We are certainly coming off the back of a depressed period for dealmakers. The Office for National Statistics has revealed that the total number of M&A deals involving UK companies fell to 152 in the second quarter, down by two-thirds on the previous three months, with the 37 deals completed in May a particular low point.
Things may be looking up, assuming Covid-19 is indeed loosening its grip on our diseased collective psyche. The value of global M&A activity from July to September increased by 80 per cent from the previous quarter, helped along by Nvidia Corp’s (US:NVDA) $40bn tilt at Cambridge-based semiconductor designer Arm Limited.
It is not just that an M&A bottleneck had formed during lockdown, but the severe disruption to normal commercial activity has served to highlight pre-existing problems within certain businesses, thereby rendering them more vulnerable to merger proposals, hostile or otherwise.
It is difficult to say whether the potential impact of a no-deal Brexit is reflected in UK multiples, but the benchmark valuation is at its lowest ebb in decades relative to the other main global indices.
The comparatively tech-lite weighting of the FTSE 100 may help to explain why top-tier valuations look anaemic relative to the US market and elsewhere. The value of the Nasdaq index is up by 23.9 per cent in the year to date, whereas a relatively mature and cyclical UK benchmark is down by a fifth. The reality is that even if the UK and the European Union (EU) broker an 11th hour trade deal, the main benefits are likely to be felt by the more domestically focused FTSE 250 index.
That should leave some FTSE 100 constituents looking even better value, but investors need not get too carried away. Even if our domestic benchmark is somewhat deficient in terms of tech allocations, the main US indices have been held aloft by just a handful of companies which have derived benefit from the same set of circumstances that have wrought havoc on so many segments of the economy.
The civil aviation industry has been among the hardest hit by the Covid-19 lockdowns and travel restrictions. You will not find a better illustration of this than the recent travails of Rolls-Royce (RR.), an engineering group that is bound-up with the UK’s industrial prestige on the global stage.
By now, the narrative is all too familiar. Billions invested in a new generation of jet engines, only to discover that one of them — the Trent 1000 — was not up to muster. Remedial measures would cost in the region of £2.4bn, but then the group’s plans were thrown into disarray after the pandemic response resulted in a collapse of global engine flying hours. A £2bn rights issue duly followed, but it is by no means certain whether the shored-up balance sheet (including increased borrowing headroom) will prove sufficient to ward off the worst effects of the slump in civil aviation passenger numbers, which could take three to four years to recover to pre-pandemic levels, according to the International Air Transport Association.
A direct government capital injection cannot be ruled out, especially as Germany has effectively flouted EU state aid provisions through its recent support for Lufthansa (ETR: LHA). But given that the Derby-based group has lost four-fifths of its market value over the past 12 months, speculation over a possible merger deal is likely to be reignited.
The UK state has a ‘golden share’ in Rolls-Royce, thereby providing Whitehall with a veto over specific strategic decisions. The government would be loath to see the group fall into foreign hands, perhaps even from a national security perspective, but it might look upon any domestic approach more favourably. Step forward BAE Systems (BA.). A merger proposal by the UK defence heavyweight would certainly make strategic sense given Rolls-Royce’s unique aerospace capabilities, while an enterprise value-to-sales (EV/sales) ratio of 0.2, set against a five-year average of 0.9, underlines significant indebtedness coupled with a faltering top line – arguably just the time to move in.
