UK M&A – Feeding frenzy

• Pace of M&A – Twelve transactions of >£100m were announced in 1Q, which continues the heightened pace from 4Q23.

• Larger companies targeted – There are seven ongoing bids for FTSE 350 companies vs just two for the whole of last year. This reflects greater corporate appetite and confidence in the economic outlook.

• Not refilling the hopper – There has been minimal IPO activity for the past two years. We believe this needs to be actively addressed as the FTSE Smallcap will cease to exist by 2028 at the current run-rate.

• Trends are clear – The pace of de-equitisation is relentless and will inevitably continue given the low valuation accorded to UK companies.

 

Key themes

• Going up the market cap – Of the 12 transactions announced in 1Q24, seven are in the FTSE 350, two in the FTSE Smallcap, and three on AIM. In FY23, 39 transactions were announced of which two were in the FTSE 350, 14 in the FTSE Smallcap, 19 on AIM and four other.
• Increase in pace – There was a slow start to FY23 with 13 offers announced in 1H, which increased to 26 in 2H. The heightened pace of M&A has continued thus far in FY24.
• More corporate buyers – Last year, the majority (56%) of offers were from financial buyers as well as the majority by value (77%). However, corporate buyers have dominated in 2024 as the rate environment and economic outlook have become clearer.
• Multiple offers – Last year, six of the 39 bids saw a bump in the price. This largely reflected shareholder pressure to raise the initial offer rather than a competing buyer. We have seen three competitive bid situations this year, with the contest forWincanton resulting in a premium of 104%, and the latest offer for Spirent pitched at an 86% premium.
• High premiums – The average premium thus far in FY24 is 38%, which may sound skinny given the depressed valuations in the UK. However, the average premium is 55% if we just look at cash offers.
• Overseas appetite – There has been greater activity thus far from domestic bidders (67% of the total), as well as a greater number of all-share offers. This excludes the overseas offers for Currys and Direct Line, which were both rejected by their boards.
• Real Estate in focus – Real Estate has been the sector most in focus, reflecting a desire for scale, as well as relative valuations.

 

 

Reversing the trend

The underlying issue for the UK has been the scale of fund outflows, which have now lasted for 34 consecutive months. This has resulted in:

• Low valuations making M&A attractive for acquirors.
• Management teams questioning the rationale for being quoted.
• Boards more likely to agree to an offer, which has increased the chances of deal completion.
• Shareholders agreeing more readily to offers, given their need for performance and for liquidity.
• A recognition that scale and liquidity are increasingly important, particularly if overseas investors are to be interested.

It has been particularly noticeable in recent months that corporates were the main acquirors. This suggests greater confidence in the economic outlook and the interest rate environment. It also shows the attractiveness of UK companies and the potential for synergies in a low growth environment.

It has been surprising to see relatively low activity from private equity, given the c.$4tn of dry powder currently available. Although interest rates have peaked, the reality is that debt is still relatively expensive and higher equity tickets are required given the cost and ability to secure leverage. Furthermore, the fundraising market for private equity has been challenging, with the larger funds taking a material share of new money. We expect this to change as financing conditions improve, which means that private equity is likely to be a more active acquiror going forward.

Currently, there are willing buyers (attracted by the valuations available and the probability of a successful conclusion) and willing sellers (due to fund outflows and scale of premium). In addition, private markets adjust slower to tougher economic conditions, which means that acquisition multiples can be unrealistic.

The impact of the scale of de-equitisation can be seen in the FTSE Smallcap sector (obviously the FTSE 350 continues to have 350 companies). The chart below shows the trend over the past five years.

 

Figure 1: FTSE Smallcap x Investment Trusts 

Source: Bloomberg, Peel Hunt estimates

 

This shows that the number of companies reduced from 160 at the end of 2018 to 114 at the end of 2023. Based on the current bids progressing, this will reduce to only 100 proforma. The chart also shows the scale of reduction in market capitalisation of the FTSE Smallcap constituents, which of course impacts on investor attention given the reduction in allocations. It is a similar story if we include Investment Trusts, albeit at a less precipitous rate.

If we extrapolate the current trend line, then the last company will leave the FTSE Smallcap in 2028!

This all sounds very negative – but the reverse scenario can happen and can happen quickly. It really needs a trigger to break the cycle. Increased fund flow will be the key driver and this could come from:

• Increased appetite by retail investors (eg a British ISA, changes to CGT, IHT or dividend tax on UK shares)
• Reduced cost of ownership and benefit of higher liquidity through addressing the UK’s penal level of stamp duty vs other markets. 
• Allocation by pension funds and insurance companies, through government incentivisation and regulatory change to enable a greater focus on performance rather than risk.
• Increase in share buybacks, reflecting the low valuations and tax differential between capital gain and dividends.
• Appetite from overseas investors if they perceived a material change in UK fund flows.

An improvement in the economic outlook would also change the negative dynamic, with reducing inflation driving the prospect of lower rates and an improvement in economic activity and investor appetite. If we do see increased demand for UK equities, then valuations should improve materially, which would then make an IPO a more attractive option. However, there are some deep-rooted issues in the UK regarding IPOs and the health of equity capital markets, which have material issues for long-term economic growth.

 

M&A – an inexorable trend…

Below, we show the bid activity in 1Q at over £100m equity value.

Company	Offeror	Index	Sector	Equity value £bn	Payment	Announced	Initial premium	Updated premium
Belvoir Group	Property Franchise Group	AIM	Real Estate	0.1	Shares	10/01	10%	10%
LXI REIT	LondonMetric#	FTSE 250	Real Estate	1.8	Shares	11/01	9%	9%
Wincanton	CEVA Logistics	FTSE 250	Retail	0.6	Cash	19/01	52%	104%
Restricted *	Restricted *	FTSE 250	Builders	2.5	Shares	07/02	27%	27%
DS Smith	Mondi/International Paper	FTSE 100	Packaging	5.7	Shares	08/02	33%	48%
UK Commercial Property	Tritax Big Box REIT	FTSE 250	Real Estate	0.9	Shares	12/02	11%	11%
abrdn European Logistics	TBD	Smallcap	Real Estate	0.3	n/a	19/02	na	na
Spirent	Viavi Solutions/Keysight	FTSE 250	Technology	1.2	Cash	05/03	61%	86%
Virgin Money	Nationwide	FTSE 250	Financials	2.9	Cash	07/03	38%	38%
Mattioli Woods	Pollen Street	AIM	Financials	0.4	Cash	08/03	34%	34%
Henderson Eurotrust	Henderson European Focus	Smallcap	Funds	0.3	Shares	14/03	na	na
Accrol	Navigator	AIM	Personal Care	0.1	Cash	22/03	12%	12%
Total		13		16.8			29%	38%

Key points to note are:

Value – The total equity value of the bids amounts to c.£17bn. The split per index is shown below:

Figure 3: Value and % of total value per index 

Value	Value £bn	% of market value
FTSE 100	5.7	0%
FTSE 250	9.9	3%
FTSE Smallcap ex Inv Trusts	0.6	2%
AIM	0.5	1%

Source: Peel Hunt estimates

 

This shows that companies representing 3% of the total value of the FTSE 250 are leaving in just one quarter.

Index – There are six bids progressing in the FTSE 250 currently, as shown below

Figure 4: Number and % of departures per index

	Number	% of index constituents
FTSE 100	1	1%
FTSE 250 ex Investment Trusts	6	4%
Smallcap ex Investment Trusts	2	3%
AIM	3	0%

Source: Peel Hunt estimates

The impact on the FTSE Smallcap is more than suggested by the data above as a number of constituents will be promoted to the FTSE 250 to replace the companies being acquired. In addition, two REITS are in wind-down.

Sector – The Real Estate sector has been the most active with four transactions, as shown below.

Figure 5: Split by sector

 

Source: Peel Hunt estimates

 

Month – The following chart shows the value and volume split by month.

Figure 6: Bid activity by month 

Source: Company announcements

 

Quarter – There was a marked acceleration in activity towards the end of last year, which has continued into the current year.

Figure 7: Bid activity by quarter

Source: Company accounts, Peel Hunt estimates

Although the number of bids was higher in 4Q23 than in 1Q24, the size of company being acquired has increased materially this year.  

Given the peak of the interest rate cycle, the trend in 1Q suggests that activity will be heightened throughout 2024. This further reinforces the need for material reform to ensure a healthy UK equity capital market.