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While many leading surveys point to a record Q1 2018 for M&A activity globally, reports on the U.K. element of that surge are less clear. Recent enthusiastic coverage in the British financial press has trumpeted record activity in the U.K. M&A market for Q1 2018, especially by U.S. acquirers, claiming it as the highest since the record year for Q1 of 11 years ago. Mergermarket reported that the U.K. (closely followed by Germany) remained the most targeted country by both transaction value and deal count, with the U.K. receiving 284 deals worth $62.7 billion, its strongest first quarter value since 2001. On the other hand, Bureau van Dyke’s Global M&A Review reported the value of deals in Q1 2018 in the U.K. at $76.9 billion, down slightly from the $78.1 billion of Q1 2017. Similarly, the volume of deals in Q1 2018 was reported at 1,359, a slight reduction from the 1,572 deals noted in Q1 2017.
Variations between surveys are inevitable given the differing criteria adopted, including the threshold of deal size for inclusion in the survey, the value adopted for deals with undisclosed values, or where the stake acquired is less than 30 percent. In addition, the U.K. Office for National Statistics points out that delay between the announcement of a proposed transaction and the time taken to negotiate and close the deal can cloud statistical interpretation, especially when endeavoring to relate M&A activity to economic or tax conditions or political events, such as Brexit.
So far this year, according to Mergermarket, domestic M&A accounts for 61.4 percent of the U.K.’s total M&A value, presumably propelled by political uncertainty pushing U.K. corporations toward defensive consolidation.
Nevertheless, the fact remains that inward M&A investment into the U.K. is strong, and leading the way are acquirers from the U.S., followed by France, Switzerland and Japan. The first quarter of 2018 saw 68 deals from the U.S. into the U.K., including U.S. futures exchange CME Group’s acquisition of NEX Group, formerly known as ICAP, for 3.9 billion pounds, GTT Communications Inc.’s acquisition of Interoute Communications Ltd for 1.7 billion pounds and the acquisition of MRH GB by Motor Fuel Group Ltd, a portfolio company of Clayton Dubilier & Rice LLC for 1.2 billion pounds.
U.S. investment in the U.K. is not confined to M&A deals. Recent research by Beauhurst has found a notable increase in U.S. equity investments in British tech companies, especially from investors based in Silicon Valley and on the East Coast. For example, U.S. investment in British companies headquartered in the so-called Golden Triangle formed by London, Oxford and Cambridge has increased from 0.5 billion pounds in 2011 to 2.2 billion pounds in 2017, with a focus on companies at venture stage, usually preprofit, and growth stage. Access to the U.S. market is often cited as a major reason for U.K. companies seeking U.S. investment.
There are a number of possible factors contributing to this robust U.S. acquisition of U.K. targets, including Brexit, U.S. tax changes, a strengthening Eurozone, saturation of the U.S. target market, buoyant acquirer equity, the low cost of borrowing, cheap sterling and cultural factors.
Acquisition rationale will vary from buyer to buyer. One buyer might be drawing comfort from the hoped-for stability to come from the two-year transition deal agreed between the U.K. and EU. Other buyers may have become hardened to regulatory and political uncertainty, not allowing such factors to discourage an otherwise attractive deal. No doubt some U.K. targets are feeling vulnerable in light of Brexit and therefore are more open to takeover by a bigger, stronger U.S. acquirer. U.S. buyers may be expecting a warmer welcome from U.K. targets who need to forge less EU centric, post-Brexit trade strategies.
U.S. Tax Changes
Historically, corporate tax rates in the U.S. have been significantly higher than those in other major economies. Consequently, some U.S. corporations pursued inversion structures, setting up headquarters in foreign jurisdictions to reduce their tax burdens. Donald Trump’s presidential campaign called for tax changes to benefit corporations while repatriating funds held outside the U.S. The Tax Cuts and Jobs Act, passed by the U.S. Congress and signed into law by President Trump on Dec. 22, 2017, is the most significant change in U.S. tax law in decades. A primary goal of the TCJA is to make U.S. corporations more competitive by setting a single, low corporate tax rate (down from a graduated rate as high as 35 percent to a flat rate of 21 percent), eliminating the corporate alternative minimum tax, shifting to a territorial tax system, and introducing a one-time transition tax on repatriated foreign earnings. As a result, though U.S. corporations may have less incentive to acquire foreign targets for inversion purposes, increased access to offshore cash following the mandatory transition tax on unrepatriated earnings and ongoing access to foreign profits without incremental U.S. tax should give U.S. buyers bigger war chests with which to finance M&A acquisitions, whether in the U.S., the U.K. or elsewhere. However, U.S. corporations are still parsing through the complexities of the TCJA and, interestingly, there may be some advantages for U.S. corporations to move their headquarters outside the U.S. For example, as part of Dana Inc.’s acquisition of Driveline, it will domicile the combined company in the U.K. Of course, wider strategic objectives, rather than levels of tax, drive deal making, and lower taxes, while favorably impacting potential value growth, are unlikely of themselves to greatly increase U.S. M&A activity in the U.K.
The World Bank’s predicted Eurozone growth rate in 2017 was upgraded by 0.7 points to 2.4 percent and its predictions that the good news would continue in 2018 (raising its forecast for the year by 0.6 points to 2.1 percent) have inspired greater confidence and an appetite for deals, not only on the continent, but also with the U.K. Deals that may have been under consideration for a while are coming to fruition.
Saturation in the U.S. Market
Dealmakers and commentators have noted that the U.S. deal market has become saturated, particularly at the mid-market level, as corporate cash available for strategic transactions remains high, while private equity has also been actively seeking transactions in all market tiers.
High Equity Values
Despite U.S. stock market volatility, equity valuations remain historically high, allowing would-be acquirers to use stock to finance acquisitions.
While businesses may bemoan the creeping increase in the cost of borrowing (the three-month LIBOR has risen from 0.25 percent in 2015 towards 2.5 percent in 2018), interest rates remain at historically low levels, enabling buyers to finance their acquisitions. The Bank of Englandand the U.S. Federal Reserve may increasingly warn of the need for interest hikes to stem incipient inflation, but borrowers know that, absent major political setback, any such interest rate hikes will be in small incremental steps in order to avoid upsetting finely balanced economic confidence. It remains to be seen how the TCJA will affect U.S. corporate activity, as it contains provisions discouraging highly leveraged corporations by significantly reducing the deductibility of interest expense.
The pound stood at about $1.45 immediately before the Brexit referendum in June 2016. It had fallen to $1.20 by January 2017, but then recovered gradually during 2017 to reach over $1.40 in April 2018. It has since fallen back to below $1.35, but is still higher than it was in early 2017. The lower inbound M&A activity in the last two quarters of 2017 (failing to reach the levels when opportunistic buyers took advantage of the cheaper sterling following the referendum) suggests that the strengthening of sterling has affected foreign investment. Nonetheless, at $1.35, sterling-denominated assets may still be viewed by outside investors as a bargain, with the hope that values will rebound once the U.K. economy stabilizes outside the EU. This may be more the case for investors denominated in a strong euro.
Cultural factors may also promote U.S.-U.K. transactions, with a mutual language, common law legal systems and compatible business attitudes.
Time for a Correction?
Despite these optimistic factors, given that the current U.S. and EU stock market upswing is close to the longest on record, commentators are asking whether a slowdown or reversal may be imminent.
Laurie A. Sanders is a partner at Osborn McDerby LLP.
The opinions expressed are those of the author and do not necessarily reflect the views of the firm, its clients, or Portfolio Media, Inc., or any of its or their respective affiliates. This article is for general informational purposes and is not intended to be and should not be taken as legal advice.