Heartwood IM: M&A off to a strong start in the second quarter

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Michael Stanes, investment director at Heartwood Investment Management argues that the recent boost to M&A’s is goof news for European equity investors. 

Royal Dutch Shell’s announcement to acquire BG for £47bn makes it the largest deal in the oil and gas sector since Exxon Mobil’s acquisition of XTO in 2009. Some are viewing this deal as a harbinger of further consolidation in the oil and gas sector, following the 50% decline in the oil price since July 2014. The news comes on the back of other announcements, including Halliburton’s plans to buy Baker Hughes in the US and Repsol’s (Spain) proposed takeover of Talisman Energy (Canada).

Shell’s motives for this deal appear to be to increase its production and reserves and boost its global standing in key markets such as Brazil. Meanwhile, BG’s share price has fallen nearly 30% since June 2014, due to the sliding oil price and a resultant weak balance sheet position reflecting £8bn of net debt.

The drivers of consolidation in the oil and gas sector are fairly obvious, as the industry adjusts to the lower oil price and creates cost efficiencies.  However, other industries are also seeing consolidation.

In Europe, EU regulatory changes have stimulated a wave of new deals in the telecommunications sector. Europe’s second largest deal in the first quarter of 2015 was BT’s purchase of EE. Other recent examples include Altice’s acquisition of Numericable, while Orange has openly stated that it has been in talks with Telecom Italia to discuss a possible alliance.

Of course, the above M&A developments can be seen as specific industry trends. However, while M&A activity was down globally in the first quarter of 2015 (Source: M&A Portal), interestingly, it has been increasing in Western Europe over two successive quarters both in terms of the number of deals and value (a 25% increase over two successive quarters in terms of value). European activity was boosted by significant increases in M&A targeting UK, French and German companies. In France, Holcim’s takeover of the rival Lafarge was the region’s biggest deal in value in the first quarter and the second largest transaction globally.

M&A activity tends to be an indicator that there is more confidence in the economic environment. Europe has lagged the cycle versus the US in this regard, but recent evidence might point to an inflection point. In 2014, we saw US corporates re-leveraging and engaging in more shareholder friendly activities. European corporates remained conservative through this period, maintaining relatively high cash balances and low debt due to the uncertain economic outlook.

However, as economic data trends have been improving, there is more evidence of European corporates re-leveraging: the euro-denominated investment grade corporate market saw record issuance in the first quarter of 2015, notwithstanding that 30% of this supply originated from US corporates taking advantage of lower rates and a weaker currency.  That said, if US growth rebounds in the second quarter as we expect, a stronger US dollar could also pave the way for US corporates to target overseas companies.

All of this is good news for European equity investors, although perhaps less positive for corporate bondholders, as companies look to create synergies and cost efficiencies to boost profitability and shareholder value. Shell’s acquisition might be borne out of economic pressure, but nonetheless it shows that European corporates are taking rather bolder decisions than has been the case over the past few years.

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