Oh no, a merger boom....

The last thing the City needs right now is another takeover boom, as I explain in my Money Week column this week. Here's a taster.

The bulls are rampant again. Bonuses are back. Million-plus houses in London are being snapped up. And, if we needed any more evidence that the City has regained much of its swagger and confidence, it now looks like a merger boom is cranking up into action.
The American food giant Kraft started the week with a £10.2 billion bid for the chocolate manufacturer Cadbury. The weekend papers were full of stories of a bidding war for Deutsche Telecom’s British mobile unit., T-Mobile, before a joint-venture with Orange was sewn up. It is not long since the mining giant Xstrata lodged a £41 billion merger proposal for its rival Anglo American.
A this rate, we’ll soon be in the middle of a full-scale merger boom, much like the telecoms and media takeover craze that powered the bull market of the late 1990s.
But this time around, the City should resist. The fund managers should tell the predators to get lost, and the bankers should tell their clients they are not interested. If there is one thing the capital markets need to do right now, it is to demonstrate that they have put self-serving, fee-driven short-termism behind them. And there would be no better way of doing that than by killing this merger wave off before it picks up any more momentum.
It isn’t hard to understand why some big deals are being put on the agenda again. After the savaging equity markets took in the past year, assets are cheap by any historical standards. Regardless of whether you think the global economy has recovered, or whether the downturn has another dip in it, there is probably not going to be a better moment to expand an industrial empire. If you aren’t going to make a bid for that great rival you’ve been coveting for the past decade this year, then you probably never will. British assets are particularly cheap. The FTSE hasn’t recovered as fast as other markets, and the pound has devalued significantly against the dollar and the euro.
Nor is it just a matter of opportunistic timing. The chances are that the next decade will be a lot tougher economically that the one we have just been through. Global demand will be sluggish as debt mountains, both public and private, get paid down. Making money is going to be a hard slog. Taking over a rival, cutting costs, and hopefully edging up prices as competition is reduced, is one of the few guaranteed ways of improving profits when times are hard.
The City, if the past is any guide, will pile in enthusiastically, doing everything it can to stoke another merger boom.
Bankers will be licking the lips at all the fat fees that can be earned from M&A deals. Fund will be looking forward to locking in the profits of the last six months, and pocketing healthy takeover premium as well. Take Cadbury’s for example: the shares went down to 445p at the depth of the credit crunch, but soared past 800p the morning the Kraft bid was launched. It will be hard to resist profits like that.
Hard, but not impossible.
In truth, the last thing the City bankers and fund managers should be doing is slipping straight back to their bad old ways. One of the main problems the City needs to tackle is the way it rewards short-term porifts at the expense of long-term prosperity. That’s true of bonuses, most obviously. But it is true of the M&A market as well.
The overwhelming evidence is that mega-mergers don’t work. They destroy value on an epic scale. Vodafone chewed up billions making itself the biggest mobile company in the world whilst losing market share at home. Glaxo devoured Wellcome and then SmithKline Beecham, and didn’t end up any bigger than it had been when it started. Conglomerates put together through wheeler-dealing, such as Hanson, fell apart even faster than they were created.
True, the bankers make some fat fees. But only at the cost of destroying long-term relationships with companies that could have provided work for decades to come. And the fund managers get a short-term boost to their profits. But only at the cost hollowing out the base of companies they can invest in.
Again, think about Cadbury. The UK has precious few globally successful consumer goods companies. A hundred years of work has gone into creating some of the most recognisable confectionary brands in the world. Almost certainly, if they are subsumed into a giant Kraft conglomerate, they will slowly be forgotten about and eventually die off. Sure, the fund managers will make a quick extra 30% profit on the shares, and that will flatter the next quarterly report to their investors. But there will be one less high-quality British company to invest in. Cadbury could have provided them with steady profits and dividends for years – precisely the kind of blue-chip stock that pension funds need to hold in their portfolio.
Likewise Anglo American. True, plenty of fund managers have questions about the way the mining conglomerate is being managed. It may well not be extracting all the value that can be squeezed out of its assets. Over the long-term, however, a huge merger is unlikely to fix that. If the shareholders aren’t happy, they can always sack the management. But if they sell the company, they won’t get to share in its long-term growth. And the FTSE will lose another big, quality company – after all if platinum, gold, diamond mining isn’t a good long-term business, then it is hard to know what is.
The City, including the fund managers, the hedge funds, and the bankers, could send a simple message. Over Cadbury or Anglo American, they could say, this is a quality business, and if there are any problems, we’ll ask the management to fix them. If they aren’t up to it, we’ll appoint new ones. But we don’t see any point in a mega-merger: it will just distract management, and destroy value in the long-term.
True, there is probably about as much chance of happening as there is of a packet of chocolate buttons surviving break-time in a school playground. If it did, however, it would send a powerful message that the City had changed. And before the fund managers pocket the profits, and before the bankers start trying to rustle up a rival bid, they should at least pause to ponder whether another merger boom is really what they want right now.