Europe’s nascent merger boom

Sep 6th 2005
From The Economist Global Agenda

European mergers are booming, as Gas Natural's €22.5 billion bid for Endesa demonstrates. But economic nationalism remains an obstacle

WHEN is a cross-border takeover in Europe a good thing? For the French government, the answer seems to be clear. It is to be applauded when the company doing the buying hails from France, but treated with deep suspicion when the target is French. Spooked by rumours that Danone, a food company that owns much-loved French brands, might be taken over by America’s PepsiCo, the government has announced its intention to come up with a list of strategic French industries that will be protected from foreign takeover. “Our policy is not to oppose by principle every acquisition of a French company,” says François Loos, minister for industry. But if yoghurt is a strategic industry, Mr Loos’s promised list may be quite long.

While French politicians contemplate an industrial Maginot line, French businessmen are snapping up companies elsewhere in Europe. According to Dealogic, a research firm, French firms spent almost $60 billion on foreign takeovers in Europe alone in the first seven months of this year (see table). Pernod Ricard, a drinks company, bought its British rival Allied Domecq; Suez, a utilities company, bought Electrabel of Belgium; France Telecom took over Spain’s Amena, a mobile-phone operator. Just last week, another French firm, Saint-Gobain, a building-materials company, had a £3.6 billion ($6.5 billion) hostile bid for Britain’s BPB rejected.

“We are in the early stages of a new merger cycle,” says Jeffrey Rosen of Lazard, an investment bank. Deal activity in all big European markets is up by about 50%. There is great potential for value-creating deals within the European Union (EU), as fragmented national economies merge into a real single market. But there are big obstacles too. As France shows, many politicians cling to the idea of “national champions” and create obstacles to cross-border mergers.

Still, there are powerful forces pushing in the opposite direction. Strong corporate profits are driving the current increase in mergers and acquisitions (M&A). After atoning for the past merger wave’s excesses with cost cuts and sales of unrelated businesses, many big companies have healthy balance sheets. Credit is cheap, and shareholders are keen on takeovers once again. France Telecom shares jumped after the announcement of its acquisition of Amena, as did those of Pernod Ricard and Suez after their respective takeovers were made public.

Company bosses are more cheerful too, according to recent opinion surveys. This may reflect a belated uptick in the EU’s economic performance. The European Commission forecasts the economy will expand by around 0.4% and 0.6% in the third and fourth quarters respectively—the fastest growth since the first half of 2004, though much depends on oil prices.

At present, European mergers represent about one-third of global deals, while American deals account for half. Europe’s share is set to grow, but only if politicians resist their instinct to meddle with international mergers, which represent more than half the total. Banking and utilities, for instance, remain largely national industries in Europe, because they are considered “strategic”. Cross-border takeovers in these sectors are intensely political. The French and Italian governments squabbled for more than a year about whether to allow Electricité de France to buy Edison, an Italian power company. Antonio Fazio, the governor of the Bank of Italy, spent months this year employing unusual methods (with the tacit approval of the government) to block a Spanish and a Dutch bid for two of the country’s mid-sized banks.

In such “strategic” industries, politicians are still obsessed with creating national champions that will be in a position to gobble up foreign rivals when national barriers finally fall. Spain's Socialist government is reported to be in favour of Barcelona-based Gas Natural's daring €22.5 billion ($28 billion) bid for Endesa, Spain's largest utility, which was announced this week. If the unsolicited approach gets the nod from both shareholders and regulators, it would be the country's largest takeover and create the world's third-largest privately owned utility.

When it comes to keeping jewels out of foreign hands, the main exception is Britain. One of its largest banks, Abbey, was snapped up by Spanish rival Santander last year. And foreigners have been allowed to buy big electricity and water companies. This week E.ON, a giant German energy group, confirmed that it is considering a bid for Scottish Power, Britain's fifth-largest utility.

Pushing private equity

European politicians’ interference is not yet egregious enough to discourage the British and American private-equity firms that are becoming an increasing presence in the euro zone. About one-fifth to one-third of current European merger activity is generated by private-equity firms. These firms manage funds that take controlling stakes in what they think are undervalued and badly managed companies. On August 22nd Permira, a firm based in London, and Kohlberg Kravis Roberts, a New York firm, took over SBS, a pan-European broadcaster.

The rise of private equity should be good news for corporate Europe. Such firms can sharpen up business performance, by snapping up neglected bits of conglomerates and running them as independent businesses. There is obvious scope for this in Europe, where the degree of conglomeration is far higher than in America.

Any high-profile move by an “Anglo-Saxon” private-equity firm in continental Europe is sure to be controversial. But even so, under current European law, national governments can do very little to block bids for private companies. EU officials have been quick to point out that, if France genuinely tries to protect a range of “strategic” industries from takeover, it would be in “flagrant” breach of EU law on the free movement of capital.

This could be the best year for European M&A since the internet-bubble years of the late 1990s. If there were another mega deal such as last year’s €55 billion ($65 billion) merger of Sanofi-Synthélabo and Aventis, two French pharmaceutical firms, mergers could cross the $1 trillion threshold for the first time since 2000. But if the deal is a cross-border merger, and the target is French, stand by for fireworks.

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