Defensive all-share mergers: desperate measures
All-stock deals this year almost resembled a scarlet letter
Corporate debt was ultra-cheap in 2020. Nobody understood that better than shareholders of companies for sale. Despite an exuberant stock market, few elected to sell themselves for stock alone. Buyers could not borrow for free to pay cash for target companies. It just felt like it. The average investment-grade triple B bond yield was only 2.1 per cent by late December. All-stock deals almost resembled a scarlet letter, signalling that the buyer and seller were distressed, or at least desperate.
US independent oil drillers finally decided to consolidate to survive in the second half of the year. From July, four oil companies — Noble Energy, WPX Energy, Concho Resources and Parsley Energy — sold themselves to rivals who paid with shares. Premiums were absent, with cost savings the prize. A November rally in commodity prices made these combinations look smart. Even so, shares in WPX acquirer Devon Energy remain at half the levels they were in early 2020. Joining forces is still the best chance for survival in the shale fields.
Food delivery is supposed to be a growth industry but the profits have been scant so far. A perpetual price war spurred consolidation this year. Uber, after failing to strike a deal for Grubhub, paid $2.7bn in shares for Postmates. Grubhub shareholders decided instead to take a $7.3bn offer from Europe’s Just Eat. For an ostensibly nascent industry, taking shares may not be such a bad outcome, giving selling investors upside exposure.
How compelling is cheap debt? Imagine a company could borrow at a 3 per cent coupon — a veritable high yield these days. On an after-tax basis, the cost of debt is just above 2 per cent. The reciprocal of that figure, 40 to 50 times, is the price-to-earnings ratio that a company’s stock would have to trade at in order for its shares to be competitive with a cash bid. Until interest rates normalise, sellers will know that they can demand to be paid a premium in upfront cash.