Upturn is ahead for acquisitions, predicts L&G

INVESTMENT giant Legal & General predicts an upturn in mergers and acquisitions (M&A) this year as well-funded companies look to grow.

L&G said companies with high free cash flows offer the best investment outlook for their ability to respond to growth opportunities and make dividend payments.

A number of large Yorkshire companies have revealed they are considering M&A activity in recent weeks. Coal miner Hargreaves Services, which owns Yorkshire's Maltby colliery, yesterday confirmed it is considering teaming up with Doncaster's UK Coal to exploit its deep mines' potential.

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York-based estate agency and surveying group LSL Property Services recently said it is weighing up more acquisitions after its "transformational" 1 purchase of more than 200 estate agencies from Lloyds Banking Group.

And rumours were yesterday circulating linking York-based housebuilder Persimmon with a potential bid for rival Barratt Developments, following recent talk of a move for Bovis Homes.

"We think M&A will start to pick up slowly during the year across industries," said L&G Investment Management's equity strategist, Georgina Taylor. "For companies with strong balance sheets looking to acquire growth in the current environment, this provides a good opportunity."

LSL made steady progress on cutting debt last year, which analysts believe could leave it debt free by the end of 2010.

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That would leave it with bank facilities of 75m for expansion. At its recent interim results, Hargreaves Services hailed strong cash conversion and "comfortable" gearing.

Persimmon has cut debt from 600m at the end of 2008 to 268m at the end of 2009, relying on strong cash generation rather than shareholders' funds.

"There is a fairly good relationship between M&A and equity market performance with a lag of around six months," said Ms Taylor. "Therefore the strong performance in equities during 2009 suggests we should see a rise in M&A this year. From a UK perspective, the fall in sterling has increased the attractiveness of UK assets for overseas buyers."

In its regular Fundamentals briefing, L&G, which owns around 4.5 per cent of the FTSE all share index, also predicted a tricky year ahead for UK equities.

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Ms Taylor said the strong rally seeing by leading share indices in 2009 is unlikely to continue this year. "Last year equity investors were rewarded for choosing to invest in equities, almost regardless of what part of the market they placed their money," she said. "That's over for now. Things are going to be a lot tougher this year."

Ms Taylor said equity gains are likely to be far more modest this year because of the fragility to the UK recovery, the need for Government to cut debt, and the high cost of capital.

L&G predicts the FTSE 100 index is unlikely to progress further and will end the year at 5,600, close to its current level.

But Ms Taylor said opportunities remain despite the flat outlook for stock indices.

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Roughly 70 per cent of UK's biggest listed companies' sales come from outside the UK, giving significant exposure to global growth patterns and currency fluctuations.

"We maintain our view that emerging markets will deliver superior growth versus developed economies," said Ms Taylor. She said the fall in sterling will also increase UK companies' competitiveness, creating a "welcome and important buffer".

Ms Taylor added this year may mark an increase in capital spending for larger UK companies, although mainly financed through cash flow rather than capital markets." However, rather than investing in developed economies where growth will be slow, she said spending will be in emerging markets.

ELECTION 'WILL AFFECT MARKETS'

Legal & General believes this year's General Election will be a drag on equity markets as political parties wait until after the poll to fully outline their plans to cutting the UK's huge deficit.

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Ratings agencies have warned the UK faces downgrades to its credit ratings unless it comes up with a credible plan to cut the deficit.

"In the medium term that money needs to be paid back," said L&G economist James Carrick. "We don't think equity can break out because of this fiscal risk."

He said Government can either slow growth by curbing spending over the next few years, which would hold back growth and markets. Or it could ignore warnings and continue spending, which would result in downgrades, pushing up interest rates and further straining the banking sector.

He added a hung parliament would increase the risk of downgrades.

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But L&G equity strategist Georgina Taylor said other markets will reflect domestic uncertainty more clearly. "We will see more volatility through the bond market and sterling than through equities," she said.