Will this year herald the return of merger fever?
The drivers behind mergers have evolved, but corporate finance will remain central, writes Jonathan Clarke, managing director – Centrus
At the start of this year, colleagues and I were musing whether we had seen the end of the ‘mega-merger’ or whether the coming year would feature more corporate activity, to use the slightly self-satisfied term sometimes applied.
Centrus worked with Accord and GreenSquare on their recent transaction to create a 25,000-home association, and more widely there does seem to be more market discussion on the concept. Our consensus – sensible financial advisors being cautious folk – was that it was hard to tell, partly because the housing sector is influenced by so many factors. In a merger context these include strategic fit, views on the market and operating environment, government policy and personalities.
Five or six years ago, there was a strong sense that efficiency meant scale and that was a factor behind some of the bigger deals such as the formation of Clarion from Affinity Sutton and Circle.
Some ‘mid-sized’ mergers have, in my view, an even clearer narrative on that front, along with creating the capacity to step out of the comfort zone of Section 106 developments and into more land-led development.
One thing which has changed since 2015/16 is that for mergers of that vintage the corporate finance strategy was heavily focused on the banks.
There was a substantial amount of latent value in cheap pre-2008 debt, hedge mark-to-markets were sizeable thus inflexible, sometimes borrowers had very permissive on-lending limits and suchlike – plenty to negotiate over.
Since then, the bank portfolios of many associations have been overhauled for one reason or another, while the scope of capital markets issuance has grown massively.
There is literally a wealth of smaller private deals in public securities and placements. An increasing proportion of smaller deals involve some degree of bank-style corporate restrictions which, with the best will in the world, are not always helpful or appropriate for long-term instruments with spens prepayment penalties.
Investor relations and the future approach to capital markets is therefore central to any but the smallest merger discussion. This starts with taking investors’ sensitivities about not knowing things too early, or too late, seriously – but the central thread is clarity of investment narrative.
The magic dust of merger ambition needs to be used sparingly – everyone likes ‘financial resilience’ and ‘efficiency’. Most investors will have a view that implementing corporate change can take longer than expected and deliver less, and they are right; talking about significant upscaling in development output or risk profile makes people nervous from a credit perspective.
We have had a look back at the pricing of various merger parties’ bonds around the time of public announcements and transaction completion. Drawing clear conclusions is difficult because every merger is different and takes place in a different context.
For example, at the present time spreads remain very tight, even as gilt rates have risen back to pre-COVID-19 levels – it is a borrowers’ market.
But from looking at secondary price movements, there is evidence of space for engagement during the six-plus months mergers take, rather than evidence of big knee-jerk swings.
That is consistent with what we’ve seen with holders of private placements where consents have on occasion been necessary for significant changes.
This is positive, but doesn’t change the underlying reality that, from a marketing perspective, the uncertainty of a partnership or merger discussion represents a complicating factor in constructing the investor message.
So what will drive future deals (see below)?
What will drive future deals?
Vision and strategy
Personalities will always play a role, and what makes organisations effective has a lot to do with vision and strategy.
We are hopefully just coming out from the shadow of COVID-19, but there may well be bumps in that road.
Where is the market going?
Government policy sometimes drives the market but always responds to it, eventually.
Vision and strategy is not provided by one person alone, but it is often heavily influenced by one person or a small group.
The longer-term perspective is important but personalities can have a constructive role in any organisation and even more so in major transactions.
In terms of government policy, much government resource is focused on managing COVID-19, along with post-Brexit changes. We will need to wait and see what happens to the planning system, for example, but the direction of travel is potentially fewer affordable homes delivered by planning gain. This seems potentially a poor policy, all things considered, but appears to be the direction of travel.
On regulation more generally, the government is correctly beefing up tenant accountability. Larger associations will likely, in my view, continue to find themselves pulled and pushed towards playing a proactive role in creating development and regeneration in their area.
We may not be back in the world of the 1990s with ‘regeneration’ spoken about as an unmitigated ‘good thing’, but more pride in the sector’s ability to deliver impact and change would be well-placed. Mergers will sometimes drive this in parts of the country where there are big opportunities.
And as for the market? Britain will continue to need more homes, economic equality will remain a distant prospect, and the need for sub-market rented homes and support to access the housing market will remain.
If interest rates stay at relatively low levels for years to come, by hook or by crook of monetary policy levers, commercial investors will continue to see opportunity to provide equity and debt to the market and to work with, and maybe sometimes compete against, the established charitable sector.
Investment competition will prompt some associations to continue to become ‘more like’ commercial investors – and most commercial investors have an ambition for growth because with size comes financial flexibility.
So in my own view, the drivers for mergers will remain and more strategic confidence may promote the activity.
Whether boards and leadership teams see it as adding value in any particular organisation, or a distraction from delivering against pressing and already-identified real objectives, will depend as always on a host of factors.