Five reasons why the M&A boom is all hype
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Associate Editor
David Stevenson Aug 26, 2010
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Yesterday, the economic backdrop got even scarier. Some truly awful figures emerged from the States. Core durable goods orders collapsed. Maybe even worse, US new home sales plunged in July to a new record low. No wonder stock markets on both sides of the Atlantic took it all quite badly, even if they later recovered.
Some bulls will tell you, though, that there's still a good reason to be keen on shares right now. A major takeover boom could be on the way. And that, those optimists will tell you, is good news for stocks.
But here's why you shouldn't believe the M&A hype.
M&A is suddenly back in fashion
Back in 2007, you'll probably recall, the US housing market was where the financial crisis really started.
Now that market looks like it's on the brink of a repeat performance. In addition, America's economy is busy double dipping. In turn, that's bound to hit the rest of the world. And stock markets have clearly got the jitters about it.
But this time, say the bulls, we shouldn't fret. In fact, they say, we should look forward to the next big M&A (merger and acquisition) boom to push stock prices back up again.
So how on earth can this be happening? The key is a mix of "near-zero percent central bank interest rates and the biggest wave of firings since WWII", says Alexis Xydias at Bloomberg. That's allowed firms to borrow much more cheaply than before and stack up cash by cutting costs. "Never before have US companies piled up cash faster compared with interest costs than they are now", says Xydias.
It all adds up to $1.8trn sitting on US corporate balance sheets alone at end-March, says the Federal Reserve. That's up 26% on the year before. And this cash pile is likely to grow further, say Credit Suisse and Bloomberg, to the highest level relative to those businesses' stock market valuations in at least two decades.
What's more, the money is already burning a hole in the pockets of some companies. This year has already seen almost $500bn of corporate takeover activity in the US. It's been a similar story in Europe, where the past month has been the busiest since October 2008 with $162bn-worth of deals, including BHP Billiton's $39bn crack at Potash Corp.
And with over $700bn of cash sitting on their balance sheets, according to William Wright at MarketWatch, European companies still "have the means to do deals".
Surely this should shore up stock markets despite the current worries?
Five reasons stock markets won't surge
Don't bet on it. Sure, more money around supporting bid talk is bound to push up the share prices of some 'target' companies.
But there are five reasons why the bulls could be getting too excited about a new M&A boom.
First, the consulting firm McKinsey has just produced a report about takeover opportunities. But it warns company predators not to lose their discipline and buy up any old rubbish. If they heed that advice, there won't be the free-for-all we saw in the last M&A boom.
Second, while takeover talk can push up the market worth of targets, the flip side is that it can depress the price of bidders. So apart from during the hype period when a deal is actually being done, there's no guarantee that any real long-term 'added value' will be created by merging two businesses.
Third, balance sheets may well not be as strong as the bulls reckon. As Peter Boockvar at Miller Tabak points out, US corporations may have lots of cash but they've also got plenty of borrowings as well.
In truth, "corporate USA's balance sheets are in bad shape", said the FT's Lex column last month, with a record $7.2 trillion of debt. In other words, American companies overall have four times as much debt as cash. That's hardly the ideal start point for a major acquisition spree.
Fourth, many firms "may well want to sit on their cash piles", says the Economist. That's particularly likely as the economy heads for a double dip. At such times it's always handy to keep some spare cash around. Again, this means less chance of a takeover boom.
Fifth, even if there were a major pick up in M&A activity, history shows this would tend to follow a big market move rather than start one off. Have a look at this chart.
Source: Bloomberg
Here the MSCI World index – global share prices, in red – has been plotted against the global value of M&A transactions, in purple. I've smoothed the latter by using the 20-day moving average of daily deals. And while this still jags around, one trend is very clear.
Not only do spikes in M&A deals often follow major upward market moves, they're also a regular harbinger of an overall share pullback. That's because much of the big price action has already taken place.
What's my conclusion? Don't be fooled that a takeover boom could kick start the stock market in the face of its other problems. And don't buy stocks just because someone says they might be bid targets.
What you should do next
Our advice remains the same: you'll make the most money over time by buying shares when they're cheap, not when they're being hyped up on the likes of bid talk.
And in Friday's MoneyWeek magazine, our Round Table experts have spotlighted 13 shares they reckon fit the bill. If you're a subscriber, don't miss it. And if you're not already a subscriber, get your first three copies free here.
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A lack of credit is still strangling Western economies. But that's not the case in emerging markets. And that means now could prove a good time to diversify into them, says Saelensminde. Here, he tips the cheapest way to do it.
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