Strategy & Operations » Leadership & Management » Lock, stock and barrel

THE HALF-YEAR reporting season has seen the publication of promising figures by UK corporates, and the number of companies ramping up their interim dividends and share buyback schemes suggests that cash positions are healthy. If you were to judge by these two facts alone, many companies have now started to emerge, blinking into the daylight, after a period of retrenchment.

Businesses have been accumulating large amounts of cash in the past few years. Given the fact that the low-interest rate environment now makes holding cash on the balance sheet even more inefficient than normal, these businesses are coming under increased pressure to deploy that cash productively.

Reasons for acquisitionsWhile some companies have chosen to line the pockets of their shareholders with cash – Rio Tinto has said that it will increase its share buyback programme by $2bn to $7bn, and Rightmove has hiked its dividend by a whopping 40% – there is no doubt that mergers and acquisitions are back on the agenda for many finance directors, particularly as the market is looking so favourable towards deal-making at the moment.

In the first quarter of 2011, the total value of M&A deals by UK businesses increased by 63% to £23.2bn from £14.2bn, according to a report by Mergermarket and accountant PKF. Appetite for M&A remains strong among mid-sized companies that use it as a means to target growth. Research by accountancy firm BDO found almost 60% of businesses are considering an acquisition in the next 12 months, while the number of deals recorded by its private company price index in the first half of the year increased by 12.5%, compared with the second half of 2010.

Crossing borders

Cross-border deal activity in the UK has also grown significantly during the first half of 2011. Research by investment bank Baird showed that the number of deals involving outbound M&A from UK acquirers increased by 25%, compared with the same period in 2010, to a total of 366 deals. Data from the Office for National Statistics revealed that expenditure on international acquisitions rose to £18.3bn in the first quarter of 2011, up from £3.8bn in the fourth quarter of 2010.

“Investors expect to see a well-balanced and structured business,” says David Simpson, global head of M&A at KPMG. “The premium paid by investors is generally more for a business that operates in more than one geography.”

Influence on valuation climateBut what will be motivating deals for FDs? A report into M&A confidence in 2011 by KPMG found that 39% of respondents said their companies were interested in increasing revenue growth. Other top reasons included expanding both the customer base and the company’s geographic reach in the coming year.

Matt Waddell, corporate finance partner at PwC, agrees that growth is driving M&A more than any other metric, such as cutting costs, enhancing intellectual property or introducing new products. In a low-growth environment, inorganic growth becomes more important, he says.

“What seems to be driving M&A is growth,” Waddell tells Financial Director. “Through the back end of the recession, trade buyers turned the taps off and chief executives became internally focused for, perhaps, the first time ever. They have done their housekeeping and are now sitting on piles of cash. There are not many sectors of the economy where organic growth plans are that exciting.”

The sleep-at-night test

Highest volume of transactionsHowever, Greece is still an open financial wound, the economic health of Italy remains on the slide, and the market is undergoing massive turbulence following Standard & Poor’s decision to downgrade the sovereign debt rating of the US. As a consequence, many FDs are wary about sticking their heads above the parapet.

According to the KMPG survey, all of this has been inhibiting deal activity. When asked to name the top two factors making it harder to complete deals, 34% cited the general negative market conditions and another 34% named the unpredictable nature of revenue projections.

Simpson says these conditions mean that “there are plenty of opportunities for unforeseen circumstances” to make an acquisition harmful rather than beneficial to the acquiring company.

“You have to pass the sleep-at-night test and ask, ‘If I spend money, will I imperil my business?’. FDs must make sure their own house is in order before they go out and buy,” says Simpson.

The optimism and appetite for M&A are both clearly present at the moment, but the notion that investors are going to support a merger or an acquisition does not come without certain caveats. Judging by the market’s reaction to a cross section of deals that have taken place this year, the markets have only rewarded deals that are marked by streamlining, specialisation and in-market consolidation.


When rental vehicle operator Avis Budget Group announced plans to buy UK-based car rental company Avis Europe for about £635m in June, shares in Avis Europe surged by about 58% on the London Stock Exchange. This was largely perceived to be due to the fact that Avis Europe holds the rights to use the Avis and Budget brands through various licensing deals. Similarly, shares of NYSE Euronext and Deutsche Börse reacted well when their merger discussion became public in February.

Difficulty of processesBut markets have also reacted adversely to deals that are perceived as moving away from the company’s core offering and diversifying too much. This reflects the caution that still exists. When US disinfectant manufacturer Ecolab agreed to buy water management company Nalco for $5.4bn in July, its share price slumped by 7% in morning trading as investors became unsettled by the company’s push beyond its core business. This represented its biggest drop since December 2008.

The CFO of one Bermuda-based reinsurance broker once told me that “diversification should be renamed di-worse-ification”. He was vehemently against the industry trend of branching out into new product lines and jurisdictions. KPMG’s Simpson says he is not against businesses diversifying through acquisition, but he does concede that looking within your own market makes better sense, given the valuation climate.

Companies that streamline their businesses instead of diversifying have the advantage of knowing their markets better than those that do branch out, he says.

“If you are in a sector, you know that you have a better chance of getting it right, especially when it comes to what sort of multiples you should be paying,” he says. ?