Clerical Medical sees food retail as an area of the market where further merger and acquisition acti...
Clerical Medical sees food retail as an area of the market where further merger and acquisition activity will be a positive.
Overall the group believes M&A activity is no longer a sign that share price outperformance will then take place. This is in part because it sees little evidence that there is much more useful consolidation to take place in the UK market.
Tim Rees, director of UK equities at Clerical Medical, is not optimistic about any further activity in the oils, pharmaceuticals or telecoms sectors.
He thinks these are difficult environments to be in and they have not gained all that much by M&A. He is underweight pharmaceuticals because he thinks the fundamentals are too highly rated. He is overweight oils, mainly because of his holding in Shell, but that is not based on potential consolidation but on a management change which he thinks will make significant performance impact.
Rees says: "The market is more balanced now and it is time to go back to old-fashioned stock picking again."
Rees thinks globalisation is not going to stop and companies will require access to wider markets. He is looking out for M&A activity in food retail, as the big European food manufacturers look for access to the lucrative British market.
If Britain is flooded with European competitors, this will lower margins but there will always be advantages of geographical diversity.
Merrill Lynch is more optimistic on the impact of M&A activity and Khuram Chaudhry, UK equities strategist for the group, thinks there is a lot of consolidation potential in financials, and in particular in the insurance industry.
Rees says there was plenty of interest in the demutualising building societies, which should have provided a lot of opportunities for investors.
He says purchases of these companies is difficult as there are so many shareholders, so it is not possible to make a rapid deal with a small number of large players. The original flurry of interest has also left them expensive on the whole, Rees believes.
Chaudhry says: "As bond yields have fallen, people have been pushed into growth stocks. Generally, people looked to M&A activity as a way of bringing value to shareholders.
"If they are sitting on a cash pile they can either use it to buy back shares or pay it out to shareholders in an extraordinary dividend but that should be only if they cannot do anything else with it."
He thinks the BP Amoco deal deserved market rewards because it solved specific
problems. At the time there was an oversupply of oil in the world and M&A decreases supply as well as cuts down running costs.
Also, giant multinationals populate the oil industry, and to have any influence in the industry a company needs to join their ranks.
Rees says: "There was a good reason for the move. BP joining with Amoco turned it in to one of the top three players in the world. It gave it the presence and global spread and opportunities to develop new areas that it did not have before."
The UK telecoms industry has the same problem of over supply. Orange's holding company, Hutchinson, sold 5% of its stake recently and Securicor sold 40% of its Cellnet stock
Chaudhry says: "If there were huge returns to be made and these were big growth areas, they would not do that."
Pharmaceuticals form another area for potential consolidation because of its unique problems of product turnaround.
Pharmaceuticals have high R&D costs and products have a long and uncertain gestation period. Consolidation can have real earnings impact, as research material is shared and more money can be siphoned into fewer projects.
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