In the aftermath of the EU referendum vote, the reaction from currency and stock markets has been swift. It is clear that Brexit has shaken investor confidence. However, M&A markets are typically driven by longer-term decision-making processes. Brexit has created uncertainties and some M&A plans are being put on hold. But we think the post-Brexit tumult creates opportunities as well. In the coming months, we expect there will be both threats to M&A dealmakers and unique opportunities for them.
Prior to the referendum vote, M&A market activity in the UK. Particularly on larger and private equity-led deals, had started to slow down. Although in some areas such as the domestic mid-market, transaction activity had remained relatively robust and largely consistent with prior years.
It is clear that uncertainty tends to be a drag on M&A activities. And policy-makers can now help dealmakers with clarity and guidance on the UK’s new economic and trading environment as soon as possible. Indeed, there is strong historical evidence that M&A markets tend to recover quickly once uncertainty subsides.
The overwhelming sentiment from a Deloitte snap poll of global M&A advisors. Immediately after the Brexit vote suggests a large proportion of companies are planning a “wait and see” approach to UK-related deals. M&A markets appear to be approaching the post-Brexit world in a rational and considered way. Clearly, there is much for M&A dealmakers to think through and this could potentially elongate. The dealmaking process and drive additional due diligence considerations around areas such as exposure to FX and trade arrangements. Companies may also need to consider short-term actions to preserve value in their assets as uncertainty in the markets may provide some headwinds to the M&A processes.
But for some, there is a positive side to the turbulence. Our snap poll indicated that opportunity hunters outnumbered those avoiding the UK by a significant margin. In the short term, the depreciation of the pound and some falls in share prices mean. That some UK-based companies might be available at attractive valuations. Indeed, some of the companies that announced M&A deals immediately post-Brexit have already highlighted how currency depreciation has spurred their decision to go ahead.
There are likely to be further opportunities for FTSE 350 companies as well. Despite the volatility in stock markets. Their strong corporate cash reserves and relatively high price-to-earnings multiples could provide them with the ammunition to buy overseas assets and diversify their earnings.
On the funding side, one further outcome of the Brexit vote is that. It could potentially accelerate the shift from banks to alternative lending funds in the UK-leveraged finance mid-market as these funds take the opportunity to keep the M&A markets active.
Following the Brexit vote the British pound suffered its largest two-day fall against the US dollar since a floating exchange rate was reintroduced.
The fall in the currency is taking place against a backdrop of sluggish growth in global trade. A slowdown in China, ultra-low interest rates. A large UK current account deficit, and the uncertain consequences of the future exit from the EU.
In the last few years, the impact of currency devaluation on M&A is unclear. During the global financial crisis. When the British pound experienced a depreciation of 19% between 2007 and 2009 against the US dollar. It was accompanied by a sharp 42% decline in UK M&A activity. This was a period of great economic uncertainty and some of the potential benefits of a weaker British pound failed to materialize. For instance, a study made by the Bank of England of the 2007-09 depreciation found there was no major boost to exports during that period.
However, during the most recent M&A wave between 2013 and 2015. US dollar appreciation against the British pound provoked opportunistic activity by overseas buyers in the UK M&A market. The 11% decline of the British pound against the US dollar helped to spur an overall 20% increase in M&A activity. During this period there was a 30% increase in inbound M&A activity in the UK. Largely driven by the US companies who were picking up UK assets at attractive valuations. This was also against the backdrop of a UK economy that was growing faster than other EU countries.
One conclusion is that we should not expect M&A investment in the UK solely because the currency is weak. M&A investments are driven by business confidence and the growth prospects of the underlying business. However, if the targeted business has attractive growth prospects the weaker British pound will make the deal look more attractive. Indeed, in the immediate aftermath of the Brexit vote. There were at least two major inbound acquisitions of UK consumer-facing businesses that have cited the weaker British pound as one of the key drivers for the transaction.
