The bulls are rampant again. Bonuses are back. £1m houses in London are being snapped up. And, if we needed any more evidence that the City has regained much of its swagger, it looks like a merger boom is cranking up into action.
US food giant Kraft began the week with a £10.2bn bid for British confectioner 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’s not long since mining giant Xstrata lodged a £41bn merger proposal for its rival Anglo American. At 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.
You can understand why some big deals are back on the agenda. After the savaging equity markets took in the past year, assets are cheap by historical standards. Regardless of what you think will happen to the global economy, there probably won’t be a better time to expand an industrial empire. 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.
And it’s not just about opportunistic timing. Chances are, the next decade will be a lot tougher economically than the one we’ve just been through. Global demand will be sluggish as debt mountains, both public and private, get paid down. Making money won’t be easy. Taking over a rival, cutting costs, and raising prices as competition is reduced, is one of the few guaranteed ways of raising 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 lick their lips at the fat fees to be earned from M&A deals. Funds will look forward to locking in the profits of the past six months, and pocketing healthy takeover premia too. Take Cadbury: the share price dived to 445p at the depth of the crunch, but soared past 800p when the Kraft bid was launched.
But, in truth, the last thing that City bankers and fund managers should be doing is slipping straight back into their bad old ways. One of the main problems the City must tackle is the way it rewards short-term profits at the expense of long-term prosperity. That’s true of bonuses, clearly. But it’s true of the M&A market too. The overwhelming evidence is that mega-mergers destroy value on an epic scale. Vodafone chewed up billions making itself the world’s biggest mobile company, while losing market share at home. Glaxo devoured Wellcome, then SmithKline Beecham, yet didn’t end up any bigger than when it started. Conglomerates put together through wheeler-dealing, such as Hanson, fell apart even faster than they were created.
Bankers make fat fees. But only at the cost of destroying long-term relationships with companies that could have provided work for decades ahead. Fund managers get a short-term boost to their profits. But only at the cost of hollowing out the base of companies they can invest in. Again, take Cadbury. The UK has precious few globally successful consumer goods groups. A hundred years of work has gone into creating some of the world’s most recognisable confectionery brands. If they are subsumed into a Kraft conglomerate, they will probably slowly be forgotten about and eventually die off. Fund managers will make a quick extra 30% profit on the shares, which 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 given them 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 firm is being managed. Perhaps it is not extracting all the value that can be squeezed out of its assets. But a huge merger is unlikely to fix that. If the shareholders aren’t happy, they can sack the management. But if they sell the group, they won’t get to share in its long-term growth. And the FTSE will lose another big, quality company – if platinum, gold and diamond mining isn’t a good long-term business, it’s 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.”
There’s about as much chance of that happening as there is of a packet of chocolate buttons surviving break-time in a school playground. But if it did, it would send a powerful message that the City had changed. And before the fund managers pocket the profits and the bankers start trying to rustle up rival bids, they should at least pause to ponder whether another merger boom is really what they need right now.