Is a "Brexit Discount" Leaving UK Firms Vulnerable to Foreign Takeovers?

UK Policy Economy & sustainability

Is a "Brexit Discount" Leaving UK Firms Vulnerable to Foreign Takeovers?

Commentary
Posted on: 5th April 2022
Jeegar Kakkad
Head of Productivity and Innovation

Last year was a record for foreign takeovers of UK companies, with 734 UK firms acquired[1] by overseas buyers in 2021 —reflecting a 400% rise since 2015.

While inward investment has economic benefits, this boom in foreign takeovers has raised questions about whether UK companies are being bought up on the cheap, and whether this trend is in the UK’s best economic and national security interests.

Between 2010 and 2015, inward acquisitions of UK companies and overseas takeovers by UK companies had largely tracked each other, averaging around 165 per year (see Chart 1). Since then, however, both the volume and value of overseas acquisitions of UK companies have begun to rise. Primarily, most of the increase in takeovers of UK businesses have come from companies based in the US, the EU or the rest of Europe, while takeovers from companies in Asia are running 2.5x – 3x higher since the referendum than before it.

Figure 1 - Inward acquisitions of UK companies up 400% since 2015

Source: ONS and TBI

Looking internationally, the post-2016 rise in foreign takeovers in the UK comes at a time when foreign acquisitions were falling or flat in other developed countries. According to UNCTAD, between 2015 and 2020 (the latest year for comparable data) the number of inward mergers and acquisitions was falling or flat in the US (-4.5%), Germany (+2.5%), France (down 2.2%), and Japan (-3.5%). UK companies are uniquely seen as bargains to be snapped up by foreign investors. But why?

The 'Brexit Discount'

One reason for this increase in takeovers of UK companies is the discount financial markets are now placing on UK-based companies. Since voting to leave the EU in 2016, UK stock market returns have lagged international peers, creating a persistent and historically wide valuation discount.

In May 2016, the FTSE-100 was valued on par with other developed world markets. Within a year, a 14% gap had emerged, widening to 25% by the end of 2019. By the first quarter of 2022, Panmure Gordon estimates that the UK’s valuation gap was about 35%. Much of this gap reflects the industrial mix of the UK markets: controlling for the sectoral composition reduces the discount to about 12%. The gap remains even when accounting for different approaches to ESG and levels of liquidity.

Figure 2 - The UK Discount – the valuation gap between the UK equity market and the RoW

Source: Panmure Gordon and Refinitiv

Estimates for the valuation gap for the tech sector suggest that UK-based semiconductor company ARM would see a 30% valuation uplift by listing in New York rather than London. This suggests that financial markets believe the structural economic damage of leaving the EU justifies a ‘Brexit Discount’ on UK companies. Depressed valuations coupled with world class capabilities have made UK companies attractive targets to foreign buyers.

A New Framework for Takeovers in Strategic Sectors

Successive UK governments have been welcoming to foreign ownership. Investment from overseas brings many benefits to the UK economy, including new technological and managerial know-how, new competitive pressures, and potentially higher pay and productivity. Indeed, FDI flows into the UK have risen since 2016, with both reinvested earnings and intra-company borrowing from foreign parent companies both rising relative to pre-referendum averages.

Yet the recent wave of foreign takeovers has included approaches to companies in politically sensitive sectors, from semiconductors firms ARM and Newport Wafer Fab (NWF) to defence companies Cobham, Ultra and Meggit.

Despite making commitments when it bought Cobham, private equity firm Advent International has since sold off half of the company, leaving the company without any UK manufacturing sites. NVIDIA’s purchase of ARM was identified as problematic before collapsing. The Business Secretary is currently reviewing the CMA’s assessment of Cobham’s purchase of UK defence company Ultra. And after initially being cleared by the CMA and the Business Secretary, the acquisition of NWF by a Chinese-owned tech company was referred by the Prime Minister to the National Security Advisor for further review (and has only recently been approved).

New national security and investment rules introduced at the start of 2022 require mandatory notifications of qualifying acquisitions and investments in 17 sensitive sectors (including AI, defence, and energy), and give the Business Secretary the power to call-in any other acquisitions. The newly created Investment Scrutiny Unit would assess these takeovers, either clearing them or requiring a full national security review. The Business Secretary would then have the power to impose remedies to address any national security concerns, to block deals, or to require acquisitions that have taken place to be divested or unwound.

Having new powers is one thing, but there is no clarity on when and how the government might deploy them or, most importantly, the framework through which it will assess national security concerns. NWF, for example, endured months of uncertainty over whether the takeover that was completed in July 2021 would stand or be unwound. Only recently has it been approved. Such opacity raises the risk that political rather than economic considerations will dominate decisions. This level of uncertainty is economically damaging.

The “Brexit Discount” has led to record levels of foreign takeovers of UK companies. The UK needs to remain open to inward investment if we want to modernise our economy, generate growth and protect our national security and defence capabilities.

As such, the UK needs further reform to its takeover rules by depoliticising sensitive decisions in favour of a regime with more predictability, transparency and accountability. The Institute will set out our priorities for reform in the coming months. In the meantime, the government’s ad hoc, uncertain approach to foreign takeovers risks justifying the Brexit Discount markets have placed on the UK.

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