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Trevor GreenSenior Portfolio Manager @TrevorGreen
Uncertainty surrounding the UK economy is potentially driving a new wave of outward merger and acquisition activity.
6 minute read
With the outlook for domestic economic activity in the UK clouded by the country’s negotiations to exit the European Union and heightened political uncertainty, it is unsurprising the government is stepping up its efforts to encourage outward investment in new markets.
To that end, the Department for International Trade (DIT) in September launched a new policy to “help companies invest abroad with confidence”1.
While outward direct investment may once have been “seen as a fig leaf for outsourcing jobs and cutting costs at the expense of domestic investment and jobs for British workers”, according to Liam Fox, Secretary of State for International Trade, he believes expanding into new markets will be vital if the UK is to exploit the “unprecedented economic opportunity” provided by Brexit.
Increased investment goes hand-in-hand with increased trade, according to the DIT, which says companies with investments and operations in more than one country account for 80 per cent of all world trade. British firms who take ownership of foreign assets can also integrate the UK supply chain into large international projects, creating more export opportunities, adds Fox.
Moreover, investing abroad helps turn British companies into global brands, and there is “clear evidence UK companies that invest overseas become more competitive and productive” through the acquisition of new technologies and local business know-how that is transferred back to Britain1.
Brave new world
There certainly appears to be a greater focus among UK small and medium-sized enterprises (SMEs) on overseas expansion following the Brexit vote. A recent report by the Dubai Multi Commodities Centre (DMCC) found that 42 per cent of UK SMEs are interested in expanding their operations abroad to leverage new opportunities2.
According to the report, the key drivers of this trend include the attractiveness of emerging markets, the growing need for a global presence, and the availability and wealth of overseas talent and resources. DMCC argues the uncertainty caused by Brexit is leading UK companies “to take greater risks than they ordinarily would, and to take the leap into geographical diversification”.
Thirty six per cent of respondents believe the UK has too much uncertainty surrounding it now and is no longer an attractive option for investment.
Although early days, there is hard data to support the view UK companies are becoming increasingly outward looking. UK companies spent US$109 billion on overseas acquisitions in the first half of 2017, an annual increase of 60 per cent3. These figures run counter to the theory UK companies are more likely to end up as prey than predators because of the weaker pound. British companies appear to be using local currency debt to counter the impact of sterling weakness4.
Ramping up
Professional services firm EY believes merger and acquisition (M&A) activity by UK companies is set to increase in 2018. A report released by EY in November found that 60 per cent of UK companies are planning acquisitions over the next 12 months, up nine percentage points since April 20175.
The US remains the top-outbound destination for UK acquirers, followed by France, Germany and India. Around 63 per cent of UK respondents said they are reorganising their geographic operations in response to “potential changes in trade policies or an increase in protectionism”, much higher than the global figure of 41 per cent and a response to the issues raised by Brexit.
Trevor Green, Head of UK Equities at Aviva Investors, points to recent examples of UK companies acquiring overseas companies as indicative of this theme. They include Reckitt Benckiser’s £14bn takeover of Mead Johnson6, DS Smith’s £722m takeover of the US paper and packaging business Interstate Resources7, while Sage8 and UDG Healthcare9 have also made acquisitions on the other side of the Atlantic. All have been completed in the second half of 2017.
Other UK companies, including Melrose and Sherborne, have said they are looking for acquisitions. Green would be “very surprised, in the current environment, if these proved to be totally UK- focused businesses”.
Labour concerns
Workforce issues, particularly where companies employ large numbers of EU staff, are a key factor driving companies to consider their operations, says Green. As recently as August, Sir Martin Sorrell, CEO of the global advertising and marketing services giant WPP, summed up the predicament facing UK companies.
"The migration issue or the fluidity of people is really important to us,” he said. “About 17 per cent of the 14,000 or 15,000 people we have in the UK come from the EU. If there are severe restrictions on their movement - inward or outward - in future, that obviously impacts our business in the UK. Our response to that has been actually to increase our investment in France, Germany, Italy, and Spain because those are four of our top ten markets and we can't afford to lose influence in those markets.”
Multinational slow burn
Overall, however, Tim Sarson, value change management partner and “Brexpert” at KPMG, believes multinationals are reacting slowly to the prospect of Brexit.
“Some of the more forward-thinking companies are using Brexit as an opportunity to reconsider their overall global operating model,” explains Sarson, who has spent his career advising multinationals. “But most companies are simply focused on keeping the wheels turning on day one, asking what should we do before March 2019 rather than taking long-term strategic decisions.”
Sector by sector
Brexit will have a differing impact on individual economic sectors and this is informing investment decisions. Companies reliant on government contracts in Europe are building up their presence in continental Europe. This is particularly true of the aerospace and defence sectors, says Sarson, adding that many of these companies have been doing this in the US for years.
Heavily-regulated sectors such as banking and life sciences, which includes pharmaceuticals and medical equipment, are transferring certain activities to other EU countries to ensure they remain compliant. This could lead to tens of thousands of jobs moving to Europe in the banking sector, whereas the figures will more likely be in the thousands overall in the pharmaceutical sector.
The same is true of airlines such as EasyJet, says Green. The airline had no option but to apply for a new air operator’s certificate in the euro-zone, unveiling Vienna as its new EU hub with some staff moving from Luton to Austria.
The pharmaceutical sector, like the food industry, is also characterised by just-in-time product deliveries and that too is informing the short-term measures being put in place to maintain service levels after Brexit. Hospitals, for example, rely on temperature-controlled vaccines with a short shelf life, while much of the perishable food supplied to retailers is imported from continental Europe. Companies in both sectors, says Sarson, are focusing on logistics and building stockpiles on this side of the Channel to ensure they can easily deliver.
Meanwhile, other industrial sectors, such as autos, are highly interconnected. Many UK companies produce components for other industrial groups and there are multiple movements of parts and products and components across the Channel before the finished good appears. Hence, industry’s oft-quoted desire for a “frictionless” trade deal with the EU.
Businesses are just starting to look at measures that could mitigate Brexit’s impact on consumers, “mapping out their supply chains in great detail to identify pinch points and create solutions”, says Sarson.
There are various consumer goods sectors with similarities to the industrial and food retailing sector, where companies are also adapting; albeit on a small scale and at a slow pace for now.
The major expenditure over the next 12 months will be in logistics and building up stock levels. That means the working capital position at some of these businesses is going to become “quite difficult”, says Sarson.
“Banks are aware that some companies will have a lot more cash locked up in stock and they have been talking to KPMG about how they can plan for and predict the working capital requirements of their customers,” Sarson adds.
Thinking strategically
Sarson believes multinationals tend to be highly bureaucratic, where change happens slowly. Once they have the crisis management plans in place, they will start to take a strategic view of the post-Brexit world. “But they will also be looking at other long-term issues such as automation, ageing populations and skill shortages to name a few,” he adds.
Meanwhile, EY’s chief economist Mark Gregory believes companies will wait to see what trade deal the UK signs with Europe before they act decisively. “At some point you have to make a decision on where you are going to site a factory, but until that point arrives business will wait for more information on whether the UK opts for a soft or hard Brexit,” he explains.
In the 1950s, President de Gaulle rejected the UK’s application to join the then European Economic Community; arguing if Britain had to choose between Europe and the open sea, it would always choose the latter. In the coming years it will become clear whether UK companies have no option but to head out once again into the open sea. If so, Green believes the implications for long-term earnings and stock selection could prove profound.
References
2 DMCC Freezones: Brexit Security for British SMEs
3 UK companies defy political uncertainty with dealmaking uptick, The Telegraph, 31 July 2017
4 Predictions were wrong: Brexit is not hurting the UK’s M&A market, fn London, 05 December 2017
5 Pick up in M&A points to UK companies defying uncertainty, EY, 06 November 2017
7 DS Smith enters U.S. with $920 million buy, reports higher FY profit, Reuters, 29 June 2017
8 Sage completes the acquisition of Intacct, Sage, 03 August 2017
