Scotland M&A review

The collapse of the Dunfermline Building Society may have dented consumer confidence, but it hasn’t discouraged dealmakers from expanding north of the border

The collapse of the Dunfermline Building Society may have dented consumer confidence, but it hasn’t discouraged dealmakers from expanding north of the border

One of the most recent casualties of the financial crisis wasn’t a failed bank, but one of Scotland’s major financial institutions, the Dunfermline Building Society. What began life as a small building society 140 years ago had steadily evolved into Scotland’s largest mutual with more than a quarter of a million loyal customers.

The financial rock took a hit last month when it was taken over by Nationwide in a move that would rescue the ailing business from certain collapse due to its questionable investments in commercial property.

Although the financial nitty-gritty of the deal hasn’t been revealed, Nationwide has cherry-picked the healthier parts of Dunfermline’s business, snapping up its retail deposits worth £2.3 billion, 34 branches, head office and the majority of the residential lending book worth £1 billion. As part of the deal, the UK government has shelled out £1.6 billion for the less attractive portfolio of toxic loans and high-risk mortgages, appointing KPMG to find a buyer.

First Minister and leader of the Scottish National Party Alex Salmond described Dunfermline as crucial during a Scottish Parliamentary debate earlier this month. Said Salmond, “The Dunfermline has provided loans of more than £675 million to the business sector and has around a 22 per cent market share in lending to the Scottish social housing sector. No one [in the chamber] can therefore be in any doubt that the future of the Dunfermline is of vital importance to Scotland.”

The £1.6 billion UK government bail-out has shaken the confidence of Dunfermline’s dependable savers and delivered a serious blow to perceptions of building societies as investment safe havens with sensible strategies and transparent financial dealings. Nevertheless, local analysts and commentators believe Dunfermline’s demise does not indicate that it’s a terrible time to invest in or expand within Scotland.

Bryan Johnston, director at brokers Brewin Dolphin in Edinburgh, says: “Most of us are bitterly disappointed at what has happened. Like many other financial institutions, the Dunfermline got over-enthusiastic about its lending policy and threw away its original knitting. It was originally set up as a small building society providing home loans to savers. One might question how they found themselves in the realm of commercial property and lending money to various propositions.”

Adds Johnston, “It’s another tragedy on the financial front, but it’s not unique to Scotland. Northern Rock was Newcastle’s disaster and the Bradford & Bingley was the Midlands – it’s another symptom of the global financial crisis.”

Jeremy Batstone-Carr, head of research at Charles Stanley Wealth, tends to agree, suggesting that there will be little or no impact on risk appetite in Scotland. “The Dunfermline had a presence and a high degree of loyalty among its customers. From a consumer perspective, its impact is significant, however, from the corporate perspective it doesn’t register highly on the Richter Scale.”

Financial aftershocks

The financial services industry in Scotland has historically been buoyant, growing at more than twice the rate of its UK counterpart over the past five years and worth around £7 billion, or seven per cent of total Scottish GDP. According to Scottish Enterprise, the financial and business services sectors combined account for a quarter of Scottish GDP and sustain more than 86,000 jobs.

Over the past 12 months, the industry has been the stage for a number of M&A mega-deals, including the acquisition of a 58 per cent stake – subsequently upped to 70 per cent – in Royal Bank of Scotland (RBS). The government also moved to acquire a 58 per cent stake in HBOS prior to its merger with Lloyds TSB. These mega-deals although part of a broader recapitalisation of a number of leading banks have gone some way to damaging the reputation of the Scottish financial services market, which prior to the credit crunch ranked as the fifth most important financial centre in Europe.

Adds Johnston, “We are a bit weary of the determination of some to apportion blame to others. We are all to some extent culpable. We lived in an environment of freely available loans, seemingly to interpret a loan as a gift. We forgot that there are two principles: Firstly, to interrogate whom you are giving the money and secondly, that loans have to be repaid.”

Energetic deal flow
One of the country’s largest employers is the Scottish oil and gas industry, with more than four per cent of the local workforce dependent on production. Scottish government estimates, which are based on average oil and gas prices in 2008-09 indicate that North Sea revenue could be worth as much as £14 billion.

In the first six months of 2008, the oil and gas market was fertile ground for dealmaking as M&A activity in and around Aberdeen remained stable, with Scottish advisers uniformly witnessing a flurry of activity in the first quarter propelled by changes to the Capital Gains Tax (CGT) regime. “Taper relief caused this spike in private company disposals, pulling forward deals that would have otherwise completed later and temporarily inflating M&A numbers,” says Graeme Cassells, partner at accountancy firm PKF.

Later that year, M&A activity in this sector mirrored global trends as the liquidity crisis caused deal values to plummet. Number-cruncher Zephyr reports that M&A price tags for UK oil and gas assets more than halved last year, falling from 145 disclosed transactions worth £4.7 billion in 2007 to 121 deals worth just £2 billion.

Much like the rest of the UK, advisers north of the border witnessed a spiralling decline in dealmaking after the CGT deadline on 5 April 2008. Says Merlyn Gregory, manager of diligence services at Calash: “The slowdown continued throughout 2008, which we had anticipated owing to a drop in liquidity available to businesses. For us, it hit rock bottom in November when uncertainty peaked and very few deals happened at all.”

Gregory notes that a prolonged drop in the oil price often causes larger companies to review and dispose of non-core assets, adding, “but this time, the problem isn’t simply about the oil price, it’s about liquidity. The supply shortage will drive oil price, but predicting an overall upturn in the market is more difficult.”

In the corporate drive to identify strategic fits, improve efficiencies and capitalise on depressed prices, deals continued to be written within the sector. One such oil
and gas transaction took place in July when Norwegian engineering group pounced on Scotland-based Qserv, an independent provider of well, process and pipeline services to the North Sea and international markets, for an initial payment of NOK1 billion (£100 million) with a deferred element expected in 2011.

“This acquisition enhances our portfolio of services to our existing UK Continental Shelf clients,” says Mads Anderson, executive vice president of Aker Solutions. The deal will bring a range of products under one roof and enable the company to combine services for domestic and international markets.

Domiciled in Aberdeen, Qserv was established in 2001 and has some 400 employees, 250 of which work offshore. For the most part, its activities are focused on North Sea operations, but it also operates in West Africa, the Middle East and South-East Asia. Its reported turnover in 2007 was some NOK500 million.

Deal pipeline
The outlook for M&A activity may be difficult to call, but the numbers point to fewer deals with smaller price tags coming to the table. Gregory suggests other patterns are emerging: “It’s beginning to pick up slowly, but deals are taking longer to close as clients seek greater detail. We expect to see a gradual increase in deal activity towards the end of the year.

“The market for commercial due diligence has previously been perceived as not strictly necessary, but an added comfort. Now it’s a fundamental requirement,” she adds.

The slowdown has seen the Aberdeen-based due diligence provider working on more strategic projects for private equity firms and banks to meet evolving client requirements in the liquidity squeeze. Gregory says the company’s has diversified to offer consultancy services for private equity-backed growth businesses that have previously been highly leveraged and are finding it difficult to meet the expectations of investors. “Businesses may appear to be struggling, but they are just aren’t meeting the expectations of investors,” she remarks.

In stark contrast to the challenges faced by private equity companies to gain the returns they need from their highly leveraged oil and gas investments, the nascent Scottish renewable energy sector is thriving.

New energy

Figures from the Scottish government indicate that Scotland is on course to hit its green energy targets of 50 per cent of electricity generated from renewables by 2020, with an interim target of 31 per cent by 2011.

Rob Cormie, head of corporate finance at Edinburgh investment bank Quayle Munro, is doubtful: “The targets being set by Scotland are extraordinarily challenging. I think there will have to be considerable changes in how renewable energy projects are procured and brought to fruition for it to happen, especially around the planning system or grid access as it can take forever.”

Cormie has been appointed to raise between £60 million and £70 million for the construction of Carraig Gheal Wind Farm in Argyll on the west coast of Scotland. On sourcing funding Cormie comments: “Raising finance has been fine and it will be done this summer. We’ve had to go back to basics with a really well structured deal.”

“Banks have more opportunities than capital available to lend, so your project has to be one of the best, otherwise it won’t get done because they are making a choice based around sector and relationships.”

The onshore wind farm project is owned by Statkraft, a European renewable energy group based in Norway, and GreenPower, an independent Scottish developer of wind and hydro projects based in Alloa with a portfolio of over 400MW – equivalent to some £600 million of investment. Construction of the site is expected to begin later this year, featuring 20 turbines with a capacity to generate 60MW that will provide energy to Argyll and Bute.

Cormie believes he has a strong proposition for the banks: “While values have come off a little, renewables is one of the sectors that has held up.”

Other deals within this sector of an international nature include France-based Carbone Lorraine’s acquisition of Scotland-based Calcarb, the second largest manufacturer of rigid graphite felt for the solar industry. The Bellshill business was bought as a bolt-on to complement Carbone Lorraine’s graphite services for solar, industrial, semiconductor and high temperature furnace components, the company said in a press statement.

Carbone Lorraine, which has 6,800 employees worldwide, bought a 60 per cent stake in the Scottish manufacturer in December and has an option to increase its shareholding to 100 per cent this year. Although the terms of the transaction have not been revealed, the company said the deal was funded through debt. The new unit created through the deal is expected to boost sales by $50 million (£34 million) this year.

Drinking in deals
A closer look at the local manufacturing sector suggests that the Scots are a nation of bon vivants as the largest contribution to manufacturing GVA in Scotland comes from the food and drink sector – totalling more than £3 billion in 2006, according to the latest figures from Scottish Enterprise. In fact, the nation’s food and drink manufacturing industry generates annual sales of some £7.4 billion and employs a fifth of Scotland’s manufacturing employees.

Soft drinks manufacturer and maker of Irn Bru, Tizer and Orangina AG Barr outperformed the market last year, raking in profits and increasing its dividend despite a 2.2 per cent a drop in volume in the UK soft drinks market, according to Nielsen Scantrack data to January 2009.

In March, the Cumbernauld-based business reported strong preliminary results for the year ended January 2009, posting a 9.7 per cent increase on pre-tax profits to £23.4 million on a turnover of £169.7 million, also up at 14.4 per cent. By increasing its final dividend by 7.7 per cent to 42p, AG Barr was somewhat of a corporate rarity.

In spite of these financial highlights, AG Barr’s Strathmore Spring brand took a hammering as demand softened for premium drinks, particularly water, smoothies and top-end juices last year. UK water market volumes fell by ten per cent as a result of bad weather and consumers tightening their belts. Additionally, environmental considerations, such as the sustainability of bottled water added to the brand’s woes.

Distressed deals
In the short term, falling demand for bottled water has led to struggling businesses driving M&A in this space. A case in point is Highland Spring’s acquisition of Speyside Glenlivit Water Company in March.

Speyside collapsed into administration to be snapped up by the UK’s number-two bottled water manufacturer, Highland Spring, last month. The deal was written in record time, and not for the superstitious as it closed on Friday 13th March. The acquisition was done through Edinburgh administrator Invocas who was in negotiations with a number of parties vying for the business.

Notes Les Montgomery, CEO of Highland Spring, “The business was losing circa £300,000 a year because the cost base was too high for the turnover. We’re aiming to get the business into the black within 12 months.”

Montgomery has plans to revive the business by swelling volumes, which is
sold through hotels and restaurants, through his distribution network. Speyside will also benefit from Highland’s “purchasing synergies”.

Although Montgomery would not discuss the financial terms of the deal, he said the acquisition had been funded from existing cash resources and that a member of the management team had been assigned to implement a 100-day integration plan. “We couldn’t have it causing a distraction to our main business.”

On the softening UK water market, Montgomery comments, “Many businesses are suffering at this current time and water is no exception, but there is loyalty to UK products and the perception that Scottish Water is the best.”

Speyside is not the CEO’s deal debut as back in April 2001 Highland Spring acquired its Blackford neighbour, The Gleneagles Spring Water Company, from Time Group for an undisclosed figure.

The ambitious CEO says he was able to steer the company back into the black by “boosting volumes and bringing sales opportunities to the business through its distribution network”. He is confident that this can also be done with Speyside.

Gleneagles is sourced from the Perthshire Gleneagles Estate and had a £1.3 million turnover to July 2000.

On whether there are more deals in the water pipeline for Highland Spring or any of the other major bottled water players, Montgomery observes that there are around 400 bottled water companies across the UK, but that most of the major players are multinationals, such as Danone and Nestlé. “I think they are too small to be of interest to multinationals, but you never know, I’m always on the look out.”

Marc Barber

Marc Barber

Marc was editor of GrowthBusiness from 2006 to 2010. He specialised in writing about entrepreneurs, private equity and venture capital, mid-market M&A, small caps and high-growth businesses.

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