Should we protect national champions?

published 18 August 2019

960-plane-634 — Cobham's military kit is now in the hands of foreigners

What's happened?

UK defence business Cobham agreed last month to a £4bn takeover offer by US private-equity group Advent International. The buyout of the 85-year-old aviation pioneer has sparked concern that highly specialised air-to-air refuelling technology could be transferred to the US.

The family of the group's founder, which still retains a 1.5% stake in the business, is among those publicly opposing the deal. In a letter to the defence secretary, Lady Cobham wrote that "there are real risks in the takeover to UK security and to important hi-tech jobs".

What's the problem?

Private-equity buyers are often accused of asset stripping selling off parts of a company to realise a quick profit and failing to invest in the research and human capital needed for long-term success. In the case of a UK defence business those concerns are particularly acute because asset stripping threatens to destroy domestic know-how. In the worst-case scenario, that could leave the Ministry of Defence dependent on foreign suppliers for crucial military kit. Another concern is technology transfer.

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The recent outcry about Huawei's involvement in the UK's 5G network is only the most well-known case. Notable Chinese purchases in the past decade have included the port of Piraeus in Greece, the hostile takeover of German robotics specialist Kuka and the buyout of Sweden's Volvo. There are worries that such deals could allow the theft of intellectual property, or facilitate spying.

How do the UK's rules compare?

Ever since the Thatcher revolution, British takeover policy has been based on the principle that it doesn't matter who owns the country's businesses so long as they deliver for consumers. Scarred by the failed nationalisations of the 1970s British Leyland is the most famous example Whitehall decided that markets know best. The result is what is sometimes dubbed the "Wimbledon effect" London has flourished as a global business hub despite a relative dearth of British champions.

So, we're open to all comers then?

Not quite. Britain has been progressively tightening its foreign-ownership laws ever since the wildly unpopular 2010 Kraft Heinz takeover of Cadbury, which highlighted the ease with which foreign businesses could swoop in on established British names and slash jobs. Concern about Chinese and Russian espionage has sparked more recent reforms on national security grounds.

Last June the government lowered the threshold at which ministers can intervene in takeovers from businesses with a turnover of £70m to all those with a turnover of at least £1m.

What about national security?

Theresa May's government also launched a consultation that proposed changes to the current regime, with corporate bosses required to notify authorities about potential deals that endanger national security. The new rules cover not only takeovers, but also all sales of assets and intellectual property and are similar to existing rules in places such as Japan, Australia and Germany. But although British ministers enjoy ever greater powers to intervene, in practice the preferred approach is not to block deals, but to seek guarantees.

Yet promises can be broken. Last year authorities waved through buyout firm Melrose's £8bn takeover of engineer and defence supplier GKN in return for an undertaking to continue investing in the UK. Yet in April Melrose announced plans to close a GKN factory in Birmingham.

Is security really the issue?

Politicians facing re-election have huge incentives to tinker in the national economy in order to score short-term political points and "national security" can provide a plausible-sounding cover story for all kind of tinkering. Donald Trump invoked it last year when he imposed steel tariffs on the EU. No one doubts that steel is a crucial input for the US military and civilian economy, says Theodore Moran on voxeu.org.

Yet the global industry is so fragmented that no external supplier could realistically withhold steel from US purchasers for political reasons. That suggests that national security should only be invoked in quite narrowly drawn cases where a technology is crucial and difficult to replace.

How important is foreign investment?

Foreign direct investment (FDI) often brings with it new management techniques and technology that can whip failing industries into shape. And about half the productivity gap between Britain and America is down to bad management, says The Economist.

Economic research across several industries suggests that the "David Brents" in British boardrooms have much to learn from their peers overseas. Evidence shows that foreign-owned businesses invest more in research and development, which boosts productivity and wages.

A study by the OECD think tank found that in Britain wages in foreign-owned companies were about 5% higher than they would have been were the firm under British ownership. Bad takeovers make headlines, but there are successes too. Carmaker Jaguar Land Rover, for example, "revived after it was bought by India's Tata Group" in 2008.

What next for takeovers?

Chinese interest in foreign acquisitions has fallen in recent years as Western regulators become more suspicious and Beijing clamps down on capital flight. The Cobham acquisition suggests the next wave of foreign takeovers is instead likely to come from US buyout firms. Loose monetary policy has prompted investors looking for a decent yield to pour funds into private equity.

The result is that the value of leveraged buyouts hit $256bn in the first six months of this year, says Refinitiv, the highest since the financial crisis. Expect more takeovers and more debates about whether it's worth protecting Britain's industrial base.

Alex is an investment writer who has been contributing to MoneyWeek since 2015. He has been the magazine’s markets editor since 2019.

Alex has a passion for demystifying the often arcane world of finance for a general readership. While financial media tends to focus compulsively on the latest trend, the best opportunities can lie forgotten elsewhere.

He is especially interested in European equities – where his fluent French helps him to cover the continent’s largest bourse – and emerging markets, where his experience living in Beijing, and conversational Chinese, prove useful.

Hailing from Leeds, he studied Philosophy, Politics and Economics at the University of Oxford. He also holds a Master of Public Health from the University of Manchester.