Even before the referendum, many industries were experiencing pressure to initiate M&A deals. In the wake of Brexit, we expect to see the mix of M&A activity by industries change. (See Exhibit 2.)
Energy and Industrial Goods. The share price of most companies in aerospace and defense has been resilient, owing to their high share of foreign revenues. UK companies with a high proportion of domestic revenues, such as Babcock International and QinetiQ, have been harder hit. They may now be attractive to private equity or to foreign buyers looking to expand into the UK.
Brexit may also trigger some divestment activities. For instance, Cobham could look to offload noncore US assets that are struggling to gain US defense contracts owing to foreign ownership.
The homebuilding industry was hit hard by an expected reduction in demand following the referendum; share prices were down more than 30%. Undoubtedly, the industry will experience uncertainty and suppressed volumes over the next few years. However, we see an opportunity for consolidation, given several factors. First, the long-term outlook is positive, owing to the persistent shortage of housing in the UK. Second, the industry is fragmented, with the top three companies—Barratt, Persimmon, and Taylor Wimpey—accounting for only 25% to 30% of private-housing output. Finally, consolidation offers potential synergies in design, procurement, sales, and corporate overhead. Any consolidation play will most likely come from a trade buyer. However, low asset values and the housing shortage could pique PE interest.
In construction and engineering, Brexit will not trigger a large wave of M&A in the civil and structural segments but may accelerate the global trend toward consolidation. Global companies have been consolidating in recent years as they look to create larger entities with a diversified footprint, expand into adjacent industries, integrate design and construction activities, and consolidate design centers in order to be more competitive. Historically, businesses focused on the UK and Europe have been less attractive because of their relatively low growth. However, their low valuations may be sufficient to attract inbound M&A, particularly from Asian trade buyers seeking to purchase strong brands such as Atkins and Balfour Beatty.
We don’t expect to see a large increase in M&A activity in building materials. Nevertheless, foreign players such as Saint-Gobain may move to diversify or to strengthen their UK position during this period of uncertainty and low asset prices. Pressure on distressed companies in the industry may also trigger domestic consolidation aimed at reducing overhead costs and taking advantage of common customer bases; for example, large UK companies may merge with Grafton, Marshalls, or Ibstock. Global UK-listed players (such as CRH, Wolseley, and Ashtead) will probably continue making smaller acquisitions.
Financial Services. M&A activity will probably halt in banking and consumer finance as uncertainty brought on by Brexit makes asset valuations difficult. Key drivers of uncertainty for banks include an increase in funding costs, low loan growth, an increase in nonperforming loans, and delays in base rate increases, which depress net interest margins. Additionally, capital markets face uncertainty from the potential end of financial passporting.
If valuations fall further, large banks may start acquiring monoline or specialist lending businesses such as MBNA. However, with most players trading at a price-to-book ratio of 0.5 to 1.5, current valuations are not low enough to trigger such activity.
The life insurance industry is unlikely to attract inbound M&A, even at current depressed valuations. The UK life insurance market’s products, systems, sales practices, and regulators differ considerably from those of other markets. As a result, integration offers few opportunities for synergies. On the contrary, uncertainty and increased volatility could push more foreign companies to divest their UK businesses. Closed-book operators like Phoenix may look to take advantage of such divestments. Brexit may put additional pressure on UK insurers to diversify and increase scale by, for instance, moving into asset management.
The commercial insurance industry is consolidating, owing to the lack of growth in developed markets and the potential for economies of scale. Many UK-based insurers have been acquired by large global companies, such as Brit, acquired by the Canadian firm Fairfax, and Amlin, purchased by the Japanese firm Mitsui Sumitomo. The fall in the pound may accelerate this trend.
Consumer and Retail. Most players in consumer staples operate international businesses; hence, Brexit would trigger increased activity in this industry only for businesses that have a high degree of exposure to the UK.
For example, we may see a merger between Britvic and A.G. Barr to increase scale in the UK soft-drinks market (a previous attempt to merge was called off in 2013). Or PZ Cussons could be purchased, given current valuations, by a consumer packaged goods company seeking to reshape its portfolio, such as Reckitt Benckiser, P&G, or Unilever.
In retail, we don’t expect a high level of M&A activity in discretionary segments, in which companies tend to be differentiated, thus limiting the potential for scale benefits. The most likely source of activity is from private equity or Chinese buyers looking to capitalize on low asset valuations. Many UK retail companies are relatively weak financially and might be interesting acquisition targets, such as Sports Direct.
We expect limited activity in food retail. One opportunity is the merger of Morrisons with Co-op’s grocery business unit—a move that would increase buying power and create a complementary convenience and supermarket footprint.
Travel, Media, and Entertainment. The case for consolidation in commercial airlines in Europe was already quite compelling before the Brexit vote, but companies faced significant hurdles owing to national interests, antitrust challenges, and limits on foreign ownership. We foresee no immediate reduction of these hurdles. If Brexit triggers a broader macroeconomic slowdown, however, governments may allow further consolidation among the flagship carriers, such as IAG.
In telecommunications and TV, UK production costs have fallen by 10% owing to a decline in the pound. Brexit may increase inbound activity, as US players who were already mulling over acquisitions of UK production companies speed up their acquisition schedule. Strict antitrust regulations in this industry would likely prevent any major domestic deals, but given industry pressure, we may see the consolidation of smaller production houses or the acquisition of UK production companies by international players seeking synergies and access to low-cost capabilities.
Brexit might trigger consolidation in casinos and betting. However, such activity will likely prove difficult, given antitrust challenges, as was evident in the merger attempt between Gala Coral and Ladbrokes. Brexit will probably accelerate the trend toward diversification across subsectors. The takeover attempt by 888 and Rank Group of William Hill is a case in point. We will also likely see vertical integration and investment to mitigate technology risks (for example, William Hill’s investment in NYX).
Brexit’s anticipated impact on demand in restaurants and pubs, combined with a cyclical decline and new government regulation ending “tied pubs”—pubs that are required to purchase a portion of their beer from a particular brewer—may stimulate a new wave of consolidation in this area. Larger and more financially stable players, such as Mitchells & Butler, may buy struggling peers in order to manage their footprints and achieve scale in procurement and food service.