Should you worry about foreign takeovers?

Does it matter that a Spanish company owns and runs our main airports? If French companies own our power and water companies? What are we to make of General Electric snapping up the aerospace division of Smiths Group last month? The openness of the UK corporate sector to foreign ownership often amazes commentators abroad. After all the Americans will not let foreigners buy airlines, television networks or any business remotely connected with security. France protect eleven sectors from foreign contractors, including casinos and food giant Danone. Spain is fighting a last-ditch battle to stop Eon of Germany buying Endesa, Spain's national energy champion. British businesses and political leaders are generally comfortable about this state of affairs. Even when the state-run Russian energy company Gazprom expressed an interest in buying Centrica last year, Tony Blair ruled out any possibility that the government would block the bid.

Foreign takeovers: UK car industry rescued by the Japanese

The bottom line is that it is costly to be xenophobic in matters of economics. Take the UK car industry as an example. Under British ownership the industry failed to meet the challenges of international competition. We didn't do ourselves any favours by merging all our small weak competitors into a large weak competitor British Leyland, which at one time was the third largest car company in the world, in the hope that one national champion would enjoy "critical mass", "global reach" or any other industrial policy clich you care to mention. In 1972 1.9 million passenger cars were produced in the UK. Ten years on this output had collapsed to below 0.9 million cars as feeble management and militant workers conspired to destroy the industry. Then came the renaissance.

 First Nissan came to Sunderland to build a plant that is still the most efficient in Europe, then Toyota set up in Derbyshire and Honda in Swindon. Today, the largest viable car firms in the UK have Japanese ownership, management and design. In 2005 Nissan produced 315,000 cars, the UK's largest producer, Toyota, Britain's second largest producer made 264,000 and Honda, the fifth largest, rolled out 187,000 units.  In total, 1.6 million cars were produced in the UK in 2005.

Foreign takeovers: the 'Wimbledon effect'

This is an example of a successful foreign investment story. A nation's economic objective is to enhance the added value created in Britain. We can only add value by having skills and capabilities which are better than those of our international competitors. Accordingly we should welcome foreign ownership when it adds to skills and capabilities. It follows that we should not be disturbed by the fact that much of what is done in the City of London is done by firms with foreign parents.  Ownership may have been transferred in the last 20 years, but London is still where the value is added.

The UK has benefited enormously from its open economic borders, free markets and its welcoming of foreign capital and talent.  Free movement of capital and talent has given Britain a unique selling point and a real competitive advantage. Indeed London's success as a financial centre can be described as the "Wimbledon effect". Every year Britain stages the world's most prestigious tennis tournament, yet in the last 25 years British players, particularly ladies, have not featured prominently. So it is no surprise that Richard Lambert, director general of the CBI, pronounced himself as untroubled by the possibility of the London Stock Exchange falling into foreign hands.

Foreign takeovers: some valid concerns

But not all foreign takeovers meet our value added criteria. Take an acquisition involving Britain losing head office functions when company control moves abroad and where research and development, technology and design functions move overseas. A second objection is that foreign companies often structure their UK operations to minimise their British tax liabilities.

This means that Gordon Brown has to plunder the personal sector here to make up for the shortfall. Meanwhile opponents of the Great British sell-off worry that foreign owners may be tempted to close down British subsidiaries first, when times become hard, since there is less employment protection in the UK than elsewhere in Europe. Moreover it is disconcerting that our trading partners do not embrace the spirit of openness that the UK does, as foreign takeovers by British companies are potentially blocked by economic chauvinism. The accusation that the playing field is tilted against the UK is particularly notable regarding acquisitions by Spanish companies, who have been able to write-off goodwill against tax. In effect this is a Spanish state subsidy that would give a Spanish company an advantage in a bidding war. But it may also involve a transfer of wealth from the Spanish tax payer to UK shareholders.

There is some substance to these objections, but there are also counter arguments.  Most foreign companies buy UK businesses to build on them, not demolish them. What sense is there in paying a premium price to treat it like a second class asset? Companies such as Boeing are substantial net importers from the UK because of the strength of their supply chains in this country. Boeing spends between $1-3bn a year on the supply chain in UK supporting 30,000 jobs. Moreover research by McKinsey shows that subsidiaries of global companies to be more productive and innovative, having greater pools of expertise to draw on. Indeed after GE acquired Amersham International for £5.7bn in 2003 it moved its global healthcare headquarters to the UK from Milwaukee. 

But by far the worst form of foreign investment is that which is driven by government subsidies and regional aid.  The sort of foreign direct investments we should be wary of are those associated with enthusiastic ministerial announcements creating thousands of jobs in the depressed region of the country. These companies have not come to the UK to make British skills available to the wider market. They have been attracted by the top bidder in a subsidy competition funded by you the tax payer.

Foreign takeovers: a lesson from the DeLorean scandal

The most infamous example is the DeLorean car fiasco. Former General Motors high-flyer John DeLorean had a plan to build a stylish gull-wing European sports car at a price that would make it attractive to the American market. A state-of-the-art factory was built on a muddy field on the outskirts of Belfast, a city best known for sectarian violence and high unemployment. In 1978 the plant opened, and the first car came off the production line in 1981. But early optimism soon turned sour. Although the cars had a futuristic design, the windows leaked and the engines seized. Only 8,500 cars were made, and production ceased in early 1983. As DeLorean's financial problems mounted he was arrested for cocaine trafficking. Over £80m of tax payers money went into the scheme with little to show for it. This is the one type of foreign direct investment that we should be most sceptical of.

To sum up, although it is galling for British companies to be targets for corporations from countries that close their borders to foreign ownership, it is important not to lose sight of the bigger picture. Historically Britain's economic success has always rested on its openness to trade, capital and talent from abroad. This characteristic has been the source of a notable competitive advantage in an era of globalisation. The bottom line is that in most cases foreign purchasers in effect transfer wealth from their own country to UK shareholders. Indeed foreign bidders have to pay premium prices for certain UK assets because they are not for sale elsewhere in the world.

By Brian Durrant for The Daily Reckoning. You can read more from Brian and many others at www.dailyreckoning.co.uk

Brian Durrant is Investment Director of The Fleet Street Letter