Whatever occurs will be pale echo of heyday
This column goes to press early, so it is written without knowledge of whether we are upon another “Merger Monday”. Deals are always most likely to be announced on Mondays as this allows executives, boards and lawyers to thrash out details over the weekend. But it seems a safe prediction that whatever deals this Monday brings, it will be a pale echo of the “Merger Mondays” that enlivened the corporate sector throughout the late 1990s.
Raw figures on deal volumes brook little argument. In January, mergers and acquisitions activity in the US was up impressively compared with the first month of 2012 – trebling from $46bn to $153bn, according to Thomson Reuters. This shows a return of animal spirits but it is tiny compared with January 2000, when deals worth $279bn were announced.
This is also not the peak January deal volume for the post-crisis era, as more money was transacted in the US in January 2011. After that, confidence dissipated as US politics grew uglier.
Globally, the picture is similar, although the rise in Asian dealmaking over the past decade compensates for weakness in Europe. According to S&P Capital IQ, global M&A for January clocked in at $355bn, more than double January 2013 ($155.6bn) but still short of the high watermark of 2000 ($431bn).
At one level, this could be good news. The first “Merger Monday” of 2000 brought news that AOL was buying TimeWarner for $153bn, in a disastrous deal that many consider the worst of all time. Heavy deal volume indicates that executives are growing overconfident and wasting their shareholders’ money, so it may be good that they are now more cautious. The volumes of the late 1990s were in many ways a symptom of a historic bubble. Nobody should want to see them repeated.
But at another level, it should be a cause for concern. Deal volume tends to be a function of the price of debt (still very cheap), and the cost of the acquirers’ equity. The higher the multiple at which a company is trading, the more likely it is to attempt mergers funded with stock – even if its target is also overpriced.
After 2013’s rise in the S&P 500, driven mostly by higher multiples, companies can do deals more cheaply than in many years. Why are they not doing so?
A positive answer may be that they have learnt the lesson of the 1990s and are not doing deals that will not boost their share price. Note that last year’s deals were generally greeted by the market as positive moves by the acquirers. According to Dealogic, acquirers’ stock rose, by an average of 4 per cent, on the days they announced takeovers. The figures are for deals of $1bn or more, and by far the most positive response to deals on record. From 1996 to 2011, acquirers’ stock on average fell on the day they announced deals every year. So executives are growing more sensible.
Another reason is that executives, like everyone else, remain unconvinced by the economic recovery and fear that asset prices have only been rising because of the intervention of the Federal Reserve. The choppy markets of January will not have made them any more confident.
They may also think that there are better ways to boost their return on equity than buying other companies. The latest Deloitte survey of chief financial officers of large UK companies found greater confidence and a desire to expand. But only 23 per cent named acquisitions as a priority. It lagged behind cost-cutting, improving cash flow, and introducing new products or expanding into new markets.
Why might CFOs put dealmaking so low on their list of priorities? We may be bumping up against the limits of M&A. In this environment, nationalism can thwart cross-border deals, as evidenced by various failed attempts to merge rival securities exchanges in the last few years, or by Canada’s decision to block BHP’s proposed $39bn acquisition of PotashCorp in 2010.
Companies also face more active competition authorities. Megamergers on the scale seen in banking during the 1990s are unlikely to return, on competition grounds, and also because regulators think that the financial system would be safer if banks grew smaller, not larger.
Several industrial sectors have also reshuffled themselves as far as the competition authorities will allow. Persistently high profit margins might well show that dealmaking has brought down capacity and reduced competition. To go any further would be to go too far.
Developments such as the high cost in airport slots that the US Department of Justice demanded before permitting the merger of AMR and US Airways last month indicate that big strategic mergers are harder to do than before.
Dealmaking is coming back. This is healthy, as it shows returning confidence. But it is hard to imagine that it will ever be at the levels seen in the 1990s, at least in the US and Europe. That is also healthy.