* Consolidation is a key pillar of Europe’s restructuring
The European corporate landscape is both highly fragmented (>65% of
people work in SMEs vs. <50% in the US) and heavily dependent on bank
financing (c.70% of all external financing is bank-based vs <25% in the US).
In this context, consolidation represents a rich source of opportunity for
listed companies. We find that in-market acquirers outperform by c.750 bp
in the year post a deal announcement, on average. Acquirers of private
firms outperform the market by c.700 bp in the year post announcement.
* Significant scope to close the financing gap in Europe
An increasing amount of European deal activity comprises public
companies buying private (often bank finance-dependent) targets. The cost
of small bank loans (<€1 mn) is currently c.250 bp more expensive than
listed IG debt, meaning that the refinancing of acquired operations can be a
low-risk source of synergies for buyers. We see ‘financing arbitrage’
creating upside for companies which can roll-up private assets in their
sector, e.g. Brenntag, Randstad, Europcar and Smurfit. We also see
expensively financed M&A candidates offering attractive financial arbitrage
for the buyers (e.g., Tullow Oil, Ocado, Faurecia and Remy).
* Market repair benefits can be the cherry on the cake
We believe that the ‘market repair’ benefits which can result from
consolidation (e.g. potential pricing power, supply discipline) accrue only
in industries that are already moderately concentrated, and where financial
pressure and falling investment can overcome anti-trust concerns. On this
basis, we see market repair benefits as likely to be permitted in telecoms,
utilities, materials, medtech and autos. To invest in the theme we highlight
stocks including Orange, FCA, Buzzi and Smith & Nephew.
* The benefits of recent deals are yet to be realized
There are areas where consolidation has already taken place but potential
market repair benefits are not yet fully priced. Our analysts see stocks such
as Telefonica, Schibsted, Just Eat, GSK, Imperial Tobacco & Nokia as
either active or ‘passive’ beneficiaries of recent in-market deals. We identify
nine companies as beneficiaries of recent market repair. On average GS
2016 EPS estimates are 9% above I/B/E/S consensus for these stocks.