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Insight – Bordering on the ridiculous

Conventional wisdom suggests that the emergence of the eurozone will stimulate merger and acquisition activity as companies manoeuvre to develop a truly continental presence in ever-more competitive markets.

Will it happen? And if it does, what are the dangers for Britain, currently marooned outside the eurozone?

New research argues that what really happens might be a touch more complex than the conventional wisdom predicts. A study by Morgan Stanley, published in the latest issue of the Bank of England’s guide to euro preparations, Practical Issues Arising from the Euro, reveals that Europe is still “far from being a single market” when it comes to M&A activity.

The study points out that more than half of US M&A activity takes place across state boundaries, but in Europe only around a quarter of M&As involve cross-border deals. “Companies based in New York do not seem to care whether a potential target is in California, Texas or Minnesota,” says Ravi Bulchandani, executive director of Morgan Stanley and author of the study. “In Europe, national boundaries seem to be an important influence in determining the pattern of M&A activity.”

In fact, Morgan Stanley’s figures suggest that a company from the Continent is more likely to tie up with a US company than another in Europe – 41% of the deals involve a party outside Europe. Another 35% of European M&A is purely domestic. “The data suggest that cross-border consolidation in Europe is still in its very early stages,” says Bulchandani.

He points out that European companies have been on an “acquisition binge” in the US in recent years. Since 1995, there have been 684 deals worth $927bn in which European companies acquire US firms. This compares with 586 deals worth $363bn coming the other way.

Bulchandani argues: “The lack of cross-border consolidation in Europe may reflect the fact that there is a dearth of truly pan-European corporate assets for US companies to buy. For US companies engaged in global expansion who want to complete the European piece of a global strategy, it is not clear how to choose between say a French, German, Italian or British company.”

He says that language and cultural barriers offer only a partial explanation for the comparative unwillingness of European companies to get together.

But national regulations and laws could provide a hidden barrier, even though overt opposition to a cross-border takeover is not allowed under the Single European Act. Instead, companies are more likely to be daunted by the complexity of the different rules and regulations they need to master in each jurisdiction.

“Breaking down these barriers will be a slow process as local regulations are tested for compatibility with single market legislation,” says Bulchandani.

“And it will be acquirors and targets engaging in cross-border M&A activity who will test and challenge the compatibility of local laws, regulations and customs with the European single market.”

But it is also likely that the slow development of a single European capital market is holding back cross-border M&A. In theory, it should be as easy to use shares in, say, a French company to acquire a German firm as another French operation. In practice, that is rarely the case because of the “flowback” of foreign shares into their home market.

Bulchandani points out that there is still a “home country bias” in patterns of share ownership across Europe. If Europe had a truly integrated capital market an institutional investor would hold no more than around 9% to 10% of domestic equities. But Morgan Stanley equity research suggests that within the eurozone, domestic equity holdings in mutual funds stand at 31%.

One reason why there are fewer European mergers and acquisitions than expected could be because continental firms are significantly less successful at harvesting shareholder value from them. A study by KPMG, Unlocking Shareholder Value: the Keys to Success, found that both the US and UK are better at creating new shareholder value from mergers than continental European countries.

It puts this partly down to the fact that the US and UK have more experience of the practical problems of making mergers work after the deal is done, while language and cultural barriers can undermine a deal with Europe.

According to the survey, M&A deals analysed that involved the UK were 32% more likely than average to be successful – ie, create shareholder value. Deals were 23% more likely than average to be successful when the US was involved. This compares with just 6% for deals involving the EU.

KPMG also argue that companies entering into cross-border deals need to “pay particular attention to the problems of cultural integration”.

And it argues that companies entering into cross-border deals need to “pay particular attention to the problems of cultural integration”. It advises: “They must focus effort on communication programmes and should look at reward systems to reinforce change management programmes.”

But, despite the difficulties of cross-border mergers, there has been a sharp jump in the value of all mergers undertaken by European companies in the last two years (1999 and 2000) to more than $1.4bn in each of the years. Christopher Huhne, a Liberal Democrat MEP, has suggested this is part of a “vast restructuring of the European economy”.

He points out that the strong rate of sterling relative to the euro has contributed to the loss of 397,000 manufacturing jobs since March 1998.

Businesses can hedge future sterling revenues – by selling them for euros – but they can’t hedge costs. “If sterling rises, they become less competitive even if they make a profit on their forward contract.”

Huhne, co-author of a book on the euro, Both Sides of the Coin (The Case for and Against the Euro), argues: “This has dangers for Britain. The biggest British businesses, often participating in the mergers boom, may slowly emigrate to their biggest market in the euro-area, in effect becoming euro companies. But medium-sized British businesses will not have that option. They will continue to suffer the disadvantage of incurring costs in a currency different from the currency of their biggest export market.”

The adoption of the euro as a retail currency from 1 January 2002 could create a profound psychological shift in Europeans’ perceptions. It will accentuate the problem of price transparency by levelling down price expectations among customers. Which, in turn, will stimulate a search for higher productivity to sharpen competitiveness among producers.

That could mean European companies will have to look more for mergers among themselves than with US partners. If so, they will have to learn how to overcome the barriers to integration – and fast.

Practical Issues Arising from the Euro is available at

Unlocking Shareholder Value: the Keys to Success is available at uk/services/transaction/case.htm.

Both Sides of the Coin (The Case for and Against the Euro) by Christopher Huhne and James Forder is available from Profile Books, price #8.99.

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