Robust economic growth in 2007 to boost UK mergers and acquisitions
Mon, Nov 13 2006, 16:23 GMT
by Lloyds TSB Financial Markets Economic Research Team
Faster economic growth and buoyant liquidity will boost mergers and acquisition activity in 2007
Economic growth in the UK has been estimated at 2.8% in the 12 months to Q3 2006 - this compares with growth of just 1.9% during 2005 as a whole. A buoyant world economy, a stronger housing market, positive real earnings growth, rising employment and relatively low short and long term interest rates seem to be the main factors that account for the pick up in UK economic activity. Our 2007 UK outlook is for a continuation of this economic performance, with manufacturing output boosting growth and helping to rebalance the economy away from its reliance on consumer and government spending. With companies sitting on around £70bn of cash and equity markets and bond markets still buoyant, how will the economic recovery impact on mergers and acquisitions activity in 2007?
UK mergers and acquisitions are already rising strongly
We think that higher short term interest rates are unlikely to dent the boom in mergers and acquisitions that is currently underway, both in the UK and globally. Table 1 shows that the number of companies acquired in the UK by UK companies last year was 769, well up from 430 in 2002. UK firms bought 365 companies overseas last year and 242 companies in the UK were purchased by firms from abroad. This makes a total of 1,376 company acquisitions involving the UK last year. Our estimate suggests that this figure will be matched or surpassed this year, and in 2007. It is worth noting that this total figure of 1,376 acquisitions last year was last beaten in 1998, ahead of the peak in the stock market boom in 1999. Table 2 shows that in value terms the picture is similar, with £25bn spent by UK firms in 2005 and an estimated £30bn this year. We expect over £40bn to be spent in the UK next year.
The pattern has changed for inflows involving UK firms and foreign firms in terms of value, however, with an outflow from the UK of £33bn last year set against the inflow of £50bn. Clearly, this implies that the UK is a magnet for foreign investment at present. The total of £108bn last year and estimated £143bn this year is the highest since 2000. Chart a shows the number and value of these transactions. Chart b shows that the activity in the UK is increasingly in cash, perhaps reflecting the large cash holding of UK companies. But with equity markets now rising, perhaps 2007 will see a greater share of this category. Fixed interest funding remains low, as shown in the chart. Chart c and d show that the UK buys more companies in the EU than anywhere else in the world and that the EU reciprocates, overtaking US firms last year for the first time since 2002.
What is boosting this activity?
Even though short term interest rates are rising long term interest rates are still low, so overall debt financing for companies is still relatively cheap. Indeed, the rate of UK economic growth that we are expecting next year, in particular the contribution from growth in the manufacturing sector and increased investment spending, could lead to even stronger activity in the acquisitions market than this year. Moreover, broad money growth in the UK was up by 14.5% in the year to September 2006, a 16 year high, suggesting there is plenty of liquidity around in the economy. In addition and as mentioned above, UK companies cash reserves are standing at around $70bn, nearly 6% of the value of annual output of the economy and the highest surplus on record. Interestingly, takeovers have been one of the key factors driving up UK and European equity markets in 2006, and the high level of liquidity available to companies is not just a UK phenomena but a European and global one as well. With stronger equity markets, finance becomes even cheaper and acquisitions even more attractive for companies. With so much cash around, it is not surprising that a large proportion of the take-overs in the UK have been in cash, see chart b. Finally, with UK company investment spending projected to rise by 4% next year, some of that investment is likely to involve mergers and acquisitions as well as spending on new plant and machinery.
With very narrow spreads between corporate bonds and risk free cash - government bonds - there is cheap finance available for acquisitions. However, as chart b shows, companies are not issuing fixed income debt to fund acquisitions, preferring cash and equity finance instead. Of course, all good things must come to an end and this boom cannot continue unabated forever, but over view is that it can continue for at least the next fifteen months. And we look for 2007 to be even more buoyant than 2006, as equity markets rise and UK economic growth accelerates.
