American companies' appetite for U.K. mid-cap companies is increasing after two years of purchases, and the trend is likely to continue, according to a London-based fund manager.
Behind this trend are the strong U.S. dollar and the tax advantages for U.S. companies that make purchases abroad, said Neil Hermon, director of U.K. equities at the Henderson Smaller Companies Investment Trust, in a presentation in London.
"That activity is accelerating, rather than decelerating. I think those deals will continue to happen," he said.
The dollar has gained more than 4.6% to the British pound over the past year. Many U.S. companies have used acquisitions abroad to shift their tax domiciles in order to cut their tax bill, a move frowned upon by the U.S. government but still preferred by some firms.
American companies are not interested in narrowly focused, strictly domestic U.K. assets. Instead, they prefer to use the London-listed companies as gateways to the rest of the world.
"They buy global companies with niche positions, most likely in the industrial and technology sector," Hermon said. "They're buying unique U.K. assets that have a global outlook."
Among the U.K. companies his trust owns that have been bought by American firms, he cited Cambridge Silicon Radio (CSRE), which was bought by fellow chip-maker Qualcomm (QCOM) for around $2.4 billion in a transaction that closed last month.
New York Stock Exchange-listed Delphi Automotive (DLPH) announced in July it would buy London-listed cable maker HellermanTyton, in a transaction worth around $1.7 billion, to consolidate its position in the connected-car market.
Keysight Technologies (KEYS) completed the acquisition of U.K.-based software-maker Anite last month, in a $600 million deal that the U.S. company said would support its "strategy to grow in wireless and expand its software offerings."
It's not just listed U.S. companies that are buying U.K. ones. London-listed Quintain Estates, which was behind the development of the Wembley Arena, was bought in July by U.S. private equity fund Lone Star for more than $1 billion, in a bet that the red-hot property sector in the British capital will continue its upward direction.
Another private equity firm, Providence Equity Partners, partnered with WPP in July to buy Chime Communications, a U.K. company founded by Lord Bell, the former public relations guru of ex-Prime Minister Margaret Thatcher.
U.S. companies see Europe is finally recovering and they are trying to take advantage of the difference between the economic cycles in the two regions by buying while valuations are still attractive and as the ECB's money-printing boosts earnings in Europe. However, they prefer to use the U.K. as a proxy because it is more difficult to buy companies in the eurozone.
Language and culture may be some of the hurdles that U.S. companies face when trying to acquire stakes in companies in continental Europe, Hermon said.
The buying spree is still in its early stages. It only started two years ago, and a cycle of mergers and acquisitions usually lasts five years, he added.
However, the trend could be stopped short by a macroeconomic shock such as "China going in a tailspin" or "interest rates raising much faster than forecast," in his opinion.
But such a shock is not his main scenario. "We're overweight sectors like technology and media -- so we have a growth bias," he said.
From a macroeconomic point of view, Hermon is worried about the developments in China, but he noted that Europe was still in a recovery, helped by quantitative easing. In the U.S. and U.K., interest rates "will be going up sometime in the next 12 months."
The key to his investing is not to worry too much about the macroeconomic outlook but to try to find mid-cap and small-cap companies with solid balance sheets and growth prospects. He has been using the latest volatility in stock markets to add to his fund's U.K. mid- and small-cap holdings.