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By Richard J Hunter, Head of UK Equities, Hargreaves Lansdown

The FT reported that over a 24 hour period last week, deals were announced with a combined total of $75 billion dollars, or £40 billion. The resurgence in Merger and Acquisition activity, which had had something of a lull compared to 2005 and the early part of 2006, could well prove a catalyst for markets across the globe.

But what is driving the merger mania and why has it returned now in such force?

The main answer concerns the fact that money is currently cheap. Interest rates are historically low but, just as importantly, at the present time debt is cheaper than equity. In other words, whereas in the past it has been more efficient to raise money through the market in the form of equity, (how many rights issues have we seen recently?) because of the interest rate position it is now cheaper to borrow cash. This gap between return on equity and cost of equity is now as high as it has been since the 1990s and shows little sign of closing in the current environment.

In addition, this becomes something of an ongoing circle. Money is borrowed to finance taking a publicly quoted company private, which means that the shareholders of that company receive cash which, in theory, they reinvest into the market. Ultimately, so the theory goes, there are fewer companies left due to this takeover activity and therefore the buying pressure exerts an upward influence on share prices. The rather ugly name for this phenomenon, "deequitisation" is something that market technicians are currently divided about.

It is also estimated that as a result of this raft of M&A activity, coupled with money borrowed but not yet invested, there could be anything up to $300 billion waiting on the sidelines to be invested. Should the institutions that are awash with this cash choose to enter the equity markets, there will obviously be further for the bull run to travel.

So which sectors are benefiting from this activity?

It is fair to say that most sectors have been touched by some form of M&A or another, but the ones which are particularly busy at present are the mining, property, financial and utility sectors.

The commodities boom and ongoing demand from the world's fastest growing economies of China and India have provided the kick start in the mining sector. Property worldwide continues to defy gravity and in terms of the financial sector, ongoing globalisation and cross-border trading has had its effect on everything from banks to insurance companies to Stock Exchanges themselves.

In terms of the utility sector, this has had an injection of interest due to the strong and stable nature of water/electricity/gas companies' earnings. Another report has recently suggested that when the European Union's energy markets are liberalised, it will be much simpler for utility companies to consolidate, which should bring a whole new wave of acquisitions.

Of course, there are concerns. Private equity companies which are highly geared are therefore exposed to an ongoing rise in interest rates, should this happen. Their debt would then become much more expensive to service, and this could result in a number of defaults which would unsettle both the markets and indeed the lending industry.

However, at least for now, interest rates seem to have generally levelled, company earnings remain strong and the interest in extremely profitable businesses from private equity concerns shows no signs of abating.

With the amount of cash reputedly available for investment, there are few blue chip stocks which are out of reach, and since the rest of the market is therefore "in play", it is no surprise that bid speculation continues to swirl around many of the leading names.

Not all of this speculation results in actual deals, but even the froth which the rumours give the shares is an added bonus to investors, given the growth that the companies, and therefore their share prices, are currently delivering.


Richard J Hunter
Head of UK Equities
Hargreaves Lansdown Stockbrokers

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