Investment sentiment was sour at the start of the year as there was a fear the US Federal Reserve were going to carry out an aggressive rate-hiking cycle, and inadvertently push the US economy into a recession.
Mergers and acquisitions (M&A) activity usually flourishes in a bull market as there is an incentive to buy into the market while the tide is rising. Conversely, when the economic outlook is not so hot, and investor confidence is thought to be in decline, traders tend to trim their exposure to the markets, and the same goes for companies.
M&A activity is often funded with debt, and during a bearish run on global stock markets, speculators tend to sniff out companies that are highly geared, which are sometimes ones that overstretched themselves on account of taking over another company. Even if the deal was largely funded through equity, no firm wants to be known as the one that has bitten off more than it can chew, and has possibly overpaid for the pleasure too.
Companies’ appetite to take on more risk and go on the hunt for possible targets picked up in the latter half of 2019, as investment sentiment ticked up, as it became clear the Fed were not going to go down the rate-hiking route. In fact sentiment went in the opposite direction, and the US central bank ended up cutting rates in June. Other central banks around the world had moved to a more dovish stance too, hence stock markets' strong performance, and when that kicked in, M&A deals started to tick up too.
Merging with another group or buying out a firm can offer many advantages. It can be a good way to expand into different aspects of the business or different geographical regions. Sometimes M&A activity is pursued as a way of securing supplies or fending off competition. One of the main reasons for firms to enter into a tie-up is for economies of scale, and to be able to take advantage of synergies.
The auto sector has come under increasing pressure on account of a slowdown in global demand, China in particular, while the growth of the electric car industry is challenging well-established brands. The changes in the sector promoted PSA, the owner of Peugeot, to enter into merger talks with Fiat Chrysler. The deal has been confirmed, but it will be subject to regulatory approval. Should the deal get the green light, it would create the fourth-largest auto maker in the world, and a cost-saving benefit of around €3.7 billion. This is a great example of a synergy-motivated merger as the companies need to adapt to the changes in the industry.
Recently, Cineworld launched a bid to acquire Canada’s Cineplex for C$2.8 billion. The London-listed company is clearly keen to gain exposure to Canada as Cineplex is the largest operator in the country, both in terms of box office sales as well as screens. Cineworld believe the move will generate $130 million worth of synergies by the end of the 2021 financial year. Economies of scale are a nice by-product of a deal, but it needs to be taken in the context of the C$2.8 billion takeover – which will be funded by debt. Keep in mind, Cineworld, acquired Regal Entertainment in the US two years ago for $3.6 billion, and that move was largely funded by debt too. In August, Cineworld revealed a downbeat set of first-half numbers as pro-forma revenue slipped by 11.1%. Financing acquisitions through debt can backfire as interest repayments must be made, and if the move doesn’t go according to plan, you can become trapped in a weight of debt.
LVMH is expanding its vast range of luxury brands as it has agreed to acquire Tiffany for over $16 billion. LVMH are known for high-end brands like Dom Perignon and Dior, and now Tiffany will be the latest string to tie bow. The share price of the New-York listed jeweller hit an all-time high in 2018, but has come off the boil since then. The group is finding it tough to appeal to younger generations. The fall in its stock price made it a potential target. LVHM acquired Bulgari, the jeweller, in 2011, and since then group has seen gone from strength to strength, so some traders feel the LVMH will put the sparkle back into Tiffany.
M&A activity often sparks others in the industry to throw their hat into the ring too as companies might feel they are missing out on a good deal, or perhaps, they feel they could become vulnerable in the wake of the transaction. Just Eat are on track to merge with Takeway.com – a deal that is worth £4.8 billio,n but Prosus has upped its offer for Just Eat to £5.1 billion. Despite the higher offer from Prosus, the board of directors of Just Eat are still advising shareholders to press ahead with the Takeaway.com deal, as it will create a firm that will house the two most profitable online food delivery companies in Europe. This industry has been rife with M&A activity in recent years, and the competition is heating up as Amazon are hoping to invest in Deliveroo, pending regulatory approval. When it comes to expansion through M&A, the highest offer isn’t always the best, as the companies need to be a good fit, and complement each other, which is why Just Eat are keeping Prosus at arm’s length.
Galliford Try shares took a knock in April when the company issued a profit warning. The construction and civil engineering firm, like many of its direct competitors, was hurt by the project overrunning, plus agreeing to contracts that had too thin margins. The tough competition in the sector meant it became a race to the bottom in terms of profit margins, which was ultimately costly for the shareholders. In a bid to streamline its business as well as ramp up its cash position, Galliford decided to spin-off its housebuilding unit, Linden Homes for £1.1 billion, and the sale was made to Bovis Homes. This deal was mutually beneficial as Galliford needed to dispose of a non-core business, and focus on its main activities, while Bovis are well experienced in that area, and can take advantage of economies of scale. The takeover is a win-win as it helps Galliford turn a corner, while the Linden unit gets the expertise of a major player in the sector.
As far as global stock markets are concerned, 2019 is set finish on a far better note than it began. The bullish sentiment in equity markets should mean that M&A activity in 2020 will be similar to what we saw in the latter half of this year. Deals are often funded through equity, and high equity valuations should spur more empire building. Interest rates are very low, and several major central banks around the would cut rates this year, and it seems that monetary policy is likely to remain loose for the foreseeable future ,and that should fuel takeover M&A activity too.
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