Question of confidence - Increasing market optimism may be interpreted in different ways


Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

Recent articles on The Value Perspective such as Merger will out and Merger most horrid will have left regular visitors convinced of two things – the first being the need for us to find a new M&A-based pun. Of far greater importance, however, is our broad caution about M&A deals because the inclination of companies to do them when markets are high means they tend to destroy value rather than create it.

That being the case, it was interesting to see some data on UK M&A trends coming straight from the horse’s mouth, as it were, as the London Stock Exchange Group (LSEG) issued a pre-close update for the 11 months to 28 February 2014. Just to be clear, while the company does also run the Italian stock exchange, the lion’s share of the numbers that follow will relate to the Mergers & Acquisition (M&A) activity of companies listed in the UK.

Over those 11 months, the total equity capital raised on the LSEG’s markets jumped to £28.3bn from £14.8bn in the previous period – a year-on-year increase of 91%. New issues such as initial public offerings (IPOs) were also up on the previous period (162 versus 107) with the bulk of that number coming on the UK’s Alternative Investment Market (99 versus 68).

One might reasonably conclude from such figures that, first, things are bubbling away a bit more in the small-cap arena and, second, if it is becoming easier to raise money there, people must be feeling happier about the world. Certainly the LSEG seems upbeat as it also notes “continuing good signs of issuance activity in the period ahead” but can The Value Perspective share such optimism?

Well, one figure that does give us pause for thought is the 167% year-on-year increase – from £5.2bn to £13.9bn – in the amount of money being raised by existing companies as distinct from new issues. This suggests a lot of businesses are feeling better about doing deals that they will fund partly with debt but also, increasingly, by approaching shareholders for more money.

Those are just a few statistics but they all reflect aspects of M&A we have addressed before on The Value Perspective – most notably how acquisitions and IPOs tend to be correlated with market levels rather than, say, how attractive opportunities are based on valuations. Clearly confidence is returning to the market, which means value-oriented investors ought to be more cautious – albeit on a case-by-case basis.

We are choosing our words carefully because, of course, one can never call the top (or indeed the bottom) of the market – nor should one ever try. At this point, as we see things, valuations across the UK market are not markedly expensive. In isolated sectors and companies they may well be but, across the board, they are probably best described as ‘above average’.

Back at the start of 2012, in The seesaw of sentiment, we noted that while many investors where steeling themselves for a difficult year, we felt more hopeful, basing our views on where valuations were at the time. We noted “it is precisely when everyone else is worried that things become more interesting in our eyes” but of course the opposite holds equally true.

At this point in the market cycle, as we observe evidence such as the M&A numbers above, we are minded to repeat our conclusion to that article – “Being realistic about the outlook is fine, but the inability to have just a little bit of optimism about what the future might hold can be a very costly mistake for investors in the long run” – but this time replace “optimism” with “pessimism”.


Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

I joined Schroders as a graduate in 2005 and have spent most of my time in the business as part of the UK equities team. Between 2006 and 2010 I was a research analyst responsible for producing investment research on companies in the UK construction, business services and telecoms sectors. In mid 2010 I joined Kevin Murphy and Nick Kirrage on the UK value team.

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