M&A - balance to shift in favour of corporate deals

Figures released today by the Office of National Statistics have revealed that expenditure on UK acquisitions by foreign companies rocketed from £5.4 billion in quarter one 2007 to a staggering £49 billion in the second quarter.

At the same time expenditure by British companies scooping up deals abroad rose from £4.2 billion in quarter one to £16.9 billion in quarter two. Yet with the recent turbulence in markets and the drying up of easy credit, many commentators now predict that the party is over for City deal makers. However, according to Makis Kaketsis, manager of the stellar performing F&C UK Dynamic Fund, the prospects for mergers and acquisitions may be down but they are far from "down and out."

"Corporate activity has strongly underpinned equity market returns in recent years and there is no doubt that the credit crunch over the last couple of months has seen a necessary re-pricing of both risk and debt which is going to impact corporate activity. However, I see this as primarily a factor which will tip the balance in favour of corporate deals, rather than something which will lead to a total drying up of corporate activity altogether," explained Kaketsis.

"Leveraged Buy-Outs driven by private equity players are going to find the environment much tougher but this doesn't mean they are out of the frame altogether, after all they are still awash with cash. It is simply a case that such deals will have to be done at more reasonable prices," he added.

"Of course, one man's meat is another man's poison and vice versa. In this respect, the less favourable environment for LBOs provides a relative opportunity for corporate deals to get a bigger slice of the action. Levels of corporate leverage are not high and quality businesses with strong balance sheets will still be able to get credit at reasonable prices," he said.

Kaketsis argues that in recent years deal-seeking corporates have found it difficult to compete with private equity houses. He now expects synergy driven corporate deals to be in a much stronger position and notes that a back log of potential deals has built up over the summer months, waiting for volatility in markets to subside.

"A recent example of how the balance has started to shift is the proposed acquisition of Altadis by Imperial Tobacco. Despite the compelling advantages of a corporate combination in terms of the potential cost synergies, earlier on private equity houses CVC and PAI Partners had been seen as serious contenders to scoop up Altadis. With a private equity deal no longer in the running, this indicates that the tide is now turning in favour of corporate acquisitions," said Kaketis.

According to Kaketsis, years of cheap debt have helped fuel 'Price / Earnings compression', He argues that the market has valued companies with very different growth characteristics similarly as firms with only modest or low growth profiles were seen as potential bid targets for private equity predators and therefore were speculatively rated alongside genuine growth companies. As the prospects for such private equity bid activity decreases, he believes that companies with sustainable, long-term growth potential will be able to once again command a premium to the market and therefore P/E differentials should therefore start to widen.

The F&C UK Dynamic Fund, which is ranked in the top decile of the IMA UK All Companies Sector since Kaketsis took over the Fund at the start of 2006 and also since the start of 2007, has been taking advantage of market weakness in recent weeks to selectively top up existing positions in companies which the manager believes have sustainable growth prospects. These companies include fast food franchise operator Dominos Pizzas, The Restaurant Group who own popular chains such Frankie & Benny's and Chiquitos, security and defence technology firm Ultra Electronics and Chiswick headquartered brewers Fullers.