Now what?

Today’s delivery of the letter triggering Article 50 has set the UK on a road to a far less certain future. I have been through the economic arguments countless times as to why Brexit is a thoroughly bad idea – indeed I have been making them since January 2013 – but that is an argument which has been lost and there is no point in raking over old coals. Theresa May’s speech to parliament tried to sound convincing but I suspect it fell flat on the near half of voters who do not share this government’s vision.

All the challenges it faces were contained in one sentence from the prime minister: “I want this United Kingdom to emerge from this period of change stronger, fairer, more united and more outward-looking than ever before.” It’s hard to see how we will emerge stronger given that most of the evidence suggests that there will be significant economic costs. Unless, of course, any trade deal with the EU offers most of what we have already, in which case what is the point? More outward-looking? We have just announced a withdrawal from the largest, and arguably most successful, single market in the world. I am not sure how that is consistent with the outward-looking vision she espouses. As for being united, that is a bitter irony. Almost half those who voted do not want this policy at all, and the Scots want to secede altogether. The UK will have to negotiate a hell of a deal with the EU to persuade the disaffected minority that Brexit is a risk worth taking.

The biggest problem that the government will face in the long-run is how to take back control in an increasingly globalised world. One of the great ironies of the post-Brexit world is that sterling is around 10% weaker than it was pre-referendum. Aside from the fact that this impacts upon the living standards of ordinary citizens by raising the costs of imported goods, it also makes British companies more attractive takeover targets by reducing their price in foreign currency terms. An article in The Economist noted three weeks ago that although the UK accounts for 3% of world GDP and its companies account for just 5% of global market cap, UK corporates have accounted for a quarter of all cross-border M&A activity since 1997.

This is a result of the laissez-faire approach of successive British governments towards market intervention. Moreover, over the last 10 years, foreign companies have bought significantly more UK companies than the other way around. The most high profile of these cases was the purchase of Cadbury’s plc by Kraft Inc in 2010. Just a week after promising to keep one of Cadbury's local plants open, Kraft backtracked and said it would close it. Although this resulted in a major revamp of the takeover code in 2011, it came too late for Cadbury’s workers and prompted howls of popular outrage. But here’s the rub: The UK is running out of attractive takeover targets. Admittedly, it still has attractive companies such as AstraZeneca, which beat off a bid from Pfizer in 2014, or the London Stock Exchange, whose proposed merger with Deutsche Börse was today blocked by the EU competition commissioner (of all people).

All this is a prelude to the question of what will attract global capital to the UK in future? It has fewer takeover targets and it is about to leave the EU, which will make it less attractive to firms which want a European base when they can go elsewhere. The attractiveness of London as a business location will not diminish easily: It is still a world-class city with all the amenities that the global community requires. The attractiveness of the legal system and use of the global lingua franca are added bonuses.  But depending on the nature of the deal with the EU, the London financial services industry may be in for a torrid time which will impact on the ancillary services that depend on it. Only time will tell how the likes of the Japanese and Americans will react to the prospect of having their European headquarters located outside the EU. Tax competition would certainly be one option to enhance the attractiveness of the UK but that is a race to the bottom which could put even bigger holes in the public finances.

The Economist notes that “even the free-market wing of the ruling Conservative Party … backs a change [to the takeover code] ... Britain’s 30-year experiment with a free market for takeovers is quietly coming to an end.” But the real irony is that if Brexit is at least in part a backlash against globalisation, this policy change could have been implemented years ago and saved us a lot of grief. And to double the irony, making it more difficult for foreign investors to buy UK companies is now precisely the wrong policy response when (a) most of the assets have already been sold and (b) the UK needs the capital inflows. You almost couldn’t make it up. Unfortunately that is the result of 30 years of short-sighted policy.

Mostly ARMless

I am not exactly sure what to make of the bid by Japanese company SoftBank for ARM Holdings, one of the few British tech successes of recent years. Indeed, the chips made by ARM are in devices across the world from smartphones to tablets. Whilst ARM is a reasonably sized UK company, with revenues of around $1.5bn and profits close to $500 million, which puts it just outside the top 20 largest British firms, it is a tiddler in global terms. For example, AstraZeneca – the last big British company to be involved in politically sensitive takeover negotiations – generates revenues of around $25bn, whilst a serious tech giant such as Google makes $75bn in revenue and net profits of $16bn.

What sets it apart is its strategic importance. The company has a 95% market share in the smartphone market and as the Internet of Things takes off, the kinds of processors which the company makes will be in high demand. Although the new Chancellor Philip Hammond insists it is a demonstration that 'Britain has lost none of its allure to international investors’, it flies in the face of the speech made last week by prime minister Theresa May who argued strongly that the government would be less keen on seeing strategically important businesses sold off to 'transient' foreign investors.

One of the founders of ARM has expressed regret that the future of the company will be decided in Japan rather than in Britain. As an economist, I ought not to care, although in these increasingly difficult geopolitical times the idea of a business world without borders is no longer as attractive or realistic as it appeared a few years ago. Perhaps more importantly, the profits made by the company will flow back to Japan thus exacerbating the UK's current account deficit, which is already one of the highest in the OECD. Regret has also been expressed in tech circles that yet again another national champion has been sold off, which will stymie European efforts to build companies to compete with the Silicon valley giants. But the company belongs to its shareholders and if they decide to cash in on a very generous offer, who can blame them?

Although the weakness of sterling in the wake of Brexit has made assets such as ARM cheaper in yen terms, the surge in the share price in pounds has gone up at an even faster rate. Thus, by last Friday ARM’s share price in yen terms was 3.5% higher than on 23 June. Moreover, SoftBank paid a premium of 43% relative to Friday’s close and a multiple of 60x 2016 earnings – way above the FTSE’s already-high average of 38x. It was almost too good an opportunity for shareholders to turn down, although it could yet be derailed by a counterbid or indeed by direct government intervention.

Undoubtedly, the issue will raise concerns about the UK’s willingness to sell out important businesses to foreign investors. But so long as the UK continues to operate an industrial policy in which companies have a duty only to their shareholders, and in which they are encouraged to take decisions on purely financial terms, we will undoubtedly see more deals such as these. This is all the more true as the collapse of the pound since the EU referendum reduces the costs of buying into the UK. It also boosts the revenue of those companies (such as ARM) which derive the bulk of their revenue from overseas, which will increase their attractiveness, and explains why the prices of those companies with a high degree of exposure to the EU have outperformed. Of course, it would be hugely ironic if the Brexit-induced collapse in sterling leads to more foreign takeovers, thus weakening the case of  those who thought that this was a chance to revitalise the economy in the interests of the British people.