UK takeover activity
18 mai 2023
The UK has historically been a region that attracts significant takeover interest. In this week’s commentary we look at the increase in activity this year, the reasons why and the potential long-term implications for the UK equity market.
Several factors have contributed to foreign interest in the UK, including its strong presence in the financial and legal sectors, its industrial heritage, a sizeable consumer market and the widespread use of the English language.
Compared to other G7 economies, the UK government has historically been less inclined to intervene on national security grounds when faced with foreign bids for domestic assets. Between 1997 and 2017, despite accounting for only 3% of global GDP, the UK was involved in 25% of global cross-border merger activity. It is estimated that around 50 UK-based firms eligible for the FTSE 100 Index are now under foreign ownership.
For many years, UK equities have been trading at a larger discount compared to their US counterparts. This can be partly attributed to the differing composition of the respective stock markets. The UK has a larger allocation to lower price-to-earnings (PE) valuation sectors, such as energy and materials, which make up around 23% of the FTSE 100 compared to 7% of the S&P 500 Index. Conversely, information technology represents less than 1% of the FSTE 100 but accounts for 26% of the S&P 500. Even considering these factors, the discount had reached approximately 5% leading up to the Brexit referendum in 2016.
Following the momentous decision to leave the European Union, a “Brexit discount” was applied to UK companies to reflect the structural challenges they would face. Furthermore, recent political turmoil, including three prime ministers within a span of fewer than two months towards the end of 2022, has led to an increased risk premium. Consequently, the discount between UK and US stocks has surpassed 40%.
PE discount between UK and US stocks
It is evident that as the discount has grown, the frequency of foreign takeovers of UK companies has also increased significantly. According to the Office of National Statistics, the number of takeovers valued at £1 million or more was consistently between 100 and 300 annually for the 30-year period preceding the Brexit referendum. Since then, the number has exploded.
This was evident in the first quarter of the year when the deal closed for one of our former UK holdings, Biffa plc (BIFF.LN). Another of our UK holdings, global flexible workspace provider IWG (IWG.LN), has previously attracted takeover interest, while Coats Co. (COA.LN), a global leader in threads, was acquired in the past and later delisted before being relisted a decade later.
A thriving stock exchange can benefit the economy and society as a whole. The capital provided by exchanges enables companies to grow which, in turn, means they employ more people and contribute more taxes for wider public services. However, the number of companies listed in London has almost halved from 2,101 in 2003 to 1,097 today. While this still leaves ample attractive opportunities for investment, the increase in takeovers is just one piece of the puzzle. Another factor has been the decline in new listings. Recognizing the need to adapt and attract more listings, the UK’s financial watchdog, the Financial Conduct Authority, has proposed measures aimed at enhancing the country’s appeal for domestic companies. This follows cases such as UK-based microchip giant Arm, owned by Softbank, opting to list in the US. While streamlining the listing process may remove certain barriers and improve competitiveness, it should not compromise shareholder rights.
The persistently low trading multiples of UK equities leave them susceptible to foreign takeovers. While Global Alpha does not base its investment theses solely on potential takeovers, we acknowledge that it has always been a potential tailwind for the small-cap asset class, and we anticipate heightened takeover activity in 2023.