Companies with plenty of cash stand to benefit from the M&A opportunities that can be thrown up in the air when credit conditions tighten, as they are at present. The author of this article, a fund manager, delves into the story as it plays out in Europe.
As central banks around the world tighten interest rates to (hopefully) curb the highest inflation rates in 40 years, a lot of focus will inevitably be on how to manage the challenges this creates. But there are opportunities as well, such as in the case of cash-rich firms eyeing merger and acquisition deals. With that in mind, Alistair Wittet, portfolio manager of the Comgest Growth Europe fund, takes a look at the terrain. The editors of this news service are pleased to share these views; the usual editorial disclaimers apply. Jump into the conversation! Email email@example.com
In times of rising interest rates, equities find themselves under significant pressure and investors in stocks need to think hard about separating the wheat from the chaff. For investors in quality companies, the current environment may create opportunities in an area you might least expect it: M&A.
With the ECB having enacted another significant hike in interest rates in October, M&A no longer seems to be such a good strategy for companies looking for a debt-funded shot in the arm. However, for companies that invest to enhance their growth prospects over the long-term, M&A can still be a winning strategy. This is particularly true for those companies that can afford to finance growth with their own cash rather than by raising debt, given that the availability and the cost of financing has increased significantly in 2022.
For the last 10 years low rates meant that many companies, particularly young and cash burning companies, could use debt to fund M&A activity. Cash on the balance sheet was sometimes seen as a burden due to shareholders wanting to beef up their returns with this ‘excess’ cash. However, with the cost of debt financing rising due to monetary tightening from central banks in developed markets, several young companies which previously had very promising growth outlooks, have suffered because they often are loss-making and so have very low cash reserves. Klarna, the Swedish “buy now, pay later” payments pioneer, is a good example, as its losses quadrupled in H1 2022, and its private equity valuation has fallen from $46 billion in June 2021 to $6.7 billion in June 2022 (1).
On the other hand, growth names with a history of strategic and logical M&A activity and with the cash generation to keep this up in the coming years are ones to watch, as they are largely independent from the current deterioration or tightening of the financing ecosystem. Better still, competition for assets is declining as debt-laden private equity and industry buyers retreat. In Europe, these growth names include Dassault Systèmes, L’Oréal and LVMH. These companies have all strengthened themselves in significant ways through M&A in recent years and are set to use their acquisitions to boost their long-term growth prospects.
Dassault Systèmes, a French corporation which develops software for 3D product design, data management and simulations, acquired Medidata Solutions in 2019 to expand its presence in the life sciences space. This company provides an innovative software platform to help organise and analyse the drug trials for major pharmaceutical and biotech companies. This acquisition was a strategic move: it set the company up for long-term growth by allowing it to leverage its existing expertise in 3D design and simulation to the burgeoning market for digital solutions in healthcare.
In the cosmetics space, L’Oréal used its acquisition of American skincare company CeraVe to enhance its range of skincare products. CeraVe is a fast-growing skincare brand in the US with a multi-channel distribution strategy. On the luxury side, LVMH, a world-leading luxury products group, hasn’t been resting on its laurels either. In 2021 it sealed a takeover deal to buy Tiffany’s, the famous global luxury jeweller, with an explicit view to reviving the brand and using the acquisition of the company, which has a storied history of over 150 years, to drive growth.
What all of these acquisitions have in common is strategic and logical thinking from companies wanting to leverage their existing expertise in new markets or to complement their current brand strengths. In our view, the real value is created not by the first year EPS enhancement, but by the many years of organic growth such strategic acquisitions should generate.
Crucially, these kind of companies have the cash and existing strong market positions to keep this activity up in the years ahead if they wish, making them akin to marathon runners, as they tend to show their strength when the times get tough (in this case, when the risk aversion of investors and cost of capital increases). This underlying strength further enhances their growth prospects, even as the headiest days of debt-financed M&A fall behind us and the recessionary climate comes into sight. Footnote:
1. The Financial Times, 31 August 2022.
Past investment results are not necessarily indicative of future investment results. This material is not intended for the US market. This material is for information purposes only and it does not constitute investment advice. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. All opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice.