Cheap money is burning holes in CEOs’ pockets.
It would be nice if they took advantage of rock-bottom borrowing costs to invest in factory upgrades or cutting-edge research, but instead they’re buying other companies. We’ve seen almost $1.5 trillion of mergers and acquisitions announced so far this year, according to Dealogic, and October’s $355 billion set a single-month record.
The activity reflects a guarded form of business confidence: Their own businesses may not be going gangbusters, but executives are fairly sure the economy is not on the verge of collapse. That makes them willing to put together risky deals in hopes of delivering the earnings growth shareholders want.
“You could blame the fools like me who like to see growth in earnings and revenue,” says Ken Crawford, a managing director at Argent Capital Management in Clayton. “If they have returns above their cost of capital and if the company has shown an ability to do acquisitions well, then it’s fine with us if they want to do a deal.”
Norm Conley, chief investment officer at JAG Capital Management in Ladue, notes that a lot of deals are being done by growth-challenged companies. AT&T’s acquisition of Time Warner, British American Tobacco’s offer for Reynolds American and TD Ameritrade’s purchase of Scottrade were all driven to some extent by challenges in the buyer’s core business.
“We’re seeing relatively slow economic growth, and there are not a lot of sectors that are hitting on all cylinders,” Conley says.
“When it’s challenging to get top-line growth and the industry is experiencing shrinking margin pressures, you want to figure out how to spread your costs over a broader base.”
Although 2016 probably won’t match last year’s record pace of $2.2 trillion in mergers, it will be the fourth straight year above $1 trillion. And the factors driving deals now will probably continue in 2017.
The economy is expected to keep growing, but not by a lot. Companies still have plenty of cash, and financing will remain cheap, even if the Federal Reserve raises interest rates a bit.
“Even if rates go up in December, it just goes from cheap to a little less cheap,” says Richard Peterson, senior director at S&P Global Market Intelligence.
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The next president’s priorities could either accelerate or shut down the merger boom. Donald Trump’s proposed tax holiday on repatriated foreign cash, Peterson notes, would give companies another way to pay for acquisitions.
On the other hand, Conley says, “the most likely stopper would be even more aggressive action by the antitrust regulators.” Trump has said he would block the AT&T-Time Warner deal, and Hillary Clinton has talked of the need to strengthen antitrust enforcement.
Historically, though, dealmakers are their own worst enemies. Previous peaks of activity in 2000 and 2007 were followed by recessions, and numerous studies have found that a majority of acquisitions end up destroying value.
So, should we worry? Peterson offers two contradictory data points.
The stock market has risen an average of 9 percent in the year following each of history’s 10 biggest mergers, a list that now includes AT&T-Time Warner.
However, after the 10 busiest months for merger activity, the market has fallen more often than it has risen. After a record-setting October, that should make investors at least a little uncomfortable.
David Nicklaus • 314-340-8213
@dnickbiz on Twitter
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