Are overseas takeovers a threat to the UK stock market?

A threat to a thriving equity market

 
A thriving UK stock market is important, not just for investors and companies, but also for the UK economy and society.

From the companies it finances, to the people working in the markets directly, to the companies and services which support them, to the taxes the industry contributes, which pay for vital public services. While this covers much more than the stock market alone, it is an important piece of the jigsaw.

And when the number of companies on the UK main market has fallen in 23 of the last 25 years, and stands at only 42% of its level from 25 years ago, then this has the potential to be a worrying development.

Companies being bought isn’t a bad thing as such. It can be a sign of a healthy and dynamic market and economy. But too few companies have sought to join the UK stock market, to replace the ones departing.

These takeovers may be cutting off potential future corporate success stories at the knees. When people ask, why there are not more world-beating companies being built in the UK and listed in London (don’t get me wrong they do exist, just fewer than we might want), one answer may be that they sell out too soon.

And an inability to nurture companies to sufficient scale, whatever the reason, means that when buyers do come shopping, overseas companies have more clout to do the deals. This may explain why we are unable to replicate the US outcome, where it is other US companies that have been the biggest buyers of their public companies.

There are still more than 1,100 companies in total on the UK main market (a wider universe than those analysed above) . And 2021 was one of the two years in the past 25 when that number did increase. So the UK is not in a danger zone…yet at least.

But markets operate on confidence. Success is self-fulfilling. If a country is known as a place where companies can raise money, more are drawn to it. The reverse is also true. If the UK comes to be viewed as a market in decline, whatever the reason, then a self-reinforcing decline could set in.

To ensure the UK thrives as a listings venue, it is important to look at both why too few companies have been listing and also why so many have been delisting. Emphasis so far has been on the former, such as the encouraging measures set out in the Hill review. The latter should not be forgotten.
 

Should companies care?

 
It would be possible for companies to raise money without a thriving UK stock market. They could borrow from a bank, as many already do. And, if they need to raise equity they could do so on an overseas stock exchange, or from private equity.

Moreover, many of the large international companies listed in London have no binding need to call the UK home. They could just as easily be listed elsewhere. This may be part of the problem.

The UK market may be partly a victim of its own past success in attracting overseas companies to list in London. With weaker UK roots and closer operational ties to countries outside of the UK, they are more likely to appeal to companies in those countries, and multinational buyers.

This is particularly the case for the energy and materials companies which London successfully attracted in the 2000s. 30% of the companies to delist were in one of these two industry groups, much higher than the 22% of companies those sectors made up.

But away from these large companies, a dig down the capitalisation scale unearths a deep well of more domestically-oriented small and mid-cap companies. They may be familiar (ish) names to people in the UK but many would find it harder to raise money overseas, where they would be more unknown quantities. They would have much more to lose if the UK market lost its status (with knock-on impacts on entrepreneurship etc).
 

Should investors care?

 
If you can earn a healthy return boost when a company in your portfolio is taken over then what’s the problem?

And, in a world of global investing, does it matter if a company lists on the US stock market rather than the UK, as the UK’s most successful technology company, ARM Holdings, looks set to do? It would be no less accessible, for institutions and UK individual investors alike. It might have mattered in the past but not today.

The strongest argument why investors might be doing themselves a disservice is if, in accepting a takeover bid at a premium to today’s share price, they may be missing out on even higher gains in future.

This is contentious. Previous research we have carried out found that a majority of takeovers involve a transfer of value from buying to selling shareholders. Almost 60% acquirors of US public companies went on to underperform their industry group in the one to three years after a takeover. It’s not possible to do a counter-factual and assess what would have happened if they hadn’t made the acquisition. Or whether the acquired company would have been more successful had it stayed independent.

But it’s certainly not immediately obvious that investors would make more money if they said no to more takeover bids. They might – but it would depend on the individual company, situation, and time frame. Each needs to be assessed on its own merits.
 

What are the lessons?

 
In the near term, UK equity investors should welcome renewed M&A interest in UK-listed companies. It could help narrow the valuation discount which has dogged the market in recent years.

Longer term the bigger losers from a drip, drip, drip of UK listed companies to overseas buyers are not likely to be investors, but the UK economy at large, something that policymakers and politicians should not lose focus of.

*Companies within the MSCI UK investible Markets Index at end 2011