Is the UK’s ‘M&A haven’ status damaging the economy?

30th July 2012

KPMG's Bill Michael says: "Big global banks are incredibly complex and opaque – the need and demand for greater transparency will intensify pressure on the sustainability of the universal banking model".

At the same time, the UK is still one of the top places for doing merger and acquisition activity.

Mark Gregory, Ernst & Young's chief economist and transaction partner, said: "While the sovereign debt crisis has had far reaching effects on countries in the eurozone, the UK, in terms of if its appeal in attracting domestic and cross-border transactions, has consolidated its position as one of the world's leading markets for M&A."

Although the market for M&A activity is relatively subdued, thanks to waning corporate confidence, is it possible that its position as a good place to do deals is creating problems for the UK economy?

After all, insufficiently restrained M&A activity has certainly contributed to the problems in the banking sector. It created the problem of banks that were 'too big to fail', the ABN Amro deal saddled RBS with toxic legacy assets, and the Lloyds TSB/HBOS merger left the latter with a balance sheet full of bad debts.

Historically, it has also created problems for other sectors. This article looks at the 'great' M&A failures of history, including the iconic bad mergers of AOL/Time Warner and Sprint/Nextel.

In fact, the majority of M&A activity is value-destroying rather than value-enhancing. This piece in the FT points to research from Cass Business School that confirms this point: "Latest studies show that half of all deals destroy value, an improvement on the 1980s and 1990s when the rate was 60-70 per cent. But that still means in the last few years, with annual M&A deal value running at $2tn to $2.7tn, about a trillion dollars a year has evaporated into thin air."

McKinsey & Co, the management consultants, found that large deals in fast-growing sectors are among the least successful: "Pitfalls included inward focus on integration, missing critical product or upgrade cycles; going into areas of limited overlap; and going shopping when prices were high. Tech companies, McKinsey found, fell into all three traps; consumer discretionary were also losers in large deals."

That said, research by the Cass Business School has found that the net contribution to the UK economy from M&A deals is positive overall. Good deals outweigh bad deals and the overall profit for the UK economy is £178m.

Cass has also found that deals are becoming more successful. It highlights a greater focus on the details of the deal itself – more emphasis on why the deal is taking place and the appropriate company – as a reason that they are creating more value. It says more due diligence is being done on deals and it is being done earlier. Companies generally have a better idea of the hurdles of post-merger integration than they have in the past.

Regulators are already giving more scrutiny to deals, suggesting they are increasingly wise to the problems created by poorly governed M&A activity: "Matthews Layton, Clifford Chance's global head of Corporate, said: "In many markets and sectors, there is a heightened level of scrutiny from regulators, politicians and shareholders alike, set against the backdrop of heated competition for the best assets. Sensitivity to the political and socio-cultural challenges in specific regions can be as important to the success of a deal as clearing the regulatory hurdles."

Given the structural risks to the economy of large, uncompetitive companies, this greater scrutiny is welcome. However, there remains the question of whether the Competition Commission should be setting the bar a little higher when judging whether a deal should go ahead. After all, £178m is insufficient compensation for the problems created by over-concentration in the banking sector.

 

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