When two plus two equals three

The scale of the recent spate of mergers and takeovers in the sector has taken a few people aback. But should we be surprised? And are the companies involved taking a great risk if the recession drags on longer than expected? For the answers to these questions we turned to Brian O'Brien, a partner of Pricewaterhousecoopers Real Estate

Nathan North, 'Eurobuild CEE':  Why has there been so much merger and acquisition activity on the real estate market recently?
Brian O'Brien, partner of PwC Real Estate:?It's a combination of many things. There's still a large amount of uncertainty - but at the same time there are indications that the market is recovering. After a recession, post-crisis you're always going to see mergers and acquisitions. Companies are often too busy fire-fighting during the crisis, so when there's a glimmer of hope they tend to get excited - the general belief is that in order to come out of the recession at an accelerated pace, mergers and acquisitions act as a catalyst to drive the business forward.
The current consolidation phase is no surprise - we were saying this was going to happen back in 2008-09 in our report Emerging Trends in Real Estate Europe, but the process took longer to start because of the continuing mood of uncertainty. Let's hope we don't hit a double dip, as this will change the market dynamics beyond recognition and the recovery will be much, much slower.
With the downturn has come lower volumes and reduced growth, so there is a need to achieve economies of scale. And as asset values have dropped, rationalisation and restructuring is required. ?If the cost base is high without a big enough revenue base to support it, then this has massive implications for viability. What's happening is not unusual and is very much cyclical.

Are you saying that we are simply in the consolidation phase of the economic cycle? Or is something different happening this time that will leave a permanent mark on the shape of the market?
Well, it's true to say that as we go through each economic cycle, the process of globalisation is further extended. We can see that over the past few decades, the real estate sector has grown from being a local industry to a global phenomenon. But whatever happens in the sector is driven by the money and where it is coming from. The main thing that drove the most recent boom was debt. It was cash-plus-financing that motored the economy; and as lending has now re-commenced, liquidity and equity have returned to the marketplace. However, at the moment this is extremely focused: the big money is only going to the largest global players, which carry a lower risk due to their greater diversity and scale. Although the consolidation process has been going on for the last couple of years, especially when it comes to smaller funds, what we are seeing now are the bigger, more household names joining in.

Is it the case that the big names are merging or taking each other over for the same reasons?
It's important to differentiate between them. The ProLogis and AMB merger, in my view, was motivated by economies of scale, cost-cutting and efficiency, giving both companies the opportunity to move forward rather than just sitting on their asset bases. Neither of the two were too badly hit by the credit crunch and are perhaps looking to emerge out of it at an accelerated pace. On the other hand, the CA Immo-Europolis and ING-CBRE deals are more to do with the fact that a lot of banks are divesting non-core activities, such as real estate. Banking divestment has to be separated from everything else - the banks are getting back to basics. It's being reported that the JLL and King Sturge deal was driven by the synergies shared by both businesses; however, there must also be a hint of consolidation to eliminate some of the competition and grab a larger slice of the pie.

Just how big is the current M&A activity?
It's difficult to assess the scale of this trend at the moment. But there is always something of a domino effect. I'm sure that there are now people in boardrooms identifying potential targets and setting up task forces, to work out who they can acquire or merge with. So there will be something of a rush of blood to the head of some executives - even though they hadn't previously been thinking about a merger or a takeover. Also, with every merger or acquisition, a competitor has been eliminated. When we consider that the top six agents account for the vast majority of the revenue on the market, one of the big slices of the pie has just grown bigger - and rivals are acutely aware of this.

It sounds like you think that the present level of consolidation is likely to intensify?
The consolidation phase will not go on forever, but it will still be quite apparent or visible until people say that enough is enough and go back to focusing on what they've already got. This is likely to occur when we are finally approaching or in the next boom cycle. Globalisation will continue for sure, but mergers and acquisitions do pull on resources which are focused on integrating operations in an effort to realise synergies and economies of scale.

So are there any big merger or acquisition deals in the offing?
I would not be surprised to see another merger of the large agencies. For sure there will be continued consolidation of fund managers and I also expect to see some movement in the legal and technical advisory sectors. Maybe there will be a few surprises such as firms buying businesses active in areas that are not core to their current activities. This would involve buying teams and expertise in areas that they do not specialise in, in a desire to expand the range of their services. This could happen when a company identifies a gap in their services, and as people strive to diversify and globalise their offer. Core funds could take over non-core businesses, but will still be looking for more balanced risk.

Is there a big risk for companies in taking on the debt required for these acquisitions and mergers?
The merger and acquisition activity at the moment is not of a sufficient scale to worry about. Those taking place are at significantly discounted rates compared to a few years ago. So I don't think the market is going mad or anything like that. The Prologis AMB merger was financed through a share issue, and I don't believe any money changed hands. The takeover of DTZ by BNP Paribas was apparently at no real cost to BNP Paribas. And I don't think that some of the figures quoted are a true reflection of the size of the deals. For instance, the debt taken on by the investors is often added to the quoted transaction value.

Do such mergers and takeovers cause companies a lot of disruption?
The main result of a ProLogis-AMB type of merger is an increased asset base; but when agents come together they are only merging intellectual property, which is naturally more complicated. Such firms are going to struggle to keep their key talent. For instance, some people will see an opportunity to break away, setting up their own companies to offer the same services at the same or similar quality but at a lower price. Unless the mergers are handled properly, poor communication will encourage such spin-offs to occur. And key people, unsettled by the merger process, will absolutely be targeted by other agents. And sadly, as with any merger there are going to be casualties in the form of redundancies.
Companies have to remember that it is not enough just to initially recognise the synergies - the value of the company must be preserved or enhanced. However, a lot of fire-fighting tends to go on after a merger, and according to some recent surveys a frightening number - only 20-30 pct - of companies actually get the planned value out of a merger. Instead of 2 plus 2 equalling 5 as they expected, it can even be less than 4. Still, everyone seems to think they can do this better than the others and plunge into it, but only a few succeed in creating value. But to succeed in the next economic cycle it will be necessary to acquire or merge and grow. At the moment scale is where it is at - big is very much beautiful and this is likely to continue for a very long time.