A flurry of recently announced new deals indicates that the market for mergers and acquisitions is gaining traction. According to market experts, this upward trend should continue. If their assessment is correct, this could benefit stock market investors in the short run, but could cause troubles for the markets long term, according to the author.
April 22 was a day just the way the business-minded investment bankers like it. Promptly after the Easter holidays, several multibillion-dollar deals were announced.
With smiles on their faces, merger and acquisitions experts especially were active in the pharmaceutical sector. Three transactions between Novartis, GlaxoSmithKline and Eli Lilly, valued at several billion dollars each, news about $100 billion takeover talks between Pfizer and Astra-Zeneca, as well as a $45 billion offer from Valeant Pharmaceuticals for the maker of Botox Allergan means the pharma space is the most active and where big money can be made.
Days like these fuel the hope that the downturn for the sector caused by the credit crisis can finally be overcome. Compared to the glory days of the record years 1999 and 2007, there is still plenty of room left to catch up. According to corporate law firm Clifford Change, the worldwide M&A volume in 2013 of $2.22 billion was slightly smaller compared to 2012 and even 43 percent lower compared to 2007.
But activity already picked up in the second half of 2013. As data from Mergermarket shows, the global M&A deal volume grew 33.2 percent to $599.1 billion in the first quarter of 2014, an uptrend that seems to be continuing in the second quarter as the deals announced in April confirm.
In regional terms, the U.S., as usual, was the busiest market, with deals valued at $277.8 billion, soaring 55.9 percent above the level of the year before. But experts not only see just the U.S. as a growing M&A market, but also most other regions worldwide. In Europe, for example, everything seems to be in place for a pick up in deal activity. This view is shared by Société Générale analyst Patrick Jousseaume: “We believe we are at the beginning of this M&A wave which will continue this year and next.”
Similar conclusions are drawn by analyst Dan Scott from Credit Suisse: “We maintain our conviction that activity in mergers and acquisitions will continue to trend higher, as all the main drivers for M&A remain supportive.”
Positive environment for M&A deals
According to Scott, these drivers are corporate cash piles at elevated levels, which is an inefficient capital management in a low interest rate environment. Furthermore, low corporate yields provide an inexpensive form of financing, and CEO confidence levels are rising.
Jousseaume underpins his optimism with other factors, such as a recovering economy, so companies should be more willing to take risks again. Company balance sheets have been rebuilt, thus allowing them to partly finance M&A by debt in a very favorable environment. On top of that, pricing power is under pressure, with the result that companies need to react to and shape the competitive landscape.
The confident M&A market forecast is further backed by the fact that M&A business typically picks up after the stock market reaches new highs, as it has recently in the U.S. “Traditionally M&A gathers pace in the late part of a bull market, like we are in now, since potential buyers then own a lot of cash, and with the help of high stock prices they also have another helpful acquisition currency,” explains Roger Peeters, head of research at Close Brothers Seydler Research.
From the investor’s point of view, an upturn in the M&A business would be desirable – at least if history should repeat itself.
According to the asset manager Amundi, European share prices went up 11 percent on average in the six months after a turnaround in the M&A sector over the past 25 years. This complements figures provided by Richard J. Peterson, director at S&P Capital IQ. As he calculated for the U.S., the S&P 500 Index never went down significantly during 2001 and 2013 in periods of a rising M&A volume, but rather increased 10 percent on average. During the five years in that period with falling M&A activities, the market witnessed heavy losses in three cases.
M&A activity stimulates stock prices
This track record gives hope that the current bull market can be prolonged further. For investors, M&A deals are also interesting, since in most cases the acquirer pays a premium compared to the stock prices valid before the deal announcement.
More recently, stock prices of bidders have not been punished any longer following an offer, but went up instead. As data of Bank of America-Merrill Lynch shows, bidders’ share prices jumped 48.3 percent on a 12-month basis, and those of the potential targets increased by 64 percent on average.
Performance figures like these sound like easy money. Even more so, since another study of BofA-Merrill Lynch indicates a takeover premium of 24 percent for U.S.- arge caps since 1994 and 27.9 percent for U.S. small caps takeover targets.
But as so often happens with the stock market, making money is not as easy as it seems. One problem with mergers and acquisitions is identifying the right companies. And even if the investor picks the correct one, it can sometimes take years until an offer is made for the company one has invested in. During the waiting period, one is exposed to the mood swings of the market, and if prices decline on a wholesale level, takeover candidates will mostly not be able to withstand the downward pressure.
Nevertheless, many market participants are constantly looking out for M&A candidates, and investment banks constantly provide the market with fresh ideas about potential M&A deals. Currently, market experts forecast the most activity in such sectors as telecommunications, technology, media, commodities, biotechnology and pharmaceutical.
Among the firms with a U.S. listing, analysts bet that companies such as these could become involved in one way or the other in future M&A activities: health insurer WellPoint, networking solutions provider Brocade Communications Systems, pharmacy chain Rite Aid, nutritional supplements supplier Nutraceutical International, conglomerate Honeywell, fast-food chain Wendy’s, generic producer Teva, Shire Pharmaceuticals, biotech Celgene, wireless communications towers operator SBA Communications, silicon wafer and solar wafer producer SunEdison, or Royal Gold.
But investment decisions on a company basis should not only be based on M&A hopes or rumors, but also always depend on attractive valuations and a promising chart. To avoid a concentration of risk, it may be wise to make a play on the M&A investment story via M&A baskets such as the M&A TR Index issued by Société Générale, though these products are traded only on European stock exchanges.
In summary, an upturn in M&A activities could promise more gains for stock market investors in the foreseeable future, at least if history is any guide. To put money on the table and bet on this idea makes sense. But in the long run, market participants have to monitor carefully the developments in that area, since history also teaches us that too much M&A euphoria could sound the bell for the last round in the current bull market.