Three reasons we’re about to have a new FTSE takeover frenzy

Take your eyes off the market for a few minutes and another FTSE 100 company might have disappeared. Shell has just taken control of BG. Vodafone has been engaged in a complex corporate dance with Liberty Global that may well end in a full-blown bid for the mobile telecoms giant.

Now there are reports of BT being targeted by German rival Deutsche Telekom, while speculation is swirling around drinks giant Diageo. Suddenly, the FTSE index is the fashionable place for multinationals to go shopping for assets. And it's a trend that could continue for some time.

The recovery in M&A action

For much of the last decade, the mergers and acquisitions (M&A) market had about as much life in it as the Greek economy. Only last week, the Office for National Statistics (ONS) confirmed that mergers in the UK remain at historically low levels.

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In the latest quarter, there were 28 deals between British companies, the lowest number since the ONS started compiling M&A statistics in 1969. When you include foreign companies buying British ones, the total for the three months climbed to 90, but even that is low by past standards. Before the 2008 crash, M&A deals were regularlyrunning at more than 300 a quarter.

But that might be about to change, especially at the mega-cap end of the market. Shell's takeover of BG might signal more consolidation in the oil and gas industry. Last year, AstraZeneca fended off an approach from Pfizer, but it wouldn't be surprising if there was another approach for the firm, and perhaps for its rival GlaxoSmithKline as well.

Vodafone looks certain to be involved in some kind of bid, while BT and Diageo are also in the frame. Earlier this week Diageo's shares jumped by 7% on reports that Brazilian Jorge Paulo Lemann was considering a takeover.

So why the sudden renewal of interest in FTSE companies? In part, it may be because we are reaching the point in the bull market and the business cycle where M&A inevitably picks up. Firms are flush with cash again. The memories of the last crisis have started to fade. Markets are reasonably buoyant and chief executives feel bullish. In other words, it would be surprising if there was not some upturn in deal making. Indeed, in the US, M&A is already getting back to all-time highs.But there are also three specific reasons why the FTSE may be an especially tempting target for takeovers.

First, it's relatively undervalued compared to other global indices. The index is on a price/earnings (p/e) ratio of 16 and has underperformed rivals such as the S&P 500 or the German Dax the S&P is on a p/e of more than 20. So while the FTSE 100 isn't exactly cheap, it's far from expensive compared to other developed-world markets.

The pound devalued sharply in 2008 and 2009 and has never really recovered. It is strong against the euro, but for American or Far Eastern buyers, it's still good value and that makes FTSE 100 firms more attractive targets than others around the world.

Secondly, it is stuffed full of the strong brands that multinationals and private-equity firms covet right now. Vodafone might not stand out particularly over here, but in Germany, for example, it is one of the strongest players in what is still a huge industry. It also has a vast global presence and that will always make it attractive to any company with ambitions to beef up in media or telecoms. That is even more true of Diageo, with premium brands such as Guinness and Johnnie Walker.

Great brands take a long time to build the FTSE, as one of the oldest stockmarkets in the world, is home to more of them than most. When those are in demand, so are its companies.Finally, it is one of the most open M&A markets in the world. If you fancytaking over a French or German company, you'll face a blizzard of opposition. The same is true of American and Japanese businesses.

And while no one has been brave enough to launch a hostile mega-bid on Shanghai's booming stockmarket yet, it is unlikely that they would be warmly received. The UK is far more welcoming. If your cash is good, on the whole British shareholders will happily take it, and move on swiftly to the next investment.

FTSE takeover frenzy: the age of mega-deals approaches

The net result? Expect to see two or three mega-deals in the next year or so. Who else looks tempting? Burberry has a great brand, especially to the Chinese, who are suddenly cash-rich. So does InterContinental Hotels, as indeed does British Airways, now submerged into IAG. Beleaguered supermarket chains such as Tesco and Sainsbury's are sitting on some great real estate someone might want to grab it on the cheap. Rolls-Royce has some world-beating technology, as does BAE Systems.

Whether a wave of takeovers is good for the economy is open to debate. In the past, very few companies have emerged stronger from a takeover or merger, and quite a few have been badly weakened. But it will certainly be good for investors. There are plenty of reasons for thinking the markets might be close to a peak but a wave of deals could keep the bull market running for another year or two.