A new surge in investment and acquisitions among some of Europe’s biggest industrial players looks likely as a result of new sources of corporate debt funding from the euro zone.
Bond financing in European currencies is estimated to have hit an all-time high in 1998, with a 70% increase over 1997, and with a growing proportion of euro-denominated debt. Merril Lynch estimated that about e55bn in investment-grade corporate and municipal bonds will be issued this year, and then treble by the early 2000s.
The popularity of bond financing stems from its relatively cheap rates of interest, partly brought about by the creation of a common euro capital market.
For industrial suppliers, bond financing could unleash cheaper sources of capital for expanding companies. This could in turn boost manufacturers’ demand for productivity-enhancing equipment, as the gains in productivity are more likely to outweigh the cost of financing the investment.
Borrowers and investors are starting to see the euro as a catalyst that will nurture the kind of huge liquid-debt market seen in the US, Business Week magazine predicted last month. It pointed out that it could dethrone bank lending as the prime source of corporate cash. In the US, banks account for just 30% of corporate funding, compared with 63% in Europe.
Europe’s bank-heavy lending bias also contains a disproportionate amount of lending to the biggest players the so-called ‘A’-rated companies which take 80% of bank lending, thus starving many of the European small and medium-sized companies of funding. This could change as the big players start switching to bond financing, freeing up a greater share of bank financing for smaller companies.
In the US, only 60% of bank lending is focused on the ‘A’ raters, with the remaining 40% available for the higher-risk, fledgling and mid-sized players.
The shift towards a US-style system of corporate financing is a marked reversal of the fragmented credit markets that have existed in the former European currency zones. As these come together, the cost of capital, and the cost of debt, will fall.
Suppliers of capital goods or intermediate capital goods and services look set to benefit from this. Any supplier that sells on the basis of return on investment will naturally appear more attractive to a customer if the cost of capital is lower.
Bill Hjerpe, president of Honeywell Europe, says this effect will have direct benefit on companies such as his own.
‘We sell our products on return on investment,’ he says. ‘The lower the cost of capital, the more attractive our products and services will be. That’s why we are excited by the prospect of the euro. Return on investment is deeply embedded in what we do.’
Getting closer to the US model of enterprise finance should be no bad thing for British manufacturers, which are constantly being shown the difference in productivity gains between themselves and their US counterparts comparisons which have featured heavily in the Government’s attempts to get UK industry to raise competitiveness.
Jim Carty, senior vice-president of Washington-based US trade body the National Association of Manufacturers, says much of the productivity improvements gained in the US have been simply the result of investment across companies of all sizes.
‘Those changes have come about in the main because of investment decisions by the companies involved,’ he explains. ‘There were also job losses; it was difficult, but manufacturers realised that they were facing overseas competition and they had no choice.’
The likely outcome in the UK could be similar, as manufacturing productivity responds to a long-awaited injection of investment. At the same time, further mergers and acquisitions are likely to result in more rationalisation in the supply chain.
‘There will be a price to pay,’ says Hjerpe. ‘Lower costs will entail job reductions. But people will see the benefit in the future.’