jerk reaction – there’s also been bidding wars and improved offers in recent weeks that mean share prices have continued to move higher even after the initial approach. However, this can also be bittersweet in the long term because it ultimately means the loss (from the public markets) of a quality UK asset.
There are concerns that Private Equity could be taking this as an opportunity to buy these businesses and saddle them with debt, leaving the businesses vulnerable in the long term. This is a reason why the UK government looks to be taking a keener interest in deals with rumours of intervention.
How are Luna positioning and have we benefitted from this?
At Luna we have felt that the UK equity market looks cheap versus other global markets and gradually increased our exposure towards the end of 2020. Despite the fact the FTSE 100 has picked up well in 2021, we still see tremendous value in good quality UK businesses. It took 5 years for Brexit to be ‘sorted’ and the discount on UK assets to be put in place – it could easily take a similar time for this discount to be unwound and UK businesses to trade more in line with international peers.
Where we are buying collective funds, the impact will be less obvious because one of the purposes of buying these is for diversification. However, when speaking to fund managers, as we do on a regular basis, it’s evident that the funds we have selected have also been buoyed by these developments as well.
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