European companies are now ready for deals in a way they have not been previously, and are increasingly being targeted by US and Asian companies.
Paras Anand, head of Pan-European equities at Fidelity Worldwide Investment, said that while there are likely to be fewer large-scale outright acquisitions than in the last cycle, there will be refocusing corporate activity of the “good” type.
“The current pharmaceutical activity demonstrates a play to areas of specific strength where additional scale can improve returns. The more strategic corporate activity should support market levels in the short and medium run. It may also lead to investor focus on larger companies, potentially reversing their phase of underperformance against small and mid-caps.”
In this context, said Anand, valuations which appear rich against short run earnings are more justified.
“The success of the listed corporate sector in protecting profitability during the depth of economic contraction over the last few years, has led to balance sheets moving from being conservative to very conservative to, by now, inefficient,” Anand continued. “Hence a meaningful recovery in corporate activity could run over several quarters to come, with the deals becoming larger and more strategic. We have been seeing the start of this in the Telecoms sector across Europe and in the global pharma sector this week.”
Tom Becket, chief investment officer of Psigma, investment management, noted that the healthcare sector alone had a total of $83bn of deals announced last week and further confirmation that the UK-listed behemoth AstraZeneca has been approached by Pfizer.
“However, many other sectors have also seen proposed transactions. In addition to the flurry of deals announced in the last couple of weeks, there are rumours of a number more in the offing, some major, such as French infrastructure company Alstom by the US giant GE.”
“We feel strongly that this recent outburst of corporate marriages can continue, offsetting the possible downdraft in markets from unimpressive earnings and geopolitical fears,” said Becket.
“There is pressure building on corporate managements from shareholders to do something with the mighty cash arsenals they have acquired in the last few years and they will have taken note of the positive share price reaction that acquirers have been enjoying. Sensible deals should be very accretive to earnings, given that most companies can issue debt to credit markets and at wonderfully low rates.”
This general development could have several meaningful impacts for investors, in Anand’s view.
“First, it suggests that valuations, especially of hard to replicate franchises, could appear rich when assessed against short run earnings but reflect not only their longer duration prospects but also the synergies available to any acquiring business. Second, the more strategic nature of such corporate activity may lead to a greater level of investor focus on larger companies which hitherto have experienced a long period of relative underperformance versus small and medium sized companies.”
Third, he added, it should be relatively supportive for market levels both in the short run but also potentially over the medium term as the process has the scope to improve the equity value creation for the listed sector.
