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Why the Brexit Could Spark a New Wave of M&A

When the United Kingdom voted to leave the European Union last month, the news triggered a wave of volatility across the globe.

The reason for the volatility was simple: uncertainty.

Markets hate it – and the Brexit delivered it in spades.

On a corporate level, many companies delivered another shock to their shareholders by admitting that they had no “Plan B” and don’t know what will happen.

Needless to say, that’s like kryptonite for investors.

And one thing is unanimous: Britain’s economy is in for a rough ride.

Other more proactive British firms, however, have analyzed what the new reality means for them – and positioned themselves to combat it accordingly.

Melrose Industries Plc (MRO.L) is one of them.

Melrose Goes Big to Break out of Britain

In an effort to seek exposure outside the U.K., the power generation equipment manufacturer agreed last week to acquire Rhode Island-based Nortek Inc. (NTK) for $86 per share – a chunky 40% premium to the company’s value prior to the acquisition announcement.

This normally unremarkable acquisition could be the beginning of a big and profitable trend for U.S. investors, as British companies see a sudden and urgent need to diversify out of their home market.

And that’s just what Melrose has done, given that Nortek mostly makes home products such as air conditioners, ventilation fans, home security products, and has a growing home automation division. Almost all of its sales come from the United States and Canada.

My one concern is that while Nortek is a solid company that will benefit from new homes and home improvement, $86 per share is a steep price for Melrose to pay – over 10 times the company’s cash flow.

Investors don’t seem to care, though. Melrose shares shot up by nearly as much as Nortek’s on news of the acquisition – an indication of just how desperate British shareholders are for their companies to reduce exposure to the U.K. market.

And if the deal goes through, it could just be the tip of the iceberg…

Where to Find the Next Wave of Acquisitions

We can expect other British companies with large domestic exposure to make international acquisitions.

And American companies will be the prime beneficiaries of the coming trend, as the country offers the highest number of companies willing to be acquired in an economy that’s growing, even if that growth is tepid.

The prime candidates?

Smaller to mid-sized companies, with a largely domestic, retail customer base in industries ripe for consolidation and with relatively small exposure to volatile commodities.

Manufacturers like Nortek are squarely in that wheelhouse, but so are many food companies, retailers, insurance companies, entertainment and media companies, and healthcare providers.

Granted, that’s a sizeable list. And it’s tricky to pinpoint surefire acquisition candidates at the best of times.

But the possibility of a “bracquisition” is certainly something to consider for U.S. investors.

For example, perhaps you previously favored U.S. companies seeking more exposure to international markets, whereas a more domestic-focused firm might now be a better choice.

Or perhaps some sectors you thought were fairly priced may actually be undervalued, due to the possibility of increased M&A activity.

A New “British Invasion”?

That being said, it would be remiss to not factor in the potential barriers to British-led M&A activity, too…

  • Acquisitions are more expensive for British companies. With the pound getting hammered in the wake of the Brexit vote, paying cash for acquisitions, as Melrose is, has suddenly become more expensive for British firms. Those companies will have to come to the same conclusion Melrose did – that it’s worth paying extra to diversify outside of the U.K
  • Share-for-share purchases are out. Very few companies will be open to being acquired for shares trading on one of the most volatile exchanges in the world right now.
  • Because of the high pound-denominated cost of acquisitions, British bidders are vulnerable to counterbids. This could yet happen in the Melrose/Nortek deal, where United Technologies Corp. (UTX) was rumored to be interested in the company, too. A bidding war would be good news for Nortek shareholders, of course, but in the longer run, it could discourage future British bids for other companies.

Those concerns aside, though, I’m convinced that Melrose’s acquisition of Nortek is the first wave of a new “British invasion” – one that will be good news for select American shareholders.

To living and investing in the future,

Greg Miller

Greg Miller

, Senior Analyst

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