The first few months of this year saw several major corporate takeovers in Europe. The list includes the hostile takeover offer by Sanofi, the French pharmaceutical firm, for Aventis, the Franco-German firm; and the purchase by Telefónica, the Spanish telecom company, of Bell South’s subsidiaries in Latin America. On top of that, rumors continue to circulate: Banco de Santander (Spain) is supposedly interested in Britain’s Abbey National. Three other banks — HSBC, of the United Kingdom; BNP Paribas of France; and ABN Amro of the Netherlands — are all allegedly about to undertake acquisitions in the United States. All signs point to a brisk recovery of European mergers and acquisitions.
Looking at the numbers, during the first quarter of this year, deals worth $152 billion took place on the Old Continent — an increase of 17% [in dollar value] over the same period last year. The market in Spain has been especially active, with news of 234 different deals, amounting to $14.84 billion – or 95% more than during the first quarter last year. Despite such signs of recovery, the actual number of mergers and acquisitions has dropped by 6%.
In Europe, it is not easy to close these kinds of deals, notes José Manual Campa, director of research at the IESE business school at the University of Navarre (Spain). On the contrary, “Enabling pan-European mergers and acquisitions and a genuinely unified market for integrating companies, are both tasks that remain to be accomplished in the EU,” Campa writes in his recent study, ““Mergers and acquisitions in Europe: Still pending a resolution.”
Campa explains that the creation of the euro in 2002 led to expectations of an accelerated integration of European asset markets. People believed that it would be easier for companies to raise capital, which would make it simpler for European companies to integrate their operations across national borders. This new reality would overcome business fragmentation, and end the traditional dominance of small companies in Europe.
However, business concentration in Europe is not happening as anticipated, because of major social and cultural barriers, as well as legal and political obstacles that are imposed by EU member-states. Even worse, “There is no prospect that the regulatory framework for realizing such transactions will improve over the next decade,” Campa writes.
Financial markets in Europe usually react negatively to news of cross-border buying and selling. According to Campa, this fact “reduces the incentive of managers to get involved in these deals.” In such an environment, Campa asks: Which companies and which creators of value are emerging from these mergers? What are the main obstacles to these deals? What are their medium-term prospects?
Parallel with the United States
Over the last ten years, the market for merger and acquisition markets has been very cyclical, behaving like a compass that beats to the rhythm of stock markets. The number of deals within the euro-zone reached a decisive peak in 2000. That year, 16,750 deals took place, worth about one billion euros. Ever since, the volume of activity has dropped sharply because of “the decline in the economic cycle and the drop in market capitalization of businesses,” Campa writes.
Europe is not the only continent that has suffered a drop. According to Campa, the United States also experienced a similar pattern, demonstrating that this has not been a result of Europe’s economic integration.
European mergers and acquisitions continue to take place largely between companies that are in a single national market. According to Thomson Financial Services, 52.1% of all European mergers and acquisitions in 2001 involved only one country; 14.9% involved the entire EU region. The remaining deals involved countries that did not belong to the EU, mainly the United States.
Moreover, there was a significant concentration of activity within the EU, in terms of geography. The main players in mergers and acquisitions are in countries whose stock markets have a high market capitalization; a highly liquid stock market; and a favorable regulatory environment. British companies were involved in more than 30% of the deals in the EU over the last decade.
To understand why so many deals involve just one country, you need to understand why European companies make these deals. According to one study, only 10% of all companies that acquired other companies were looking to achieve greater economies of scale. That finding defies conventional wisdom about the motives for corporate takeovers. In contrast, in 30% of all cases, the goal was to improve the acquiring company’s presence in its own domestic market; in other words, to gain market share at home. In 25% of the cases, the main goal was to gain access to new geographical markets.
According to Campa, despite all the official rhetoric favoring European integration, European governments are showing great reluctance to open their borders and lose control of their local economies. That is because companies are worried about consolidating their leadership in their own local markets.
Sources of Value Generation
The profitability of these deals is another major factor. According to Campa, “Mergers generate value for shareholders of the company that is selling. Generally speaking, they do not generate net value for shareholders of the company that is buying.” Moreover, shares of the company that is buying tend to drop because of news about the merger. According to a study by KPMG, the consulting firm, only one out of every three buyouts in Europe generates value for shareholders. In countries such as Germany, 60% of all deals in 2001 and 2002 wound up destroying shareholder value after the merger.
The study also shows that buyouts of smaller companies are usually more profitable [than buyouts of large firms], as well as buyouts that take place during a downturn in the cycle of the economy or the stock market. Long term, cash deals are usually more profitable than those involving an exchange of shares.
Buyouts that create the greatest value are generally in unregulated sectors, either in local markets or across borders. Buyouts that destroy the most value are cross-border purchases in markets — such as energy and telecommunications — that are traditionally in the hands of governments.
As Campa notes, the banking sector has undergone more concentration than most sectors. Most bank mergers have taken place within a national market; only slightly more than 10% of mergers involve European banks from more than one country. These figures reflect the average profitability anticipated in this kind of deal. Although mergers involving one country generated a profitability of 1.5% after the deals were announced, cross-border mergers generated a profitability of minus 0.4%.
Not surprisingly, whenever there is a rumor of a cross-border bank merger – or top representatives of European banks discuss that topic – analysts and bankers are quick to dampen expectations. Emilio Botín, president of Banco Santander, recently said that mergers between equals do not generate value for shareholders. What could make sense, if opportunities arise, he noted, are buyouts of a competitor. Along the same lines, Michel Tilmant, managing director of the ING group, told reporters, “cross-border consolidation is very hard to achieve in Europe. Although you can find some synergies, there are not enough [synergies] to justify tackling these kinds of deals.”
Although many people insist consolidation in the banking sector is necessary, it will not be easy to achieve. “Buying a bank in Italy is almost impossible; buying a bank in Germany is very hard,” Campa notes. “The German government is promoting consolidation of the sector, but through mergers of German banks, not through buyouts of a German bank by a foreign [non-German] bank. Not one major European bank has a presence in more than two EU countries.” Moreover, he adds, “Spanish and British banks have shown a preference for taking [ownership] positions outside Europe,” instead of expanding their presence on the Old Continent.
One reason is the cultural and linguistic affinity between, on the one hand, Spain and Latin America; and, on the other hand, between the U.K. and the United States. Thus, Spanish banks have become heavily involved in Latin America, while British banks have acted the same way in the United States.
Cultural and Legal Barriers
Campa wonders why pan-European mergers have such a hard time, given the fact they reflect a natural evolution, and a more effective way to use economies of scale that already exist. His conclusion is, investors are reacting to the damage they think these companies are going to suffer [if the deal takes place].
Some restraints are cultural, says Campa, including differences regarding “language, physical mobility, social benefits, and the importance of professional development in human activity.” These kinds of barriers are deeply rooted in Europe, and “it is not easy to change them, short-term.” On the other hand, Europe must also overcome legal and political barriers to true economic integration.
The EU’s efforts to normalize the buying and selling of companies within its borders has ultimately been a failure. After 15 years of negotiations, the EU recently approved guidelines for regulating such activities. Frits Bolkenstein, the European commissioner responsible for drawing up the initial proposal, called these guidelines “a major step backward in creating a unified European market,” according to Campa. When all is said and done, most clauses in the guidelines will be optional, and EU member-states will be able to take measures for avoiding hostile takeovers by companies that are based in foreign countries. Targeted companies will be able to take measures to arm themselves against [foreign] competitors, if such measures are permitted in the country of the purchaser; even if such measures are prohibited in their own country.
“This is not merely a reflection of the balance of power within the member-states of the EU,” writes Campa. “It also reflects widespread opposition to creating an integrated market for buying and selling companies in Europe.”
All these problems point to this conclusion: “There is only a small probability of carrying out any merger that doesn’t provide the profitability that makes it worth all the effort,” Campa writes. Moreover, if, despite all the barriers, the parties decide to go ahead with a deal, [financial] markets usually react negatively.
The new legislation “could perpetuate the barriers,” affirms Campa. To the extent that Europe is unable to restructure its markets, it will suffer a significant loss in its competitiveness. The EU will fail to comply with the agenda of Lisbon, which aims to make Europe’s economy the most competitive in the world by 2010.
Nevertheless, not all the news is bad. Campa notes, “Mergers are cyclical, and to the degree that the economy recovers, the number of mergers will also increase, despite all these regulations.”