Market Comment, UK Manufacturing to the rescue!
UK manufacturing leaders are increasingly confident and the sector is an economic and M&A bright spot
UK Manufacturing, Brexit and M&A
The April IHS Markit purchasing managers' index indicated the fastest rate of expansion in UK manufacturing in three years (and a ninth consecutive month of growth) perhaps indicating that the weakness in Sterling since the EU referendum is helping to rebalance the UK economy. Supporting this, the April CBI Industrial Trends Survey reported strong growth in orders, in particular export orders, which recorded their fastest growth in six years and expectations for year-ahead exports which were at their highest level in two decades.
The latest UK manufacturing figures provided a helpful tonic after preliminary Q1 GDP estimates showed slowing growth in the wider economy, largely driven by falling consumer demand in the light of inflationary pressures and weakening wage growth. With manufacturing only accounting for c.10.3% of overall GDP, however, there is clear context to this positivity.
In a March 2017 speech, Deputy BoE Governor Ben Broadbent highlighted that UK exporters may have hit a sweet spot driven by the weak GBP, warning at the same time, that this may not last forever as the effect of a weaker currency catches up via cost inflation and as the ease of doing business with the EU decreases with Brexit.
How is this affecting M&A in the UK?
From the Brexit referendum to mid-March, Reuters estimate that $353.2bn of deals were announced, the second highest level when compared to equivalent periods in each of the last nine years, perhaps flying in the face of conventional wisdom that a stable political environment encourages deal-making. However, this number was skewed somewhat by a small number of high value deals where overseas companies took advantage of Sterling's weakness and the continuing availability of competitive financing to secure UK assets (for example, Softbank's £24bn acquisition of ARM in July and 21st Century Fox's proposed takeover of Sky for £11.7bn.
UK businesses do, however, appear to have acclimatised to the current environment and post-referendum reticence to make big decisions appears to be fading. Deloitte's latest 'CFO Survey' indicated that CFOs from some of the UK's largest companies are increasingly saying that Brexit is unlikely to impact on M&A plans. In Q2 2016, 40% believed that Brexit would lead to a decrease in M&A, by Q1 2017 this had fallen to 11%. With the upcoming UK General Election potentially providing Theresa May with a strengthened hand when dealing with the EU as well as her own back benchers, the further 'stability' this will give offers buyers more confidence in the UK trading environment in the medium-term.
Looking to the longer-term, the picture for UK M&A is naturally less clear. UK manufacturers are actively reviewing how Brexit may affect their operations and supply chain. A desire to retain preferential EU market access may drive some outbound M&A and EU manufacturers for whom the UK is a key market may look to secure a UK footprint to avoid risk of future import controls or tariffs, but our expectation is this strategy will have limited impact for at least the next 12 months.
Equally, with the comparative ease of doing business outside the EU looking more attractive, we would expect UK manufacturers to increasingly look to Asia and other international growth markets for not just sales growth but M&A opportunities.
Ongoing competitive debt terms and a record amount of unspent capital sitting with European private equity funds will continue to be a catalyst for M&A in manufacturing and more generally across the continent. A further cut to the UK's corporation tax rate improves the country's attractiveness for investment relative to other countries; however, changes to rules around interest deductibility limiting the offset do the reverse for investors relying on debt to finance transactions (perhaps to the advantage of cash-rich acquirers, particularly those in the US able to more readily repatriate cash).
There is still significant uncertainty for UK companies to deal with in the medium term as a result of impending Brexit, however, it is clear that many UK businesses have recovered from the initial shock of the referendum and have realised that for the time being, there are opportunities through increased competitiveness with the weaker pound.
Overall sector sentiment is, if not bullish, certainly good and investment levels are holding up well.
Over the next couple of years, a more competitive GBP exchange rate can continue to help rebalance the UK's economy by driving manufacturing exports. If this rebalancing can be successfully sustained, it will have a positive impact on GDP growth and significantly reduce the country's current account deficit. Post-2019 if this can be combined with favourable post-Brexit trade deals and a sustained low tax and R&D sympathetic agenda then the UK will look like a strong market for manufacturing investment.