The rise of the mega-merger

“This time next year, there will be plans in place for eight organisations of 100,000 homes or more.” This is the confident prediction of one housing expert as more and more housing associations look at ‘mega-mergers’ to create giant organisations of unprecedented scale.

Last week’s announcement of a 135,000-home mega-merger involving L&Q, Hyde Group and East Thames could just be the tip of the iceberg. Affinity Sutton and Circle continue to prepare their 127,000-home merger, while rumours abound of at least two more large mergers on the horizon.

Whereas many mergers in the past have involved larger players swallowing up smaller organisations, these latest mergers involve two giants coming together to create organisations, which in development terms could give the volume house builders a run for their money.

So why is this happening, and what are the benefits and risks?

The obvious answer as to why is government policy and rhetoric. An Inside Housing survey of 135 association chief executives in September revealed a third believe their organisations were likely to consider a merger in response to the 1% annual rent cut.

Ministers have also been critical of associations’ housebuilding record and efficiency. The National Housing Federation’s merger code has been widely interpreted as an attempt to demonstrate to the government that the sector is open to mergers. The code asks associations to “give serious consideration to merger opportunities and other partnerships or delivery models”.

Building boost

In terms of the benefits, the potential for building more homes is what the landlords which have already announced mega-mergers are shouting most loudly about. L&Q, Hyde and East Thames reckon they can build 100,000 homes over 10 years, putting them among the top five for-profit house builders in development terms. Affinity Sutton and Circle have said their planned merger could allow them to build 20,000 homes over five years.

Combining surpluses boosts borrowing capacity and can also lead to being able to service more debt. It is no coincidence that Inside Housing research last August showed the vast majority of the sector’s largest developers are also in the top 30 list of those with the biggest surpluses.

Steve Douglas, partner at Altair, says that mega-associations will also have the scale to more easily take repairs in-house, or be in a stronger position to negotiate terms with suppliers, for whom a contract with a 100,000-home-plus organisation could be quite prestigious. Similarly, the reputation of a large builder could make it easier to attract top talent to management positions.

Larger organisations are more likely to have the scale to innovate. Mr Douglas uses the example of IT and said joining IT services together can aid greater digitalisation to improve services. “You need scale and capacity in order to research and develop,” he argues.

Reducing duplication and purchasing services across larger merged groups can lead to cheaper costs, but the subject has been the topic of academic debate, with some studies questioning if this is really the case.

This all sounds too good to be true, but there are also plenty of risks with creating a mega-merger. One is that the cost, time and effort of combining organisations outweighs the benefits.

James Tickell, partner at consultancy Campbell Tickell, said: “The opportunity cost will be very significant - the staff and board time, integrating systems, finance and pension matters, and dealing with all the practicalities.”

While everybody talks about economies of scale, organisations also need to be wary of ‘diseconomies of scale’, ie extra costs to manage the large structure. In addition to the costs, Mr Tickell says organisations need “determined and skilled leadership” to ensure they are not too distracted from their core business. Part of this distraction could also be dealing with strained industrial relations if unions oppose changes to workers’ terms and conditions.

Another risk of the mega-merger is a loss of local focus. Organisations that are merging are typically keen to stress that this won’t be the case. The CEOs of Hyde, L&Q and East Thames told Inside Housing last week that they will keep local offices and insisted the new structure will free up staff to spend more time in the community.

However, Sinéad Butters, chair of Placeshapers, says: “Locally our experience has seen the loss of local capacity, energy and commitment to troubled areas as smaller organisations have been swallowed by the larger ones.” Whether this applies to two or more larger organisations merging (as opposed to a large taking over a small) remains to be seen. She does stress that not all mergers have led to these negative outcomes and says she “loves impact, scale and doing more and more”.

While local focus might be impacted, a major concern for boards thinking of embarking on a mega-merger is to ensure that proper due diligence is carried out. It is particularly important that associations understand the financial liabilities of their merger partner. The near collapse of Cosmopolitan Housing Group in 2013 was caused partly because Chester & District Housing Trust did not realise the liabilities that were attached to merger partner Cosmopolian’s student leases.

The Homes and Communities Agency’s requirement on landlords to maintain up-to-date asset and liabilities registers is intended to combat this problem, by providing clear information to potential merger partners.

In reality, the pros and cons we have outlined here either apply to more traditional takeovers of small providers by large providers, or have been seen in other sectors. The fact of the matter is nobody knows how successful this new generation of huge organisations will be, but one thing is for sure, there will be more and more of them in the future.