Sunday Telegraph

Credit crisis does not stop a rich seam of deals from being mined

You would expect M&A to dry up in a downturn but, as Ben Harrington explains, the City is seeing some oft-rumoured deals become reality

On the evening of Tuesday August 5, Brad Mills, the chief executive of Lonmin, was in Marikana, a mining complex in the Bushveld region of South Africa, when he received a call from Mick Davis, his counterpart at Xstrata, the mining giant.

He wasn’t expecting it to be a social call but Mills was still taken aback by Davis’s abrupt message: the next morning, Lonmin would receive a takeover offer from Xstrata.

Mills immediately asked Davis for more details – price, structure, timing. But Davis curtly informed him that the details would be on the screen in the morning and rang off.

When Mills rang to tell the rest of his board, his fellow directors were shocked – and they weren’t the only ones. As the deal became public knowledge the next morning, traders were equally stunned, even though a takeover of Lonmin has been mooted regularly over the past five years.

The platinum miner, one of the smallest specialist miners in the FTSE100 index, had often been touted around the market as a bid target in a sector that was rapidly consolidating. Every few months, a variation of the Lonmin takeover rumour would sweep the trading floors.

But no formal approach emerged – until two weeks ago. This time it was serious, hostile and from a credible bidder.

Rain, England’s poor form in the Test match series and regular bouts of infighting in the Labour party: these are things that were expected this summer. But a raft of the City’s oft-mooted deal rumours becoming reality is not what the market had been anticipating during an ever-worsening credit crunch.

A string of other long-standing City rumours have also transformed into deals, including Santander’s acquisition of Alliance & Leicester, British Airways’ merger talks with Iberia, an attempted merger between TNS and GfK, Adecco’s tilt at Michael Page and UPS’s takeover plans for TNT.

Deal volumes may have fallen off a cliff – global mergers and acquisition (M&A) activity has fallen by 32 per cent compared with the same period last year, according to Thomson Financial – but many of the possible takeovers talked about for the past few years are finally coming to fruition.

More on economics

Suddenly other rumours – that J Sainsbury and Marks & Spencer will merge or that Aon, one of the world’s largest insurance brokers, will bid for smaller rival Benfield, for example – don’t seem so far fetched.

Ironically, the economic crisis has in some ways proved a catalyst for many quoted companies to consider what are known in the City as defensive mergers, which often involve share swaps.

With revenue growth looking uncertain, there is strong pressure on management teams to create value for shareholders through transactions that take out significant costs and create new income streams.

“If companies are running out of top-line growth, they have to generate growth from elsewhere,” said Andy Brough, a fund manager at Schroders. “If they can put two and two together, take out costs and come up with five, then that is good enough for us.”

In part, the credit crunch has emboldened some chief executives to pursue the deals they have been mulling over for years.

During the credit boom, the buyout buccaneers with access to cheap debt had often been able to outbid corporate buyers in auctions. Iberia, for example, was last year assiduously courted by a consortium led by TPG and Apax. Back then, if BA had proposed a stock merger with Iberia, there was a strong risk that its deal could have been ruined by a private equity interloper.

Now, however, chief executives no longer need to worry about private equity firms cooking up a better offer because banks are unlikely to provide the debt financing.

And shareholders in the target companies are less willing to entertain private equity bids because of the uncertainty surrounding the debt financing of any deal. In the past five years, buy-out firms have sniffed around Woolworths, HMV and Benfield, but all failed to pull off a deal.

“Can anyone trust private equity any more? How many times have they put something on the table and then just walked away without following through? If a private equity firm wants to do a deal now, I would like to see a 10 per cent deposit in the bank before anybody starts talking,” said Brough.

With such scepticism towards private equity in the air, many corporate bosses now feel they can use their own paper as a genuine acquisition currency because long-term institutional investors want to remain shareholders in some of the newly merged businesses.

“Share-for-share mergers allow institutional investors to participate in the upside,” said Brough.

The mood has not been lost on skilled deal-makers such as Donald Brydon, the chairman of TNS, who earlier this year engineered an all-share merger with GfK, the German research company, or Sir Martin Sorrell, WPP’s chief executive, who is still proposing that part of his bid for TNS be funded by his own company’s shares.

It remains to be seen whether GfK will now manage to come up with the money for a cash offer for TNS.

The talk is that despite approaching several potential co-investors, including Russian tycoon Suleiman Kerimov, GfK has still not found the capital.

While “defensive” deals have emerged thick and fast in 2008, the crunch has thrown up distressed situations that are forcing boards to consider opportunistic offers that they might previously have dismissed.

Santander’s acquisition of Alliance & Leicester is a prime example. A&L had resisted several overtures from Santander over many years – overtures that were probably priced at a level significantly higher than the latest offer from the Spanish banking group.

But fears over Britain’s worsening economic environment and the lack of improvement in credit markets made A&L nervous about the future. When Santander made an approach last month, A&L’s board could not afford to turn away its latest 299p-a-share, all-paper offer. The bank’s shares had closed at 219p the Friday before the weekend approach.

“Some company boards are reaching the conclusion that it’s worthwhile to take strategic value now,” said David Livingstone, the head of European M&A at Credit Suisse. “For someone thinking about selling a business, the question is this: do I continue to operate or do I cash out at a premium value and let others assume the risk?”

But he added: “There are still many cases where buyers and sellers can’t agree on value. Shareholders’ and boards’ expectations of value regarding the companies they hold have generally not fallen as much as traded equity values have.”

Clearly, this is happening in the mining and energy sectors, where nearly all of the old tall tales have been borne out. The fundamentals in these industries remain strong, acquirers are still confident of their own earnings and they are keen, as Xstrata has recently demonstrated, to carry out audacious takeovers of smaller competitors that have seen their share prices languish.

So, what next? Will BP and Shell finally walk up the aisle, or perhaps Greene King and Marstons will get together for a pint?

These are some of the old tales – many of them perfectly logical – that often get passed around dealing rooms on a Friday afternoon.

Each theoretical deal, though, has its own unique set of hurdles to completion.

In the case of Greene King and Marstons, there is said to be such strong rivalry between the management teams that they could never be integrated. And there may be serious anti-trust issues that would prohibit BP and Shell from ever coming together.

But as the economic storm clouds darken, more and more management teams could soon find that they will have to compromise.

Otherwise, they may find themselves on the receiving end of angry calls from their shareholders or, worse, a hostile bid from one of their competitors.

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/08/17/ccmanda117.xml

This website and sisters royaldutchshellgroup.com, shellnazihistory.com, royaldutchshell.website, johndonovan.website, and shellnews.net, are owned by John Donovan. There is also a Wikipedia segment.