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In this week's bottom line - 9 November 2021
Failed Mergers and Acquisitions (M&A) can bring once financially strong companies to their knees. Tony Fell, an experienced banker, created a list of 15 causes of M&A failures.
Contributed by Werner Erasmus / Ingrid Breed
The recovery in new vehicle sales and exports in the last few months was halted, notwithstanding that there was some relief brought to the sector with an easing in lockdown restrictions. The unexpected slowdown in recovery was due to load shedding and a three-week-long steel and engineering sector strike during October. New vehicle sales slowed to 41 035 units (6.1% year-on-year increase) in October, down from 43 146 units (15.9% year-on-year increase) in September. The slowdown was centred in passenger cars which increased by only 3.1% year-on-year and declined 6.9% month-on-month (down from 30.4% year-on-year in September). Domestic sales of new light commercial vehicles, bakkies and mini-buses recorded an increase of 15.9% year-on-year and heavy trucks an increase of 5.2%, while medium commercial vehicles declined 14.4% and total vehicle exports declined 30%. Despite the halt in growth, the domestic automotive industry is anticipated to continue to benefit from the strong rebound in global economic activity and favourable global conditions.
South Africa’s manufacturing PMI dropped back last month, pointing to a further slowdown in the sector’s already weak recovery. The seasonally adjusted Absa Purchasing Managers’ Index (PMI) lost further ground in October, declining to 53.6 from a downwardly revised 54.7 in September. The revision to historic data suggests that the rebound from the hit to activity in July from tighter virus restrictions and violent unrest was weaker than previously thought and faded more rapidly than expected. The business activity and new sales orders sub-indices lost the most ground. The three-week Numsa strike and the return of load-shedding for notable periods during the month help to explain the almost four-point drop in the business activity index. Supplier delivery lead times and purchasing prices remained elevated in October, highlighting the continued impact of global bottleneck pressures. Looking ahead, the manufacturing sector’s recovery will probably struggle to gain momentum. While strike action has now ended, persistent headwinds – including power cuts and the government’s fiscal consolidation plan – remain, and supply chain problems are unlikely to abate in the near-term.
The IHS Markit PMI fell to 48.6 in October, from 50.7 in the previous month. This marks its lowest level since July when the country was at the height of the third COVID wave while also experiencing violent looting in KZN and Gauteng. The headline South Africa PMI is a composite single-figure indicator of private sector business performance. Any figure greater than 50.0 indicates an overall improvement in the sector. The latest PMI figure pointed to a strong fall in activity across the private sector, largely caused by the metalworkers’ strike that disrupted output and sales. Shortages of raw materials were also highlighted by surveyed businesses, contributing again to weaker activity, longer lead times and an acceleration of input price inflation. Consequently, the private sector saw decreases in both employment and purchasing of new inputs. Exports also registered their biggest decline in over a year. On the price front, input price inflation accelerated for the second month in a row, driven by rises in the cost of raw materials, fuel and transport, as well as a weaker exchange rate. Lastly, expectations for future output fell for the first time in three months but remained strong overall. In summary, business conditions have now worsened in three of the last four months and improved only slightly in September. Economists expect this to negatively impact the third quarter economic data, although it is hoped that a swift recovery in November and December – given the strike has now ended – should help South Africa avoid a recession.
SOUTH AFRICA: THE WEEK AHEAD
Contributed by Ingrid Breed
Mining Production, due Thursday 11 November. Mining production is expected to have increased marginally in September with the consensus forecast an increase of 2.7% year-on-year from 2% in August. The sector’s gradual improvement is supported by the recovery in global industrial activity and high commodity prices. Despite this, there remains a downside risk posed by the Delta variant, associated lockdowns, global supply disruptions, planned load-shedding and a slowdown in economic growth in China.
Manufacturing Production, due Thursday 11 November. Manufacturing production is expected to have pulled back in September with the consensus forecast a decline of 1.3% year-on-year, after August’s better-than-expected 1.8% increase. Persistent global supply chain disruptions and materials shortages alongside unreliable electricity supply are expected to be the main factors that hindered production during September.
Medium-Term Budget Policy Statement, due Thursday 11 November. On Thursday the new finance minister, Enoch Godongwana, will deliver his first medium-term budget policy statement (MTBPS) which will provide an update of the projected fiscal policy direction over the next three fiscal years. The addressing of fiscal consolidation commitments, given the commodities surge that has boosted tax revenue, and a strong political push to fence in further welfare spending, remain the main points investors will look out for.
Contributed by Nick Downing
Commodity prices are booming. The S&P GSCI composite commodity index has almost doubled over the past 12 months, powered by increases across oil, metals and agricultural commodities. The price gains are attributed to the reopening of economies and pent-up demand, fuelled further by massive fiscal stimulus. Investors are also drawn to commodities due to their natural hedge against rising inflation risks and to their hedge against the potential for US dollar weakness. Copper has captured the attention of the investment community over the past week after breaking above its previous all-time high recorded in 2011 during the commodity “super-cycle”, which was led by China’s rapid industrialisation. While copper and other metal prices are showing the characteristics of another super-cycle, most economists are sceptical as China is transforming from an investment-led to a consumer-led economy. However, other economies are taking up the baton helped by extravagant infrastructure spending plans and the race towards a net zero carbon footprint within the next 30 years. The mass adoption of renewable energy and electric vehicles will lead to a step change in demand for copper and other key “green” metals. Meanwhile, the hangover from the last super-cycle means mining companies have been reluctant to develop new capacity. Due to the extended period taken to develop new mines, the existing supply constraints may last several years and potentially squeeze commodity prices even higher. Ivan Glasenburg, CEO of Glencore said the copper price needs to rise another 50% from current levels to unleash the new capacity required to meet burgeoning demand forecasts.
Contributed by Nick Downing
As widely expected, the Federal Reserve announced the unwinding or “taper” of its $120 billion per month asset purchase programme. The taper will start in $15 billion monthly instalments in November and December, which suggests the programme will expire by June next year. However, Fed chairman Jay Powell said the pace of the taper could be adjusted if conditions changed. Financial markets had been well prepared for the taper announcement and so took it in their stride, powering the S&P 500 index to a new record high on the day of the Fed meeting. Powell admitted that inflation had remained elevated for longer than expected and would probably only dip in the middle of next year. Now that the taper process is underway, the market’s attention has turned towards the start of interest rate tightening. However, Powell eased market concerns, saying “We don’t think it’s time yet to raise interest rates. There is still ground to cover to reach maximum employment, both in terms of employment and in terms of participation.” He hinted that maximum employment could be achieved by the second half of 2022, which would signal the first interest rate hike at that time, but he also cautioned that significant economic uncertainty remains. Powell added that while asset purchases would be reduced the Fed’s accumulated ($8 trillion) balance sheet will remain highly accommodative and that regarding interest rate increases, “we think we can be patient”. The continuation of easy monetary policy settings should continue to support global financial markets.
Employment growth regained momentum in October, coinciding with a retreat in the Covid Delta wave. A net 531,000 new jobs were created, up from a revised 312,000 in September. The combined August and September figure was revised upwards by 235,000. Unemployment fell from 4.8% to 4.6%. However, labour participation, which measures the percentage that are either employed or looking for work, remained unchanged at a depressed 61.6%, well below the pre-pandemic figure of 63% in February 2020. Economists are surprised that strong labour demand and rising wages have not yet boosted the number of job seekers. The big debate among economists is whether the shortage in labour supply is temporary or permanent. If it proves to be permanent, wages may need to rise at an even faster pace, leading to an increase in inflation expectations. As it is, average hourly wages increased in October by a significant 0.4% month-on-month and 4.9% year-on-year. However, Covid fears are still keeping job seekers away, which indicates the labour supply shortage will be temporary. According to a US Census survey conducted in late September and October, millions indicated they were not working due either directly or indirectly to Covid, despite the recent easing in infections and hospitalisations. Labour supply is likely to increase as Covid retreats and as the excess savings pool created by pandemic relief programmes dries up.
Following several months of negotiation, Congress finally approved President Biden’s $1.2 trillion infrastructure bill. Spending will be directed at roads, bridges, railways, ports, broadband and charging networks for electric vehicles. The actual amount of new spending over what has already been budgeted, will be a lesser amount of $550 billion, spread over 10 years. The amount is relatively small, amounting to around half of US GDP over the period. However, Congress will also attempt to pass Biden’s $1.75 trillion “Build back Better” social welfare bill by the end of the year, which should provide an additional boost to economic activity. Republicans have argued that the buoyant economy does not require extra fiscal stimulus and that it could exacerbate inflationary pressures. Democrats argue that the spending will contribute to lower inflation. According to their argument, infrastructure improvements should enhance productivity and welfare spending should allow more women to enter the workforce. Increased productivity and increased labour supply would ease inflation.
Contributed by Nick Downing
Manufacturing activity continued to contract in October according to the official National Bureau of Statistics (NBS) manufacturing purchasing managers’ index (PMI). The PMI slipped further below the neutral 50-level, from 49.6 to 49.2, its lowest since February 2020. The slowdown is attributed to surging raw material prices, an energy crisis and sharp slowdown in the property sector. However, the private sector Caixin manufacturing PMI, which had been sub-50 in August, maintained its recovery in October rising from 50.0 to 50.6. The divergence may be due to the timing of the survey, which occurs later than the NBS PMI and so avoided the worst of the energy crisis. Massive government intervention helped to ease power shortages from mid-October. Nonetheless, the Caixin production sub-index remained at sub-50 levels for a third straight month, indicating the continued impact of supply bottlenecks. The outlook for November data is clouded by the recent surge in Covid infections which have spread across most of China’s 31 provinces. China’s strict Covid-zero approach remains in place despite the vaccination of around 80% of the population, which will undoubtedly affect both domestic demand and production capacity. Production capacity constraints will also be felt in export markets, placing added pressure on supply chain bottlenecks just as companies are lifting production ahead of the Christmas festive season.
Contributed by Carel la Cock
Japan’s recovery from the pandemic has been uneven between the services and manufacturing sectors, as evident from recent earnings releases showing the latter outperforming despite recent supply chain issues. Thus far the recovery has been driven by the auto manufacturers with global demand for Japanese vehicles soaring. Japanese cars and car-parts account for nearly 20% of Japan’s exports and exports have benefited from a weaker Yen. The Yen traded as low as ¥102 against the US dollar at the start of the year and has depreciated by 12% to ¥114 by last month. Automakers have updated profit outlooks to record levels despite the global shortage in semiconductors that has clouded the global auto industry. However, many automakers said that the tailwind from the weaker Yen has partly offset the negative impact from material and semiconductor shortages. The services sector has rebounded since the state of emergency was lifted at the start of the quarter and will be boosted by demand shifting from goods to services. Airlines, travel agencies and train operators have all upgraded their outlooks for the year ahead and most companies are looking at ways to streamline operations without large scale layoffs. The tourism industry is also expected to get a boost from the resumption of government subsidies as well as the successful vaccination program that makes Japan the third most vaccinated population, behind Canada and Norway. Japan’s services sector is rebounding at an opportune time and is expected to offset the slack left by the manufacturing sector. Pent-up demand, as evident by the high savings ratios recorded in the past year, could spur a consumer led recovery that will put Japan’s economy back on track.
Contributed by Carel la Cock
The European Central Bank (ECB) has kept its benchmark interest rate unchanged at minus 0.5% and said that the pandemic emergency purchase programme (PEPP) would remain in place. ECB president, Christine Lagarde, tried to rebuff the market’s expectation of a rate increase to supress rising inflation. The two-day meeting by policy makers was dominated by discussions of inflation and while the ECB believes that inflation will track higher still, it expects prices to moderate during the course of next year. Lagarde said that inflation would “take longer to decline than originally expected” largely due to the current supply chain bottlenecks lasting well into next year. The ECB expects inflation to fall within the 2% target by 2023. Despite the strong messaging, markets moved shortly afterwards to price in a 0.1% rate hike by September next year. Analysts say that market participants believe central bankers are behind the curve and would be forced to hike rates sooner than their current trajectory. The ECB’s PEPP programme is expected to end in March although an earlier asset purchasing programme at a pace of €20bn per month will still be in place and could potentially be increased to offset the end of PEPP, currently at €80bn a month. The ECB is taking a different approach to other central banks which have acted more decisively to stem rising inflation. Only time will tell if its more moderate approach is warranted but getting it wrong could mean that future rate hikes will be much steeper and at a much faster pace, which will negatively impact the economic recovery.
Contributed by Carel la Cock
The Bank of England (BoE) has caught the markets off-guard, leaving its benchmark rate unchanged at 0.1% while increasing its inflation forecast to 5% by the spring of next year. Following comments made by BoE governor, Andrew Bailey, last month in which he stated the monetary policy committee (MPC) “will have to act” to stem inflation, the markets had expected a 25-basis point increase and for rates to rise by 1% by the end of 2022. The MPC warned that rate rises would be necessary in the coming months but would not be drawn on the timing of phasing in higher rates and said that “there was value in waiting for more information”. Mr Bailey did concede that there was disagreement amongst MPC members with two of the nine-member committee voting to increase rates immediately and another three voting to stop the quantitative easing programme. The majority view was that subdued growth and expected lower real household income will cause inflation to retreat in the second half of next year. According to BoE projections, a 1% rate hike before the end of 2022, as expected by the market, would cause inflation to fall below the 2% target and would impact the economic recovery. The BoE also expects supply chain troubles to persist well into next year while energy prices will also track higher, both causing inflation to peak at 5% in the spring before easing to at least 3% a year later. The BoE’s forecast indicates that it is comfortable to run the economy hotter for longer with inflation above the 2% target for an extended period, in contrast to the market’s expectation of swifter action over the short term. The mismatch is likely to cause some volatility over the short term.
FAR EAST AND EMERGING MARKETS
Contributed by Carel La Cock
Asian countries are seeing a broad-based economic expansion according to the latest IHS Markit Asia Sector PMI figures. Of the 18 sectors being tracked, no less than 16 increased output in April and 13 indicated higher employment levels. Automobiles and Auto parts saw the quickest growth and maintained the momentum gathered in the last three quarters. Other manufacturing sectors such as chemicals, technology equipment, machinery and equipment and household and personal use chemicals all showed promising growth, outpacing the gains made in March. The April reading of the IHS Markit ASEAN Manufacturing PMI figures also showed a steep rise in output and new orders. Vietnam reported the best growth of the ASEAN nations with their PMI hitting a two and a half year high followed by Indonesia which hit a record high. Business confidence across the region was the strongest in over a year. Service sectors also improved especially in healthcare, transportation, and industrial services, but their recovery is still lagging manufacturing. As the global economy continues to gather pace, the region is well placed to benefit from higher global demand and trade.
Y to D %
JSE All Share
JSE Fini 15
JSE Indi 25
JSE Resi 20
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THE BOTTOM LINE
Contributed by Gielie Fourie
Tony Fell (Order of Canada) created a list of the 15 major causes of Merger and Acquisition (M&A) failures that he has seen during a lifetime as a banker. At the Ben Graham Centre’s 2017 Value Investing Conference, Fell, a retired chairman and former CEO of the Royal Bank of Canada (RBC), presented his list during his lecture. He was with RBC and its predecessor for 48 years. We often hear and see that M&A deals are not as successful as they should. We hear that it is the culture or that it is this, or it is that, that are the main causes of failure. Below is Tony Fell’s brief and useful list of the 15 major causes of failed M&As.
Cause No. 1. “Start off by reminding yourself that fully two-thirds of acquisitions do not work out and actually destroy shareholder value. The odds are two-thirds stacked against you from the get-go.” Cause No. 2. “Always remember – the best deal you do in your career is often the one you don’t do.” Cause No. 3. “Always remember the buyer needs a thousand eyes – the seller only needs one.”
Cause No. 4. “Beware of so-called major transformational mergers or acquisitions – they usually blow up and many have been catastrophic.” Cause No. 5. “In any takeover it is usually best to be the seller and get a good premium.” Cause No. 6. “Synergies are often significantly over-estimated and take longer to achieve than forecasted.”
Cause No. 7. “Beware of the auction process – and don’t bid against yourself.” Cause No. 8. “Hold your ego in check, don’t get caught up in the euphoria of an acquisition and pay too much. When you pay too much, your returns may be terrible, and you may be faced with substantial write-offs.” Cause No. 9. “Beware of poor, or incomplete, acquisition due diligence. Nothing is worse than major operational or financial surprises after you buy a company.”
Cause No. 10. “Calculate earnings accretion or dilution based on a constant leverage ratio. Accretion due to increased leverage is not accretion.” Cause No. 11. “Beware of potential clashes in corporate culture of two merging companies.” Cause No. 12. “Remember that the vision of the acquisition is great, but execution is where it’s at. It’s one thing to acquire a company, it’s quite another to integrate it into your own business and run it. Vision without execution is hallucination.”
Cause No. 13. “No acquisition is make or break. There is always another train.” Cause No. 14. “On any acquisition don’t increase leverage beyond a very prudent level. Finance with equity.” Cause No. 15. “Beware of international acquisitions. Foreign markets are often more competitive than Canadian markets, with lower margins. Don’t expand beyond your ability to manage tightly.” (Fell is a Canadian).
A few South African companies have been M&A victims. Two examples, both former darlings of the JSE, come to mind. The first is Woolworths’s disastrous takeover of David Jones, an Australian upmarket department store, for A$2.1 billion (bn) (approximately R21.4 bn) in 2014. Woolworths of South Africa has no association to Australia’s Woolworths supermarket chain. The share price dropped from R103.00 in November 2015 to R27.00 in March 2020 – a drop of 74%. It is currently trading at R55.00. It still has a long way to go to make up for lost ground. The second example is the catastrophic takeover by Famous Brands of UK-based Gourmet Burger Kitchen (GBK) for £120 million (mil) (approximately R2.1bn) in 2016. The share price dropped from R166.00 in October 2016 to R23.00 in March 2020 – a drop of 86%. It has recovered to R73.00. It also still has a long way to go. Both companies had the best intensions, but enormous value was destroyed. Both cases can euphemistically be referred to as “creative destruction”. We hope Woolworths and Famous Brands recover. Failure often serves as a stepping-stone to greatness.
Tony Fell concludes: “Notwithstanding the above perhaps 10% to 20% of acquisitions are outstanding successes. You also need a lot of good luck”. Fell’s advice is no magic formula, but it comes pretty close. Successful Yin Yang integrations are rare. When it succeeds a lot of value can be created. Causes numbers 2 and 15 contributed greatly to the problems of Woolworths and Famous Brands. Take this advice and put it in the top drawer of your desk.
*All writers’ opinions are their own and do not constitute investment recommendations or financial advice. Speaking to a qualified wealth and investment professional is crucial before making financial decisions.
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