Concerns that Britain’s decision to leave the European Union (EU) would deter foreign investment appear, at least so far, to be overstated. With 155 deals worth US$35.8 billion announced in Q3 2017, inbound M&A activity targeting UK firms topped all other markets in Western Europe by both value and volume. And although deal value has fluctuated over recent years, inbound deal volume into the UK has shown a consistent if small increase, rising from 468 deals in Q1-Q3 2016 to 485 in Q1-Q3 2017.
With the potential for a transitional deal that could push Brexit’s effective date out two years past the current March 2019 deadline, and concerns that the UK could lose its appeal as a gateway to European markets following an exit from the single market, there’s no reason to expect that inbound investment will sustain its positive track—and also no reason to assume it cannot do so.
Pound for pound
There are a number of factors supporting the continuation of interest in UK assets—the relative weakness of the pound being one that cannot be ignored. While sterling has recovered partially from its dramatic fall immediately post-referendum, at the time of writing it is still down 17 percent and 12 percent against the euro and dollar respectively, compared with pre-referendum figures.
At a basic level, this makes UK companies relatively good value for money—particularly attractive in an environment defined by a continued bull run and high prices. While the FTSE 100 for the first time in history breached 7,500 points in 2017 and remains above this unprecedented high, it has become relatively attractive from a pricing perspective. The index’s price-to-earnings (P/E) ratio fell by 14.3 percent in the first six months of 2017, the FTSE All Share Index’s P/E ratio falling by 9.3 percent over the same period. This, coupled with a weak pound and high pricing in other major markets, means that UK companies represent a modest bargain for many foreign acquirers.
The global dynamic is evident in the largest deal of Q3, which saw US payments processor Vantiv agree to the US$12 billion acquisition of Worldpay, accounting for a third of all M&A value in the quarter. Largely as a result of the deal, US M&A investment into the UK reached its highest value in any quarter since Q1 2013. The transaction will see Vantiv’s foothold in the US complemented by Worldpay’s dominant position in the UK, as well as its presence in Brazil, Mexico, Argentina, Japan, China, Sweden, the Netherlands and Singapore.
It is also worth noting that the potential impact of Brexit is less of a concern for the largest UK companies than for their smaller counterparts. Multinationals benefit from the natural currency hedge of revenues derived from multiple markets, which is why the FTSE 100 is not an accurate barometer for the UK economy.
UK retains fintech crown
Vantiv’s agreement to acquire Worldpay also speaks to the broader attraction of London as a fintech hub. According to Pitchbook, in the first nine months of 2017 more than US$1 billion of venture capital was invested into UK tech firms seeking to disrupt finance, such as digital challenger bank Revolut (US$66 million), accountancy software firm Receipt Bank (US$50 million) and lending platform Prodigy Finance (US$40 million). Year-on-year investment has more than doubled to an all-time high. This makes the UK Europe’s largest fintech investment market.
While Brexit has the potential to dent London’s future standing as Europe’s leading financial center over the long term, the city remains the region’s financial nucleus. Coupled with its deep software development expertise and initiatives such as Level39 (touted as Europe’s largest fintech accelerator), this make London one of the largest and most attractive markets for investment into the sector outside of China and the US.
Speaking on the record funding figures, Nikolay Storonsky, CEO of Revolut, said: “Whether you look at it from the perspective of talent, infrastructure, access to capital or the excellent regulatory environment, London is without question the best city in the world to launch a fintech startup.”
Retail recoils
Not all sectors are immune to the “Brexit effect.” The weakness of the pound has led to inflation on the high street as the result of increased import costs, while British wage growth is trailing rising prices. This presents a significant challenge for the domestic retail sector in the months and years ahead. Any UK company that derives its revenues in sterling while relying on global supply chains is likely to face significant headwinds.
One of the biggest question marks hanging over the ongoing Brexit negotiations is what the UK’s future trading relationships will look like, and what this will mean for economic growth. Further, if Brexit causes long-term wage stagnation and secular weakness in the pound, retail and consumer M&A may become too big a gamble for many foreign bidders to stomach.
Hedging bets
There may be an opportunity for financial acquirers to turn this to their advantage. Waterland Private Equity, a top-decile-performing European buyout firm, opened its inaugural UK office in the first quarter of 2017, with the rationale to address this very challenge.
Hans Scheepers, Managing Partner of Waterland in the Netherlands, explained the reasons for taking this step: "We believe that the Brexit vote will present significant investment opportunities in the UK. We can help UK companies pursue European growth strategies using our existing presence and network across Europe. By doing this, it will create a natural hedge for them so that they not only have revenues and financing in sterling, but also in euros.” Now more than ever there is pressure for British midcap companies to expand their sales and operations into new territories to fortify their future earnings.
The UK has cemented its position over decades as a prime destination for M&A, a reflection of its familiar and well-tested legal frameworks, economic strength and deep, liquid financial markets. This hard-earned status is unlikely to change overnight, and the prospect of Brexit has yet to have the chilling effect many anticipated.
But the day is still early, where Brexit is concerned. Signs of weakness in consumer spending do not augur well for retail deals, and the most attractive M&A targets will be best defined by their expertise, IP and defensible market positions rather than by reduced price tags.
