Investors are seeing a lot of M&A activity in the marketplace at the moment, right across the board from mega-cap through to unlisted and unquoted companies. According to data from PWC on the deal volume per quarter, in the three quarters up to the end of Q2 this year we saw a consistently higher global volume of deals than in any of the previous quarters dating back until the beginning of 2019. But why is this occurring and what does it mean for investors?
There are three key economic factors that are currently driving this M&A activity. Firstly, there is currently a lot of cash in the system. Certain businesses have done well throughout the pandemic. They have not paid dividends and have plenty of money on the balance sheet.
Secondly, interest rates are low, so it is cheap to borrow money to buy out businesses. A recent example is Louis Vuitton buying out Tiffany’s in 2019. They went to the bond market to raise the money and the addition of quantitative easing from the European Central Bank meant they were able to finance the deal at negative rates. They were effectively being paid to buy out Tiffany’s.
Thirdly, some companies are using their stock to buy businesses. A company called Square in the US used its stock instead of cash to buy the business, Afterpay. Square issued new stock and gave this to the shareholders of Afterpay in exchange for their current stock.
These factors favour the buyer and this is what is driving increased M&A activity.
M&A activity in UK market
We have certainly seen increased M&A activity in the UK market, and many examples of overseas businesses and organisations buying out UK businesses across the market cap spectrum. In the first half of 2021, there were 21 announced or possible bids for London-listed companies with record value of takeovers and other deals involving UK companies recorded.
What is it about UK businesses that has made them such attractive targets for acquisition?
Essentially, since Brexit, stock market valuations in the UK have been below those seen elsewhere in much of the developed world. To put this into context we can look at the US-based EA Sports acquisition of UK-based gaming company, Codemasters. EA Sports trades on a multiple of 40x its earnings, while Codemasters traded on a multiple of 20x its earnings. They are both successful gaming businesses in their own sector but one is valued at double the other.
Implications for investors and advisers
If the current economic conditions and factors noted above persist, and we see valuations of UK companies continuing to remain lower than much of the developed world, then there is nothing to say we won’t see a continuation of this M&A activity in the months ahead.
Retail client investors will want to understand how all this activity is likely to impact on them and their portfolios and advisers need to be prepared to guide them. Investors who hold these businesses may see some short-term wins, like a sharp increase in value of these stocks overnight, but this is not so positive if you are a longer-term investor. Many of these businesses are being bought on valuations that are quite low, and less likely to suit the investor who is looking to hold these stocks over a timescale that would offer more comprehensive long-term growth.
In the event that one of the companies they own is bought out, the longer-term investor will need to identify another viable investment to serve their longer-term goals. In this environment of increased M&A activity, however – particularly in the mid-cap market – there is a shrinking pool of investment opportunities to choose from. Investors can work with their advisers to understand their options. Each share owned in a company typically gives the investor a right to vote on company matters, such as whether to accept takeover bids. Whilst clients may feel their individual actions will have little consequence, by working with advisers and fund managers, the collective actions can have a huge impact.
There is also the potential for government intervention in a climate where so many UK companies are being taken over. Rishi Sunak has made it evident the Government could look at interventionist policies to ensure the continued competitiveness of UK companies and that the UK remains a hub for innovation.
If you would like to discuss your investment goals, please get in touch.