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UK businesses – an appetite to grow through M&A

Andy Morgan Andy Morgan

Mergers and acquisitions (M&A) activity tends to track the economic cycle. However it is increasingly viewed as a key strategic pillar driving growth for UK corporates.

There has been much documented research on why large scale M&A frequently fails to deliver the anticipated benefits in terms of shareholder value for the buyer. This highlights the critical importance of a disciplined approach to M&A, which is both well executed and integrated.

In our recent business growth research, we asked companies to describe their most important strategic priorities for growth. An average of 62% of businesses included M&A among their priorities over the next one to two years, increasing to 63% over the next three to five years. However, for our Growth Generator cohort (high-growth businesses) the figures were higher: 66% plan to do M&A within one to two years, increasing to 70% within three to five years.

M&A brings breadth, depth and efficiency and is frequently key to unlocking international expansion at scale. It applies equally in the race to scale and internationalise new disruptors, extend product and service offerings in fragmented markets and respond to end customer demands of more-for-less. M&A appetite varies by sector reflecting the differing market growth profiles and existing industry structures.

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Read Leading the way to find out more about the 188 deals we advised on in 2017.

How M&A differs by sector - higher appetite for M&A

Insurance

Our research found that in the insurance sector – an industry characterised by scale at the insurer level but a fragmented market in terms of distribution and technology - more businesses than average prioritised M&A in their 1-2 and 3-5 year strategies (74% in each case). This reflects both the current level of fragmentation in the market and the benefits of economies of scale. Consolidation opportunities abound in a market where there are currently many specialised smaller players serving niches, regions or certain risk categories. This trend is compounded by the impact of new technologies on the established distribution channels and broker networks, and the associated emergence of new business models.

Real estate

In our research, this sector featured strongly in terms of M&A appetite and prioritisation over the next 1-2 years at 71%. partner for the real estate sector, Kersten Muller, says this chimes with what he has seen. Uncertainty has been driving the demand for M&A and he expects this to continue for at least 18 months. Certain sub-sectors within real estate, too, are appealing. “So-called ‘alternative investments’ are becoming attractive. This includes student accommodation, residential property in the private rental sector and healthcare properties – homes for the elderly and disabled people,” he adds.

However, there was still much activity in “traditional” areas, particularly office and warehousing distribution centres.

Bucking this trend however, is retail property. With the retail sector continuing to struggle, many investors are closely examining their portfolios. Kersten adds: “Some investors are saying that while that sub-sector is challenging, they also think there is opportunity to buy struggling real estate in order to change its direction and make it more attractive.” This can include investing sums in refurbishment for change of use.

Availability of capital – both debt and equity – is more significant for M&A investors than the cost of capital. And there is a lot of it around at the moment. “What would really have an impact on the level of activity is if financing was hard to come by,” he says. “That’s what happened in 2008 and 2009. But now there are so many different players.”

He also doesn’t believe that this is a rush before Brexit: “Once we know what the Brexit deal is, you will have lower risk investors coming back, and they’ll be priced in at that point. Ultimately it’s the underlying fundamentals of the economy that matter, and they are relatively strong at the moment notwithstanding the overhang of uncertainty.”

Automotive

Also active is automotive with 70% of those surveyed looking to prioritise M&A over the next 1-2 years. Automotive M&A activity can be quite cyclical, having been through a huge wave of supply chain consolidation in the 1990s. But there are changes.

“With automakers allocating ever increasing sums of money towards AutoTech development, many are taking a closer look at their supply chains to squeeze supplier margins and protect their own during this period of deep investment,” says Neil Barrell, our global automotive leader.

“Some UK component manufacturers are already facing difficult decisions due to the downturn in UK vehicle sales and the consumer-shift away from diesel. With the additional threat of a hard-Brexit, we may see a rise in distressed opportunities in the short-term.”

On a more positive note however, Neil adds that a hard-Brexit could see UK automakers encouraging investment in the local supply chain, in an effort to comply with the rules of origin that would form the basis of any future free trade deals.

Automotive covers more than just the supply chain for building a car and the role of the major manufacturers; it encompasses financing, leasing, vehicle retail, rental, motorsport and the myriad things that spin off a brand. M&A opportunities are emerging from the drive to new technologies including electric and autonomous vehicles, and new ownership models such as car-sharing clubs from the likes of Zipcar and DriveNow.

How M&A differs by sector - Lower appetite for M&A

Banks

By contrast banks had a lower than average appetite for M&A (only 40% listed it as a priority over the next 1-2 years). This is not surprising given the global realignment of the role of the traditional bank in the economy post the global financial crisis, and the demands on the industry to repair its balance sheet and deal with an increasingly regulated and politically charged environment.

However innovation is moving forward apace in the banking sector. There are many challenger banks and online platforms – entering and attempting to disrupt that market, which is where M&A could get quite interesting over the next few years. With the right level of capital behind them, the disruptors could even drive some of the M&A activity, as well as traditional players using M&A to get access to some of the emerging FinTech capabilities and skills which are disrupting the market. Some of these businesses, like Starling and TransferWise, have grown rapidly already through an organic strategy backed by significant investment raised through several funding rounds (Starling has raised c.$190 million to date and Transferwise c.$400 million). It remains to be seen whether M&A, as suitor or target, comes more in to play over the coming years.

Facilities management

Facilities (also low at 50%) occupy a very conservative market that is already consolidated, with businesses now covering cleaning, infrastructure of facilities and other outsourcing services. Customers demanding ‘more for less’ means companies have sought the benefits of scale and breadth to find efficiencies. This is driving some M&A activity as larger players refocus on what is core and non-core, and the shake out from Carillion continues to work its way through the market.

Our work

Conditions for economic or political forecasting remain challenging, with volatility and uncertainty the new normal, however against this background the M&A market performed strongly again in 2017. Read more about our deals in Leading the way.

How M&A differs by sector - Varied plans

Telecoms and energy

Some industries have wild differences between their 1-2 and 3-5 year plans, such as telecoms (55% and 82%) and energy (54% and 71%).

In telecoms, M&A may result from change around infrastructure (which is both industry and politically driven), and investment profiles. Head of telecoms, Chris West, says: “There is a lot of investment in telecoms infrastructure in train, with 5G network investment coming in to view and the current drive for more aggressive high speed fibre roll out. Both are likely to drive M&A activity in the medium-term.

In the more immediate future, he says M&A activity in the B2B service provider segment will continue as firms “position themselves for growth opportunities stemming from the blurring of historic boundaries between telecoms and technology”.

The energy market is subject to myriad different influences and pressures across its various sub-sectors. Maturing markets in alternative energy such as wave, solar and wind will continue to attract new investment to drive M&A, albeit while the sector faces short-term uncertainty from a policy and regulatory perspective.

Meanwhile upstream oil & gas transaction activity, having been depressed in recent years due to the collapse in the oil price at the end of 2014, “is slowly recovering due to more positive fundamentals”, says Ian Knott, Grant Thornton’s corporate finance director for Oil & Gas. This has been led by OPEC’s decision to cut production as well as concerns over the supply/demand balance rising from interruptions to supply from countries such as Libya and Venezuela, as well as the re-imposition of US sanctions on Iran.

The downturn also led to an increased focus on the use of new smarter and cheaper technologies in order to cut both exploration and production costs. Ian adds: “This is boosting M&A activity, as larger service companies seek to acquire new capabilities from small entrepreneurial businesses.

“Meanwhile, M&A in the midstream and downstream sectors is being driven by the need for businesses to evolve to cope with fundamental changes in the production landscape arising from increased US production from shale developments.”

Media and technology

While the research identified the media and technology sectors as having a lower than average appetite for M&A, there are nuances. Media, for example, is a very broad sector where there has already been a lot of consolidation.

Technology remains one of the most active M&A sectors, with significant capital attracted in terms of private equity and venture funds. There are very few investment portfolios that do not see some form of exposure to technology as a key part of their growth and return strategy.

Within media there are some clear hotspots, with traditional media players grappling with the move to the digital world and consolidation a key feature of the advertising and marketing services arena. “In the last two years, our research highlighted that there were over 250 M&A deals (disclosed) by UK acquirers,” says Vasu Majumdar, corporate finance M&A director.

What of advertising and marketing services? “There is ongoing consolidation, with the likes of WPP, Next 15, Dentsu, Mission Marketing and Four Communications being some of the key acquirers,” says Vasu. “Agencies with strong digital skills are in high demand.”

For broadcast media, the rapid growth of online distribution platforms such as Netflix and Amazon Prime has forced traditional broadcasters to look for acquisitions to strengthen their offering in high-quality original content.

Vasu adds: “Publishing has had sporadic M&A activity with niche assets and titles changing hands between publishing companies – this is partly to do with becoming specialist B2C or B2B publishers and the focus on becoming specialists in niche sectors.

Finally, he says, the events market remains strong as marketers “look for mediums that can connect strongly with buyers looking for multiple access points to end consumers”.

The rise of GAFAs (Google, Amazon, Facebook, Amazon) has come as a result of organic growth and disruption, but these players are growing into ‘M&A Machines’. With massive cash reserves and record valuations, they are a magnet for talent, and represent nirvana for many growth businesses as a potential route to exit, value realisation or route to market and scale. While growth and the “Rule of 40” remain key metrics for most tech companies, in reality many follow a hybrid route embracing organic growth, research and development and M&A.

Challenges and considerations overall

So, what of the challenges mentioned at the start? Availability of capital is not as limiting as the quality of opportunities to put it into. This is one of the biggest challenges for businesses considering M&A. Regulatory scrutiny is also playing a bigger part, as competition and broader public interest considerations continue to place large scale M&A under the microscope, and governmental moves toward protectionism could make international expansion through M&A more challenging.

M&A requires managerial talent and expertise, the capacity to manage a larger business and integrate, and the financial acumen to do it. It is essential for businesses to be very clear on what is core to their value, and how they will capture value from the deal. They also need the right quality of information for an informed decision; clarity on how to evaluate and finance the acquisition, and how to integrate it within the existing business; as well as a long-term vision of what will be core to the business in future. It is an approach that has worked already for business support services company Ceuta Group. CEO Edwin Bessant, who we spoke to during the course of our growth research, told us: “We have undertaken seven acquisitions since we started up and investigated many others. It’s such an important part of our growth strategy. Supporting this initiative, we’ve developed a stand-alone M&A team to focus on the commercial evaluations, implementation and construction of the deals. The M&A department also allows the heads/CEOs of each business to remain focused on their business and not get distracted.”

Read more about our deals in Leading the way.

For more information on M&A and to find out how we can support your business, please contact Andy Morgan.