30 January 2017

Mergers and acquisitions – an attractive source of stock market gains

By Pierre-Alexis Dumont, Head of Equities and Convertibles Portfolio Management

[Pierre-Alexis Dumont]

Mergers and acquisitions offer numerous opportunities for stock market investment. After the drastic slowdown during the crisis, these operations have already recovered their dynamism in the US, while in Europe the movement of consolidation remains at standstill. In numerous sectors, in particular regulated sectors, a resurgence of dynamism is expected over the next few quarters.

For the buyer companies, these operations offer significant attraction. For a company that is seeking to preserve its added value at a time when its intrinsic growth prospects are limited, it is easier to approve an acquisition than to undertake a thorough restructuring of its own development model, with all the social, human and governance challenges entailed. This factor is all the more true now, since the current low interest rates enable companies to fund their acquisition investments at relatively low cost.

Identifying the conditions of a successful merger

Obviously, however, not all merger operations are sure of success. For stock market investors, it is essential to identify, upstream, various signals that will favour a positive outcome of a merger or acquisition. Experience shows that the merger of close competitors brings better results than a diversification acquisition, which may require a long and difficult period of learning the new activity and assimilating the expertise specific to the new sector. By contrast, consolidation obtained by a merger between two rival companies operating in closely related segments more naturally generates synergies and gains in productivity, via the rationalization of resources and costs and the reduction of competition.

Another key factor is the capability of the merging companies to share a common corporate culture. It is interesting to note that Japanese companies, due to their specific culture, which is virtually unique in the world, encounter greater difficulties in completing successful international mergers and acquisitions. Moreover, some companies have a “merger-acquisition culture” that is a source of success and is important to evaluate. Firms such as Eurofins Scientific, Atos or AB InBev have fully integrated an active company acquisition approach into their business models, to the point that over the last few years they have maintained a rate of one or two acquisitions per year.

A vast movement of consolidation is expected in Europe

From the point of view of investors, the revival of the mergers and acquisitions market offers numerous opportunities. Whereas activity has been rebounding in the United States for the last few years, Europe should benefit from a catching-up movement over the next few quarters and is expected to return to the pace of the years 2002-2007. Operations should particularly abound in the regulated sectors of the Old Continent, for example in telecommunications, where the movement of consolidation is far from complete. The United States now has four big players at federal level. In Europe, by contrast, there are twenty-eight national markets, with twenty-eight regulating authorities and one hundred and forty operators! All these operators, on their own scale, have to make the same investments, but with many fewer potential customers to ensure profitability.

In telecommunications, as in the sectors that are becoming increasingly globalized (energy, industry, consumer staples and discretionary or pharmaceuticals), the excessively numerous European transnationals are having to regroup to improve their international competitiveness against the Chinese and American giants. The audio-visual media industry should also be closely monitored: here, the high potential for mergers derives in particular from the increased costs of broadcast programming and the constitution of giants with a disruptive business model, such as Netflix.

Whereas stock market investors traditionally focus on target companies, a more balanced vision should now be adopted. Upstream of a Mergers & Acquisitions operation, the buyer companies, as well as the targets, can now benefit fully from the expectations raised by the future merger and see increases in their share prices.  Without doubt, several attractive operations will be arousing the interest of the market: striking examples include the merger between Ahold and Delhaize, the case of British American Tobacco, which has just absorbed Reynolds, Sprint in the United States, which is well-positioned to take over the T-Mobile US subsidiary of Deutsche Telekom, or the probable sale of Puma by Kering, which should spark considerable interest from prospective buyers.

However, stock picking – the rigorous selection of appropriate securities – remains essential. As history has shown with catastrophic mergers, such as the one between Daimler and Chrysler, it is important not only to measure the full specificities of each background story and to estimate the chances of success of the operations but also to estimate the degree to which the markets have already integrated the full success of these operations, or more, into stock prices.

This document was drawn up on the basis of information, projections, estimates, forecasts and hypotheses that involve a degree of subjective judgement. The analyses and conclusions express an independent opinion formed on the basis of publicly available information on a specific date and by applying a methodology specific to Groupama AM. In view of the subjective and indicative nature of these analyses, they cannot be construed to constitute a legally binding commitment or guarantee of Groupama AM or as personal financial advice. This non-contractual document does not, under any circumstances, constitute a recommendation, request for offers, an offer to buy or sell or an arbitrage offer, and may in no case be interpreted as such.