INVESTMENT FOCUS-Big merger flops may stall Europe's stock market rally

Reuters - UK Focus

* High-profile bid attempts in Europe hit hurdles

* Weir dropped bid for Metso (Dusseldorf: VLM.DU - news) this week

* Omnicom and Publicis (Paris: FR0000130577 - news) cancelled merger plan

* Bid for Alstom (Paris: FR0010220475 - news) businesses faces political hurdles

By Sudip Kar-Gupta

LONDON, May 30 (Reuters) - Investors looking for bigmerger-driven gains on Europe's stock markets this year arehaving to temper their expectations after a number ofmulti-billion euro deals have fizzled out.

Traders and investors remain optimistic that overall mergeractivity will increase, spurred by Europe's gradual economicrecovery. European merger volume has already nearly doubled overthe last year, according to Thomson Reuters (Frankfurt: TOC.F - news) data.

But a string of botched takeovers in the past few weeks hasmade traders and investors more sceptical of the potential forM&A-fuelled share-price rewards - especially for big deals thatcarry increased political and execution risk.

"The mega-deals are proving ever more difficult, as thepoliticians get involved," Rupert Baker, an equity salesexecutive at Mirabaud Securities, said.

"I don't think we'll see any big deals for the next fewmonths, and you could be in for a lull on the market."

There is a close correlation between markets and mergers.

The pan-European STOXX 600 index is up by 5 percentsince the start of 2014, helped by the resurgence of dealmaking,which typically pushes up the shares of takeover targets.

Historically, the STOXX 600 has peaked alongside dealvolumes. It hit a high of around 400 points in mid-2007 just asEuropean M&A monthly volumes hit their highest since November1999, before markets slumped as the 2008 financial crisis hit.

This year's deal revival that has helped to drive stockmarkets higher has started to hit some big hurdles.

Earlier this week, shares in drugmaker AstraZeneca (EUREX: AZNF.EX - news)dropped after U.S. rival Pfizer (NYSE: PFE - news) walked away from makinga formal bid for AstraZeneca (NYSE: AZN - news) potentially worth about $118billion.

The two companies had been locked in a month-long publicfight over the proposed deal that sparked political concerns onboth sides of the Atlantic (Frankfurt: 98S.F - news) over jobs and tax manoeuvres.

Just days later, engineering group Weir dropped abid for Metso after the Finnish company rejected asecond, sweetened takeover offer. Shares in both companies fell.

Advertising groups Omnicom and Publicis also ditched a merger at the start of May, while attempts by GE and Siemens to bid for parts of France'sAlstom have been complicated by political meddling.

Even though dealmaking has picked up over the last year, M&Aactivity globally dropped 41 percent in May from levels reachedin April, according to Thomson Reuters data. >^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

Graphic showing STOXX 600 vs M&A volumes correlation ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^


Fund managers said that a lot of the big-name failures weredue to political and regulatory risk, rather than simply price.

"I don't think valuations are a problem, it's more thepolitical hurdles," Terry Torrison, managing director atMonaco-based McLaren Securities, said.

Valuations are attractive overall, with the averageenterprise value to core earnings (EBITDA) ratio - used bybankers to evaluate the price of a takeover - having fallen to6.7 from 7.3 over the last year, according to Thomson ReutersStarMine.

Most investors are still betting on more long-term gainsover the course of 2014 for European stock markets. A Reuterspoll in March of fund managers and strategists showed that, onaverage, they expected the STOXX 600 to end 2014 at a six-yearhigh of 353 points - up from current levels of around 344points.

And there is a steady flow of smaller deals, such as Frenchsoftware company Atos (Paris: FR0000051732 - news) 's plan this week to buy rivalBull (Paris: FR0010266601 - news) in a 620 million euro transaction.

But the collapse of mega-deals such as Pfizer/AstraZenecahas led to doubts that the long-awaited revival of European M&Awill be as smooth a ride for investors as expected.

"We are at the start of a new M&A cycle ... The problemtoday is that I would say deals are taking much longer thanbefore to be finalised," Lionel Melka, a partner at Paris-basedfund Bernheim Dreyfus, which bets on merger activity, said.

Melka cited the growing influence of governments. He pointedto China's Ministry of Commerce, which is increasingly usingantitrust rules to impose conditions on global deals such as the$35 billion Glencore Xstrata (Other OTC: GLCNF - news) merger, which took morethan a year to complete.

One M&A banker said that while smaller, "bolt-on" deals wereproving relatively easy to execute, the bigger ones were harder.

"Transformational deals are just that little bit moredifficult," the banker, who declined to be named, said.

Shares in UK medical devices company Smith & Nephew (LSE: SN.L - news) initially spiked up 17.5 percent on Wednesday this week onspeculation of a potential multi-billion dollar bid from U.S.rival Stryker (Berlin: SYK.BE - news) . But Stryker then denied it was planningto make an offer.

The market for initial public offerings (IPO) has also hadsome setbacks, with clothing chain Fat Face cancelling a marketlisting earlier this month, while British holiday-to-insurancecompany Saga had to price its market listing at thebottom of a pre-set range.

Michel Juvet, chief investment officer at Swiss bankBordier, said that signs of failed bid attempts could stall theEuropean stock market rally in the short-term.

"If you see less investors trying to buy the next target,and less investors willing to push up potential takeover bidprices, then in the short-term, it can slow down stock marketactivity," he said. (Additional reporting by Anjuli Davies, Lionel Laurent andVincent Flasseur. Editing by Jane Merriman)

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