Why European firms are preparing for a summer of love?
As is often the case in business, Europe is following America's lead. A recent spate of cross-border takeovers is one sign that the much discussed revival of merger and acquisition (M&A) activity in America is spreading to Europe. Cross-border deals tripled to $75 billion in the first quarter of this year compared with the same period last year, says Dealogic, a research firm. The big question is whether there will now be European mega-deals equivalent to recent blockbuster American mergers such as Procter & Gamble's $57 billion takeover of Gillette and the $15 billion purchase of AT&T by SBC Communications.
Europe's biggest deal so far this year is the $10 billion takeover of Gecina, a French real-estate company, by Metrovacesa, a Spanish property firm. But several other mega-mergers are being discussed. On April 5th France's Pernod Ricard, a drinks company, confirmed that it is in talks to buy Britain's Allied Domecq. The likely price is estimated at $13 billion.
“We are in the early stages of the next merger cycle in Europe,” says Paulo Pereira, head of European M&A at Morgan Stanley. Many firms are now emerging from a period of gloomy introspection in which they focused on restructuring and overhauling corporate governance. Confidence rose with strong profits in 2004. Now flush with cash, firms have plenty of options: they can return money to shareholders, invest in organic growth or—much more exciting—buy another company.
Credit is cheap and plentiful, so financing a deal is easy. With a marginal cost of debt of only 2.4% after tax, firms rated investment grade have a powerful incentive to fund acquisitions with debt, says Jon Jonsson, a credit analyst at Merrill Lynch.
Growing pains
This new-found corporate optimism is strikingly at odds with Europe's sluggish economies. On April 5th the European Commission cut its growth projection for 2005 for the euro zone from 2% to 1.6%. Indeed, slow economic growth is one reason why firms are looking to expand by acquisition rather than organically. Also, years of cost-cutting have squeezed out most potential savings, so firms are increasingly concluding that the likeliest way to cut costs further is to exploit the synergies of a merger with a similar firm.
Indeed, the greater potential for synergistic mergers is one reason for hoping that this merger wave will deliver better results than most past waves have done. European firms have often merged with unrelated firms, forming diversified conglomerates that have tended to perform particularly poorly. In the previous merger wave, in the late 1990s, many acquisitions were made to gain scale, often without any apparent regard for a deal's business logic.
Now, there are many more opportunities for mergers that rationalise industries, says Mr Pereira. Energy and telecoms markets have been liberalised. European governments are going ahead with privatisations such as the flotation this year of two big French utilities, Electricitι de France and Gaz de France. The integration of the European market is making progress. And central and eastern Europe is becoming a fertile hunting ground for takeover targets following the accession of ten new countries to the European Union.
Some observers see similarities with American M&A during the 1980s, when the break-up of many conglomerates and much consolidation within industries produced that rarity for a merger wave: huge economic benefits. The degree of conglomeration in Europe is now on a par with that in America in the early 1980s.
As Europe becomes a truly single market rather than a bundle of national ones, firms are developing Europe-wide ambitions. Rather than national champions, firms now want to be European champions, says Johannes Huth of Kohlberg, Kravis and Roberts, an American private-equity firm. The growing clout of the private-equity firms in Europe—firms which manage funds that buy controlling stakes in companies, sometimes thereby taking public firms private—is helping to drive deconglomeration. Buying non-core businesses from conglomerates, merging them with similar firms and slashing costs is meat and drink to such firms.
Already, Europe has become at least as important a source of deals as America for private-equity firms. According to Mark Pacitti of Deloitte, an auditor, they are now responsible for one-third to one-half of M&A in Britain and up to one-quarter on the continent. Two groups of private-equity firms are now battling to buy Wind, a mobile-phone business owned by Enel, an Italian energy firm.
Europe's utility industries, such as telecoms and energy, are expected to see a disproportionate amount of M&A. So are banking, insurance and other relatively unconsolidated industries, such as car-parts makers and suppliers to big supermarkets, says a recent report by CSFB, an investment bank.
European telecoms deals have already resumed. On April 4th two private-equity firms bought a controlling stake in TIM Hellas, a Greek mobile-phone operator. Last month Britain's Vodafone, the world's biggest mobile-phone company, paid $4.4 billion to control mobile operators in Romania and the Czech Republic. Sweden's TeliaSonera recently bought a 27% stake in Turkcell Iletisim Hizmetleri, a Turkish mobile-phone operator.
The outlook for banking deals is less certain. So far, European banking remains predominantly a national business, with cross-border deals relatively rare on the continent. But that may change fast, depending on what Antonio Fazio, the governor of the Bank of Italy, decides to do about a bid from Spain's BBVA for Banca Nazionale del Lavoro, Italy's sixth-biggest bank by assets, and another bid, by ABN Amro, a Dutch bank, for Banca Antoniana Popolare Veneta, the ninth-biggest. The go-ahead for these deals—which is far from certain—could produce a domino effect throughout European banking.
Curiously, the strong euro and the weakness of the dollar and dollar-linked currencies have not so far resulted in a shopping spree by European firms in America or China. It seems that European bosses still expect the dollar to fall further, and thus that any dollar-denominated revenues they acquire now may soon become a declining asset measured in euros.
Can anything spoil the coming European summer of corporate love? According to Neil Austin of KPMG, an accounting firm, the biggest threat to the merger wave happening would be a sharp rise in interest rates or a sudden decision by banks to reduce lending, both of which would hit private-equity firms particularly hard. Past experience points to a different risk. In 1995-96, as the previous merger wave began to form, firms concentrated on focused deals likely to quickly generate shareholder value. Yet European bosses, like their American counterparts, soon abandoned this cautious approach in favour of deals that suited grander empire-building ambitions. Who would bet against this history repeating itself, sooner or later?
By: N. Peter Kramer
