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UK businesses investing for growth — will your investment strategy keep you ahead of the pack? UK Plc is investing in their existing businesses … The last few months may have been characterised by gloomy news on the global economy but the UK corporate sector is in rude health if capital deployment is any guide. Over the past few years, there has been a widespread perception that the UK economy has been performing relatively poorly in terms of business investment. The EY ITEM Club Special Report on Business Investment clearly shows that this is not the case: UK business investment has been outpacing other economic indicators since 2010 to reach its highest level as a share of GDP since 20001. UK: Business investment UK: Consumer and corporate spending on tech Q1 2008=100, real terms 12.0 11.5 11.0 10.5 50 350 % of real GDP (LHS) 45 300 £bn, real terms (RHS) 40 10.0 35 9.5 30 9.0 25 8.5 20 8.0 15 7.5 10 7.0 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 Source: EY ITEM Club/Haver Analytics & OBR 1 Household spending on information processing equipment Investment by information and communications sector 250 200 150 100 50 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: EY ITEM Club/Haver Analytics EY ITEM Club Special Report on Business Investment, September 2015 EY | 1 … and buying new ones … M&A activity is on the rise, with both volumes and values increasing. Most striking is the increase in domestic activity. In the year to September 2015, deals between UK companies are up almost 20% year on year in value terms, even after excluding 2 potentially distorting megadeals. Inbound deals to the UK are up 13% by volume and more than double by value. By contrast outbound deals from the UK are down by around 12% in volume terms. With the global economy slowing while the UK recovery continues, it is unsurprising that UK assets look relatively attractive. The growth in deal volumes shows us that this is not a narrowly based phenomenon concentrated on a few large deals but an increase in activity across the economy. This is consistent with trends globally, deals are increasing in the recovering US economy as businesses chase sustainable growth. Regional M&A RTM value (US$mn) 2,000,000 1,800,000 1,600,000 1,400,000 1,200,000 1,000,000 8000,000 600,000 400,000 200,000 US Western Europe 2015* 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 0 Asia-Pac Source: Dealogic and EY Analysis UK M&A Data Value (US$mn) Volume 800,000 5,000 700,000 4,500 4,000 600,000 3,500 500,000 3,000 400,000 2,500 300,000 2,000 1,500 200,000 1,000 100,000 Source: Dealogic and EY Analysis *2015 is extrapolated from 1 Jan 2015 — 31 Aug 2015 EY | 2 Total UK volume 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 Total UK value (US$mn) 2015* 5,00 0 0 ... as are its competitors The UK’s level of capital investment still lags some way behind its international competitors — with only Italy among the G7 having investment account for a smaller share of GDP. The flexible labour market in the UK has meant labour has been cheaper relative to capital in recent years and hence capital investment as fallen as a share of inputs relative to labour costs. While this may be a sensible short-term strategy, in a dynamic world there is a risk UK business is still not investing at the rate necessary to remain competitive on a global basis. G7: Business investment UK: Real cost of capital goods and labour Q1 2008=100 % of real GDP 15 14 Japan Germany US UK France Canada Italy 115 Capital goods 110 Labour 13 105 12 100 11 95 10 90 9 85 8 1997 1999 2001 2003 2005 2007 2009 2011 2013 80 2001 2003 2005 2007 2009 2011 2013 2015 Source: EY ITEM Club/Haver Analytics Source: EY ITEM Club/Haver Analytics As a consequence of higher investment by businesses in other countries, the UK is the leading destination in Europe for Foreign Direct Investment (FDI). While FDI does offer potential economic benefits it can also signal competitive entry into the UK market. UK based businesses must be prepared to respond to increased competition for a share of the UK’s growing economy. EY | 3 Where is the money going? There are significant differences in the level of investment across sectors and geographies. In the case of capital investment, the Services sector has been leading the charge in recent years. Manufacturing is starting to increase spending but utilities, probably as a result of regulatory and policy uncertainty have cut expenditure dramatically in the last 12 months. The fall in commodity prices explains the decline in spend by the extractive industries. UK: Business investment % year 15 10 5 0 Services Electricity, gas & water –5 Mining & quarrying –10 Manufacturing –15 Other –20 2007 2008 2009 2010 2011 2012 2013 2014 2015 Total Source: EY ITEM Club/Haver Analytics M&A activity provides us with an even more granular view of UK sector activity. As shown below, over the last year investment has been driven by consumer and retail and knowledge centric industries such as life sciences, media, telecoms and technology. There is a dividing line in the UK between a set of fast moving and increasingly technology enabled sectors and those capital heavy industries that are either more reliant on public spending or are heavily regulated sectors. UK M&A 2014 Volume of deals 500 Technology 400 Consumer products & Retail 300 Diversified industrial products 200 Wealth & Asset Management Automotive & Transportation Life sciences Power & utilities Oil & Gas Insurance Mining & Banking & Capital Markets Metals Provider care Government & Public Sector Aerospace & Defense 100 0 Real estate Media & Entertainment 0 10,000 20,000 Telecommunications 30,000 40,000 50,000 60,000 70,000 Value of deals (US$mn) Source: Dealogic and EY Analysis EY | 4 Outside of the UK, there is a significant shift in geographic focus. As the analysis of M&A in the 12 months to end of September 2015 shows, deal activity in both value and volume terms is dominated by North America and Western Europe. Just as we see investment flowing into the UK as its relative economic performance strengthens, we can identify a pivot back to developed markets more generally. The recovery in the USA remains on track and Europe has started to grow more strongly while risks in the rest of the global economy have increased at the same time as growth has slowed. UK businesses should consider their full geographic portfolio in the light of changed macro-economic conditions. Global M&A by destination (LTM to September 2015 — based on target asset location) N Asia US$699bn (17.6%) 5,030 (13.7%) Europe US$841bn (21.2%) 11,461 (31.2%) Japan US$55bn (1.4%) 2,282 (6.2%) SE Asia US$41bn (1.0%) 1,441 (3.9%) North America US$2,039bn (51.4%) 11,755 (32.0%) India US$46bn (1.1%) 1,142 (3.1%) South America US$82bn (2.1%) 1,347 (3.7%) Oceania US$97bn (2.4%) 1,346 (3.7%) Africa & Middle East US$65bn (1.6%) 966 (2.6%) Source: Dealogic & EY Analysis — numbers in brackets represent share of global total The UK’s recent performance in attracting FDI paints a similar picture. Technology and service sector businesses dominate FDI but there is more manufacturing investment than is the case with M&A with both automotive and machinery & equipment putting in strong performances. The UK attracted more manufacturing FDI projects than Germany in 2014 further illustrating the strength and attractiveness of the UK market. The UK was the leading destination for FDI in Europe in 2014 confirming that corporates are deploying their capital in the UK. 2014 FDI projects by sector Sectors Software 199 Business services 88 Financial intermediation 64 Automotive Assembly 52 Machinery & Equipment 51 Food 33 Other transport services 30 Retail 29 Pharmaceuticals 26 Publishing 20 0 50 100 150 200 Source: EY European Attractiveness Monitor 2015 EY | 5 Are you investing enough in the right assets? What does this mean for UK business? Businesses have to ask themselves, have we been investing enough to remain competitive and support our growth ambitions? Given the widely held but erroneous view that investment has been low in the UK, it is possible that businesses have been assuming there was less investment going on than has actually been the case. The reality is that both UK and international businesses have been investing, with investment in capital equipment at decade wide highs, M&A activity increasing year on year and record levels of foreign direct investment into the UK. In analysing the adequacy of their investment, businesses should start by assessing if their historic level of investment has been sufficient to lay down a platform for sustained growth in the UK. UK growth is solid and likely to be sustained. Businesses that have under-invested may find capacity constraints starting to emerge and competitors potentially better placed to step into any gap created. It is also important for businesses to reassess their investment plans in the context of the changing sector dynamics highlighted in this document. Examples include the increasing role played by consumer technology in sales processes and the rising incidence of sharing in certain areas of the value chain, enabling businesses to share investment and effectively boost returns. It may well be that the level of effective assets available to competitors or new entrants is higher than might have previously been assumed. available for businesses to exploit than traditional analysis would suggest (e.g., smart phone sales) but it may also mean that businesses need to invest now to head off the disruptive threat from technological change. The growth in technology sector M&A does not just reflect deals that will impact that sector alone, in many cases technology is being acquired to disrupt other sectors. Finally on the domestic front, there is a need to consider the potential impact of the introduction of the National Living Wage from 2016. As the EY ITEM Club business investment report highlights, the relative costs of capital versus labour have changed in recent years as labour has become relatively more competitive. For some sectors, the NLW will reverse this trend and business investment may therefore become both more attractive and necessary to offset increased labour costs. Beyond the UK it is clear there is a re-balancing of the global economy taking place. In recent years much of the focus of UK corporate international activity has been on the emerging markets. Globally we can see a clear shift to investment in the developed markets of North America and Western Europe in particular. Now is the time for UK businesses to evaluate their existing and desired future geographic portfolios. Overall, the brighter picture for business investment revealed by this analysis is good news for the UK economy. But challenges and questions remain and businesses do need to move quickly to reassess their plans to ensure their capital is on the right agenda. The impact of investment in technology has at least two dimensions. Firstly, it might mean that there is more capacity Contacts Mark Gregory Michel Driessen Partner Chief Economist Partner Transaction Advisory Services T: + 44 20 7951 5890 E:[email protected] T: + 44 20 7951 8792 E:[email protected] EY Economics for Business provides knowledge, analysis and insight to help businesses understand the economic environments in which they operate, both in the UK and within the Global economy. EY | 6 EY | Assurance | Tax | Transactions | Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Ernst & Young LLP The UK firm Ernst & Young LLP is a limited liability partnership registered in England and Wales with registered number OC300001 and is a member firm of Ernst & Young Global Limited. Ernst & Young LLP, 1 More London Place, London, SE1 2AF. © 2015 Ernst & Young LLP. Published in the UK. All Rights Reserved. ED None 23108.indd (UK) 10/15. Artwork by Creative Services Group Design. In line with EY’s commitment to minimise its impact on the environment, this document has been printed on paper with a high recycled content. Information in this publication is intended to provide only a general outline of the subjects covered. It should neither be regarded as comprehensive nor sufficient for making decisions, nor should it be used in place of professional advice. Ernst & Young LLP accepts no responsibility for any loss arising from any action taken or not taken by anyone using this material. ey.com/uk