Market Research

Europe Heads Towards Rise In Corporate Simplification - JP Morgan PB

Editorial Staff, 25 July 2018

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The firm looked at the rise in M&A activity in Europe which is being used for companies to increase in corporate simplification.

M&A deals are not just something to be expected in wealth management, in Europe there has been an increase in business for corporate simplification, according to JP Morgan Private Bank.

Over the past 18 months, strategic M&A activity has picked up against a backdrop of strong corporate earnings growth, increasing business confidence, buoyant valuations, historically low volatility and easy financing conditions. 

With an abundance of cash-rich buyers, firms across multiple sectors are using the M&A boom to restructure and simplify their operations. Divesting or spinning out non-core and underperforming assets on later-cycle multiples and refocusing on the core assets can grow shareholder value. Meanwhile, ensuring share price strength of the parent company can be attributed to the potent combination of rebounding earnings growth and/or multiple re-rating. 

“In the first quarter of 2018, European asset divestments and spin-offs have accelerated. At JP Morgan Private Bank we expect this trend to continue – with disruption and shareholder activism key catalysts for progress,” said Grace Peters, European equities strategist. “Using bottom-up analysis, we have identified compelling investment opportunities in European businesses that can unlock intrinsic ‘sum-of-the-parts’ value; and reignite earnings growth through corporate simplification.”

Disruption and activism driving progress
The rate of technological change continues to increase and disruption is affecting companies across all sectors. Technology is disrupting profit pools, creating greater differentiation between the most successful businesses and the rest of the competition. 
 
Now company executives must focus their business strategies and unwind complexity that has steadily crept into portfolios over the past decade.

There has also been a resurgence of shareholder activism around the world across multiple sectors in the past 12 months. 

“Activists are no longer intimidated by larger companies. Many activist situations in the past year have involved household names with big market capitalisations,” said Peters. “While activist tactics can range from being friendly to hostile, we believe a more co-operative approach is evolving between the activist and both management and other institutional shareholders. We expect the trend towards large-cap activism and engagement to continue, particularly in Europe, where there is still much catch-up potential versus the US.”

Market rewards corporate simplification
JP Morgan has found that buying on the day that a significant divestment or spin-off is declared, and holding this company for up to six months, generated on average 2.4 per cent of outperformance relative to the Stoxx600 index.

Buying ahead of the catalyst has historically proved even more lucrative. Investors who owned the same stocks 12 months before the announcement, and continued to hold them for up to six months following the announcement of the corporate action, would have enjoyed an average of 14.6 per cent alpha relative to the European benchmark over the total holding period. 

“We see two primary drivers to keeping corporate simplification a sustained alpha-generating theme. First, if the asset divested was dilutive to growth, the streamlined group can enjoy a rebound in organic revenue and/or earnings, which rarely goes unnoticed by the stock market. Firms with higher actual or expected growth usually trade at higher multiples,” said Peters. “Second, complex multi-divisional organisations, for example a holding company or conglomerate with unrelated business segments, may close the gap to its implied "sum-of-the-parts" valuation by spinning off one or more assets so that the remaining portfolio can be better appreciated and valued by the stock market.”

Looking for value in Europe through corporate simplification
In almost every sector across Europe, JP Morgan Private Bank is seeing a heightened corporate focus on pursuing value maximisation through simplifying business operations. 

This includes the hotel, insurance and pharmaceutical sectors. Looking forward, holding companies, European automotive businesses, oil majors and mid-caps provide compelling opportunities across Europe.

“During the first half of 2018 we have observed corporate simplification become an increasing focus for European companies,” Peters said. “Portfolio changes can significantly impact on a company’s market value, helping stocks out perform both relative to the sector and the broader European equity index. The presence of activist shareholders in Europe could further motivate managements to take action when a company’s market value falls short of its intrinsic value. At JP Morgan we expect portfolio simplification to be an enduring alpha-generating theme and are excited by the many bottom-up opportunities to crystalise value across Europe.”

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