European firms told to spend on mergers
Instead of rewarding shareholders with dividends and buy-backs, companies are under growing pressure to go on a buying spree
Investors have received billions of euros from European companies so cautious about the economic outlook they could find nothing better to do with spare cash, but many now want boards to snap up rivals instead - and are rewarding them when they do.
Years of financial crisis meant companies used any surplus first to pay down debt and then keep shareholders sweet with dividends and share buy-backs. They spent nearly US$3 trillion on buy-backs globally since 2008, data showed, an increase of more than US$150 billion from the 2002-07 period.
Now the pressure is on firms to put excess cash to work. European mergers and acquisitions were down nearly a quarter on last year to US$511 billion, data showed. But globally, the shares of active buyers had enjoyed their best run since the start of the crisis, beating quiescent peers by 4.7 percentage points, consultancy Towers Watson said.
British engineer Kentz rose 13 per cent after buying US firm Valerus Field Solutions, and French retailer Carrefour beat its sector, up 1.9 per cent, on the day it announced plans to buy 127 shopping centres from real estate group Kleppiere.
"The share prices of buyers have generally reacted positively to the announcement of acquisitions this year. That shows investors want firms to put money to work and not to hoard cash," said Wolfgang Fink, head of investment banking at Goldman Sachs in Germany and Austria.
For companies worth US$1 billion and more, JP Morgan research puts that hoard of cash or cash equivalents at US$5.3 trillion globally, up from US$5.2 trillion in 2012.
And in a sign that a broader range of investors expect more deals, hedge funds that bet on the outcome of M&As have netted US$16.4 billion this year after seeing US$6.6 billion take flight last year.
Christer Gardell, co-founder of Cevian Capital, one of Europe's largest activist investors, said last month that he expected rising corporate confidence to spark a burst of deals.
The dilemma for many firms is what to buy.
But recent earnings suggest buyers will be well served by a sceptical eye when assessing value.
European companies lagged expectations on both revenues and profits this year, and many analysts said earnings growth needed to improve in order to see European share indices add much to the double-digit gains many were sitting on for the year.
The safest bet for many boards looking to hit the spot for investors would be to focus on smaller deals, said Ed Shing, global equity portfolio manager at BCS Asset Management.
"People are prepared to stump up money for a sensible deal where you're not paying a ridiculous multiple - big taking over smaller, where the valuations are still reasonable, particularly in Europe," Shing said.
Bertie Thomson, senior fund manager at Aberdeen Asset Management, said that when pitching the financial logic of the deal, boards had better focus on more than just earnings.
Picking a point when the merged company finally contributes to the bottom line is a favoured point of reference for executives looking to justify a deal, but as most deals should boost earnings, investors are more concerned with the return on money spent by the company.
Deals should improve your return on capital, Thomson said. "Some companies do it better than others, but it's still quite amazing how many focus more on earnings accretion than on returns."