Money first, massive M&A deals second

As the corporate sector amasses ever-larger piles of cash, shareholders have put increasing pressure on companies to consider other options before launching large mergers and acquisitions.

Many influential investors argue that while they anticipate a renewed round of deals next year as companies that cut back on capital expenditure during the crisis seek to buy growth, they also expect at least some money to be returned to them through share repurchases or higher dividends.

“We would rather see management teams first have the confidence to invest in their own businesses through capital expenditure, or to return some money to shareholders, than launch big M&A deals at this point in the cycle,” says Richard Turnill, head of BlackRock’s global equity team.

By the middle of this year, UK non-financial groups had stockpiled a record cash pile of more than £140bn ($218bn), the highest level since 1998, according to Morgan Stanley, the investment bank.

While fee-hungry M&A bankers and lawyers have welcomed the first stirrings of a sustained round of sizeable deals, investors have tended to punish companies that opted to take advantage of low share-price valuations to swallow up their rivals.

The share prices of companies that have attempted large purchases have tended to underperform those of their sector peers, with Kraft shares lagging behind the wider US consumer sector since completing its £11.6bn bid for Cadbury at the start of the year.

Such wariness among shareholders has seen criticism directed towards management teams that have taken their investors by surprise with unexpectedly bold takeover moves.

BHP Billiton, the Anglo-Australian miner that is the world’s largest by market value and one of the few multinational groups able to afford deals valued in the tens of billions, has come under greater scrutiny from its investors after its aborted $39bn pursuit of PotashCorp of Canada.

Its failure to land Potash – a deal that derailed after it was blocked by the Canadian government on grounds of national interest – cost the company $350m, prompting some of its largest investors to call on Marius Kloppers, chief executive, to exercise restraint.

In response to Mr Kloppers’ third failure to complete a large deal, one investor said: “I do not want them to be trawling around the world forever trying to find ways of spending my money. The company needs to get the message now, as a lot of shareholders are saying they are flogging a dead horse.”

BHP has incurred nearly $900m in fees since 2007 for its failed attempts to buy Potash and Rio Tinto – and, later, to agree a joint venture in Western Australia with the latter.

But the miner, which has long signalled it will seek growth through takeovers, remains defiant, with Jac Nasser, its chairman, defending Mr Kloppers and arguing there is “no pain, no gain with a lot of these transactions”.

The company, which saw its net debt fall to $3.3bn at the year-end after it generated net operating cash flow of $18bn last year, did provide some comfort to the disgruntled sections of its share register by relaunching its share buyback programme.

While it faced stern words from its investors for the failed Potash deal, no investors called for its management team to fall on its sword, and most remain in favour of the miner’s overall strategy.

This was not the case in the highest-profile merger-related controversy of the year: the UK-listed life assurer Prudential’s attempt to snap up AIA, the Asian insurance arm of AIG, for $35.5bn.

Amid a barrage of investor ire directed at the company, its shares fell by almost 20 per cent as the market balked at the execution risks attached to the deal, with some observers at the time speculating that the Pru itself would become a takeover target.

Investors who controlled as much as 20 per cent of Prudential shares eventually signalled they would vote down the deal, which was finally scuppered when the board of the US insurer refused to meet the Pru’s demand in the face of mounting criticism to lower the asking price.

The ill-fated tilt at AIA, which would have involved a $21bn rights issue, one of the largest on record, eventually cost millions of dollars in fees. It also led to an influential group of Prudential shareholders privately calling for the heads of either Tidjane Thiam, chief executive, or Harvey McGrath, chairman.

Both men have so far survived attempts to remove them, but their experience sent a signal to other executives pondering audacious or transformative acquisitions.

Looking forward to next year, many UK-focused investors are still hoping for larger companies to increase their dividends after the financial crisis deprived them of payouts from the financial sector.

BP’s Gulf of Mexico oil-spill disaster saw it, too, suspend its dividend. The company, which is responsible for about £1 of every £7 paid in dividends to UK pension funds by FTSE 100 companies, has since signalled that it will pay out less to investors when it resumes dividends next year.

Jim Stride, head of UK equities at Axa Investment Managers, has argued that after equity investors were extensively tapped by companies in the cause of paying down debt last year, more should be done to pay dividends, even if this involves companies issuing more shares rather than paying out cash. “The correlation is not perfect but the greatest share-price falls have occurred in the companies with the greatest cuts in dividend,” he said.

The desire for a resumption of payouts is likely to see executives pay more attention to the need to balance investor expectations with any plans to pursue large takeover deals.

If they do not, next year could well bring more shareholder protests and discarded pitches.

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