Why are British companies being sold so cheaply?

One of the things the pandemic has not stopped in its tracks is the flow of money into Britain. Since the beginning of the year, the number of takeovers for British companies has hit a 14-year high with a value of $198 billion (£142billion), three times more than the same time last year. 

According to Refinitiv, owner of the London Stock Exchange, some 68 per cent of all those takeovers of either publicly listed or private companies are by foreign predators. And of the total, 42 per cent of those overseas firms were American. 

In July alone, there were takeover deals worth $34.9 billion, 5 per cent less than in June but more than seven times the value in July 2020.

Just in the last few weeks, bids by US companies have been launched, and agreed, for two of Britain’s most critical defence manufacturers – Ultra Electronics and Meggitt – worth a total of just under £10 billion. 

The swoop for UK assets is across all industry sectors, from defence to asthma inhalers: there are rival bids on the table for the UK’s fourth biggest supermarket group, Morrisons, from ex-Tesco boss, Sir Terry Leahy, leading an offer from US private equity firm, Clayton, Dubliner & Rice, and from the SoftBank-owned Fortress group. There are bids by the Philip Morris tobacco giant for the Vectura inhaler business as well as takeovers for the lesser known Watchstone, GCP Student Living, Audioboom, Tricorn and Restore.

What’s behind this takeover frenzy? Britain’s companies are quite simply far too cheap compared to their international equivalents, and undervalued by UK investors who lack an appetite for the long-term.

When measured on a price-earnings ratio, British companies are priced much lower compared with US rivals: according to Refinitiv, the FTSE 100 trades at 15.6 against 26.9 for the S&P 500. 

The FTSE 250 index of mid-cap companies trades even lower, at 9.9 times. Take the case of defence and aerospace company, Meggitt, the FTSE 250 listed company which has just agreed a takeover by the US giant defence to space conglomerate, Parker-Hannifin. 

Parker is offering Meggitt’s shareholders a generous £8 a share – valuing it at £6.3 billion – a stonking premium on the share price which only last year was trading at £2.80. 

There may yet be a higher offer for Meggitt as another US firm, the private equity Transdigm, has another few weeks to decide to go ahead with a rival offer of £9 a share. With Meggitt’s shares trading at £8.30 today, it rather looks as though investors can smell a higher offer.

The bid for Ultra by Advent, another US private equity outfit which recently bought Cobham, the UK defence manufacturer, in a controversial deal, is also at a juicy premium. Indeed, the offer of £35 a share is 40 per cent higher than its previous record price. 

While Advent’s bid for Ultra has just been referred by the government to the Competition and Markets Authority because of its highly-sensitive defence contracts, the bid has set a new valuation on the company.

If Meggitt, which makes brakes and wheels for the F-35 and Typhoon fighter jets, and Ultra, which makes high-spec kit for nuclear submarines, are of such value to their rival, why were their shares so poorly valued by the UK’s investment community?

There are so many reasons for why UK companies are being sold so cheaply, and so easily: some are simple, some more complex, some good, some bad. Not surprisingly and unavoidably, one of the biggest reasons was the political risk associated with the Brexit negotiations. 

Since 2016, UK companies have been undervalued by around 20 per cent compared to their international peers, and particularly cheap compared to European countries. 

With Brexit out of the way, there has been some recovery but the FTSE All Share Index is still down around 15 per cent compared to the Eurostoxx 600.

Second on the list is the UK government’s open-armed approach to foreign bidders compared to the far more protectionist US and continental European competition regimes. However, the decision this week by business secretary, Kwasi Kwarteng, to intervene in Advent’s bid for Ultra may show there is now a tougher approach, certainly when it comes to the more sensitive defence sector.

Third, money is cheap. And it is the American giants – particularly the private equity companies – which have access to cheap credit and can load up with debt to leverage the funds for many of these takeovers. 

Panmure Gordon’s chief economist, Simon French, has a fourth reason for why the UK is so easy to buy: the levels of liquidity of UK stocks are far lower than their international peers as the average daily volume of share trading across the UK’s largest 500 companies was $11m a day with just a third having an average daily volume greater than $5m. 

This is far below the equivalents in top European stocks at $95m and trading in US shares at $443m. 

As French explains, most of the big institutional investors – particularly the global ones which own over half of all the shares in UK listed companies – have a high daily liquidity threshold so they have a self-imposed barrier to the arbitrage opportunities presented by UK valuations and therefore miss out on them.

Which is why foreigners look set to continue gobbling up UK plc. Research by City analysts at Canaccord Genuity suggests that more than 200 companies listed on the UK stock market are vulnerable to predators from rivals or private equity firms looking for buying opportunities.

They reckon that there will be takeovers for a number of household names including Marks & Spencer, Sainsbury’s, Vodafone and ITV by the end of the year. Time to fill your boots?